Is There a Link Between ESOPs and Better Company Performance
Due to lack of strong research or survey data, descriptions of the benefits of ESOPs have been largely based on case-by-case results or anecdotes. Part of the challenge is that management studies most often focus on publicly traded firms, while many ESOP organizations are privately held. Another is that private organizations are not required to disclose the same kinds of financial or performance information as do publicly traded companies.
The research base, however, is growing. This may be due to the increasing number of American employees with ownership rights, or an interest in the intriguing ESOP dynamic of workers sharing in the wealth they themselves help to create.
ESOP definition and history
An ESOP operates through a trust that is funded by the company’s tax-deductible contributions to purchase company stock. The contributions are distributed to employees based on plan-specific criteria, making employees owners of stock in the company for which they work. ESOPs are unique employee benefits because they are required to invest primarily in the securities of the sponsoring employer, and can be very effective vehicles for transitioning company ownership from key shareholders, for raising capital, and for creating organizations that enjoy the benefits of an ownership culture.
Attorney and investment banker Louis Kelso’s vision in conceiving the employee stock ownership plan in the 1950s was a stronger capitalist system resulting from all workers benefiting from company ownership. This concept captured the attention of legislators in the early 1970s; they argued that the benefits of facilitating broad-based ownership included reducing disparities in wealth, easing workplace tensions and increasing corporate performance.
The number of ESOPs has ebbed and flowed, according to Form 5500 reporting. There were approximately 9,200 plans in 1993, declining to 7,700 in 2000 and climbing again to 9,700 in 2006. The dire fates of some public ESOP firms, which had to deal with legislative changes in the 1980s and the more recent front-page disasters of Enron and WorldCom, are rare. The most common reason for ESOP termination is that the stock transfer transaction was completed.
Thriving or surviving?
The developing research suggests that employee-owned firms are profitable, productive and display better shareholder value. As these firms are thriving, and not just surviving, it is interesting to compare their growth and performance with that of traditional organizations.
Joseph Blasi and Douglas Kruse of Rutgers University began a groundbreaking study in 1988. These trailblazing researchers tracked privately held companies of the same size and industry until 1999. Of the 1,176 private ESOP organizations in the study group in 1988, almost 70 percent survived, as compared with approximately 55 percent of non-ESOP firms of the same size and in the same industries.
In 2000, these researchers studied all ESOP plans set up between 1988 and 1994 for which data was available. They reviewed sales, employment and sales per employee, and found that ESOP companies grew 2.3 percent to 2.4 percent faster than expected. They reported in 2003 that although a statistically valid link could not be established between the employee ownership and enhanced business results, employee ownership tends to match or exceed, on average, the performance of similar firms, perhaps by as much as 5 percent.
Survey results from 2006 corroborate the positive outcomes of ownership. According to the 15th Annual ESOP Economic Performance Survey, which reported the responses of 426 members of the ESOP Association:
91 percent said that creating employee ownership via an ESOP was a "good business decision that has helped the company."
72 percent said that their organization outperformed three major stock indexes—the Dow Jones industrial average, the Nasdaq composite and the S&P 500.
Only 9 percent said the company fared worse than all three major indexes.
68 percent said that the ESOP improved overall employee productivity.
54 percent said the organization had created an employee participation program after establishing the ESOP.
Participative management may be key
A key factor in ESOP organization success seems to be participative management.
In a 1987 study, the National Center for Employee Ownership, a nonprofit organization, analyzed 270 companies and found that those who combined employee ownership with participative management grew 8 percent to 11 percent faster annually than otherwise expected. This relationship was corroborated by later studies by the U.S. General Accounting Office (now called the Government Accountability Office), which noted that increased productivity was achieved only with higher levels of worker influence or increased voting rights.
Interestingly, research shows that higher worker satisfaction resulted when workers perceived participation and influence, or were simply provided opportunities to participate in decision-making. Satisfaction was not linked to ownership stake, or to the value of an ESOP account.
The relationship between ownership and participation is easy to understand—the element of ownership provides long-term perspective and incentive. Participation helps to empower workers to various degrees, and to support answers to the question "Why do I care?" by providing an avenue for shaping their futures and the future of their firm. In the best cases, it erodes or blurs any worker perception of leadership as "them" versus employees as "us," and begins to build an ownership community.
Moving from a traditional hierarchal leadership model to an open-book management program for managing financial results is a significant cultural and practical change. Participative management requires:
Articulating a clear and compelling mission and vision.
Creating a vehicle for communication among all levels and areas of the organization.
Providing simple tools for employees to improve their work and affect the bottom line.
Crucial to success is training employees to connect the dots in the relationships between the impact of their day-to-day tasks to whatever key metrics are established, such as scrap rate or cost of sales, and how that in turn affects expense and firm profits.
Is it right for your organization?
Evidence shows a causal relationship between ESOP implementation and favorable business results over like firms or expectations. It could be argued that participative management warrants attention not simply for the benefits accruing to employees, but for the possible dramatic returns on investment achieved through ownership and participation synergy. Studies to date provide an interesting view into this dynamic, and it is our hope that ESOP research continues to generate information and ideas for our education, consideration or action.
The start of a new year is a good time to review business and human capital objectives as they relate to your organization’s strategy for aligning business needs with human capital needs. If you have not already, it may be time to consider whether an ESOP supports your organization’s business objectives.