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ESOP Repurchase Obligation Insights

Redeeming vs. Recirculating ESOP Shares, Part One

Judith Kornfeld

August 1998

(Judith Kornfeld)One of the most interesting issues in employee stock ownership plan (ESOP) repurchase obligation planning and funding is whether shares should be recirculated in the ESOP or redeemed by the corporation. Over the years, I have heard many ESOP companies express the view that recirculating stock is undesirable because the cost is higher, i.e., you keep repurchasing the same shares over and over again. But the analyses I have done for clients have led me to conclude that this is not necessarily true. Furthermore, there are many other issues besides cost that need to be considered. Part One of this article will consider the mechanics of redeeming vs. recirculating ESOP stock and some of the non-cost issues. Part Two (appearing next month) will explore the potential effect on the value of the company's stock and the implications for the comparative costs.

First, let's review the mechanics of handling repurchase obligations through redemptions.

When stock is recirculated, the mechanics are as follows:

Some of the implications of redeeming versus recirculating are obvious:

Recirculating stock in the ESOP may raise fiduciary issues, because the trustee who is using cash balances from the plan to repurchase shares is actually making a decision to purchase the stock. The trustee must act in the best interests of plan participants and cannot be obligated to repurchase shares, so if there are reasons that a purchase of company stock might be inappropriate, the trustee may decide not to use cash from the plan to provide liquidity for distributions. This issue is mostly of concern where the company has made ongoing contributions to the ESOP in excess of current liquidity needs to accumulate cash for future repurchases. The fiduciary issues can be avoided if the trustee distributes stock and the company redeems it. Where the company does not want to make contributions to the ESOP in excess of current liquidity needs to create a "sinking fund" in the ESOP for future repurchases, the company can redeem shares and then recontribute them to the ESOP.

In Part Two of this article, we'll explore the relative cost of redeeming vs. recirculating stock and challenge the common wisdom that redeeming will necessarily result in lower long-term repurchase obligation costs.

Author biography and other columns in this series

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