Employee Ownership and Corporate Performance
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Email this pageOver the years, the NCEO has reported on new research on employee ownership and corporate performance. Now that a substantial body of work exists on the subject, we thought it would make sense to summarize it in one place. The research comes to a very definite conclusion: the combination of ownership and participative management is a powerful competitive tool. Neither ownership nor participation alone, however, accomplishes very much.The findings apply mostly to ESOP companies. As of yet, little work has been done on the impact of broad-based stock option plans on corporate performance. The findings also seem to apply primarily to closely held companies. Research indicates that public companies generally do not view employee ownership as much more than another corporate benefit. For this and other reasons explored below, the relationship between employee ownership and corporate performance in public companies is ambiguous.
The 2000 Rutgers Study
In the largest and most significant study to date of the performance of ESOPs in closely held companies, in 2000 Douglas Kruse and Joseph Blasi of Rutgers University found that ESOPs increase sales, employment, and sales/employee by about 2.3% to 2.4% per year over what would have been expected absent an ESOP. ESOP companies are also somewhat more likely to still be in business several years later. This is despite (or perhaps because of) the fact that ESOP companies are substantially more likely than comparable companies to offer other retirement benefit plans along with their ESOP.Kruse and Blasi obtained files from Dun and Bradstreet on ESOP companies that had adopted plans between 1988 and 1994. They then matched these companies to non-ESOP companies that were comparable in size, industry, and region. They then looked for which of these companies had sales and employment data available for a period three years before the plan's start and three years after. The sales and employment growth data were then compared for each year for each paired company. They also checked the companies' filings with the Department of Labor to determine which of the companies had other retirement-oriented benefit plans. Finally, they looked to see what percentage of the companies remained in business in the 1995 through 1997 period.
The process yielded 343 ESOP companies and 343 pairs for the overall sample. However, missing data meant that employment data were available only for 254 ESOP companies and 234 pairs, 138 ESOP companies and 77 pairs for sales, and 115 ESOP companies and 65 pairs for sales/employee (some pair companies could be used for more than one ESOP company).
The results showed that ESOP companies perform better in the post-ESOP period than their pre-ESOP performance would have predicted. The table below shows the difference in the pre-ESOP to post-ESOP period for ESOP companies on sales growth, employment growth, and growth in sales per employee:
| Difference in Post-ESOP to Pre-ESOP Performance | |
|---|---|
| Annual sales growth | +2.4% |
| Annual employment growth | +2.3% |
| Annual growth in sales per employee | +2.3% |
The 1986 NCEO Study
The first study to show a specific causal linkage between employee ownership and corporate performance was by Michael Quarrey and Corey Rosen of the NCEO. The study looked at the performance of employee ownership companies for five years before and after they set up their employee stock ownership plans (ESOPs). It indexed out market effects by looking at how well employee ownership companies did relative to competitors in the pre- and post-ESOP periods, then subtracted the difference. For example, if a company were growing 3% per year faster than its competitors in the pre-ESOP period, and 6% per year faster in the post-ESOP period, there would be a +3.0% difference attributable to the ESOP, other things being equal.The study found that ESOP companies had sales growth rates 3.4% per year higher and employment growth rates 3.8% per year higher in the post-ESOP period than would have been expected based on pre-ESOP performance. When the companies were divided into three groups based on how participatively managed they were, however, only the most participative companies showed a gain. These companies grew 8% to 11% per year faster than they would have been expected to grow, while the middle group did about the same, and the bottom group showed a decline in performance.
Participation alone, however, is not enough to improve performance. A large number of studies show that the impact of participation absent ownership is short-lived or ambiguous. Ownership seems to provide the cultural glue to keep participation going.
The New York and Washington Studies
Economist Gorm Winther and colleagues in New York and Washington State followed up the NCEO study, using the same research design but different samples, one of 25 employee ownership firms in New York State and one of 28 employee ownership companies in Washington State. In both studies, employee ownership per se had little or no impact on corporate performance, but a substantial impact when combined with participative management. In Washington, companies that combined ownership and participation grew in employment 10.9% per year more than would have been expected. Sales grew 6% per year more. The New York results used correlations and cannot be compared directly, but the results were in the same direction. In Washington, majority employee-owned firms that were participatively managed did even better.The Washington study also found that the synergistic effect of ownership and participation was not diminished even when the control group companies had no employee ownership, but had profit sharing and participation programs.
The Brent Kramer Study
A 2007 study of 328 majority ESOP-owned members of the ESOP Association by Brent Kramer found that these companies have sales per employee that are 8.8% greater than comparable non-ESOP companies. 100% ESOP owned companies did better than those that were over 50% but not 100%. Smaller companies and companies with greater ESOP account value per employee also did better. Employee influence on new products, work design, and marketing all were also strongly related to performance outcomes.The study does not demonstrate that having an ESOP per se causes these performance benefits: its design cannot preclude the possibility that better performing companies are more likely to have ESOPs in the first place (although prior research using before-and-after data, indexed for competition, do indicate a casual effect). The correlates of performance, however, are less subject to this chicken-and-egg problem and provide useful insight into what makes an ESOP work.
Kramer's study, "Employee Ownership and Participation Effects on Firm Outcomes," was his doctoral thesis for the City University of New York.
The GAO Study
In 1987, the U.S. General Accounting Office (GAO) did a before and after study using a similar methodology, but covering 110 firms and focusing on productivity and profitability. The measures the GAO used were controversial because they assumed that employee ownership firms did not increase overall compensation when they set up an ESOP. In fact, it appears that about half of all ESOP companies do increase compensation, and few decrease it. The GAO results are probably too conservative because of this assumption.The GAO study found that ESOPs had no impact on profits, but that participatively managed employee ownership firms increased their productivity growth rate by 52% per year. In other words, if a company's productivity growth rate were 3.0% per year, it would be 4.5% after an ESOP.
The Impact of ESOPs on Employee Compensation
One reaction to the above findings might be that employee ownership companies do better because they substitute stock for wages or benefits. A 1998 study by Peter Kardas and Jim Keogh of the Washington Department of Community, Trade, and Economic Development, and Adria Scharf of the University of Washington, Wealth and Income Consequences of Employee Ownership, shows that, in fact, employees are significantly better compensated in ESOP companies than are employees in comparable non-ESOP companies. Using 1995 employment and wage data from the Washington State Employment Security Department, and 1995 data on retirement benefits from a survey of companies and from federal income tax form 5500, the study matched up 102 ESOP companies with 499 comparison companies in terms of industrial classification and employment size. In terms of wages, the median hourly wage in the ESOP firms was 5% to 12% higher than the median hourly wage in the comparison companies, depending on the wage level of those being compared. The study found the average value of all retirement benefits in ESOP companies was equal to $32,213, with an average value in the comparison companies of about $12,735. Looking only at retirement plan assets other than ESOPs, the ESOP companies had an average value of $7,952, compared to $12,735 for non-ESOP companies. Given that the typical ESOP is actually about 20% invested in diversified assets other than company stock, employees in ESOP companies would have had about as much in diversified assets as employees would have in all assets in non-ESOP companies. In ESOP companies, the average corporate contribution per employee per year was between 9.6% and 10.8% of pay per year, depending on how it is measured. In non-ESOP companies, it was between 2.8% and 3.0%. ESOPs also have a positive impact on pay in public companies, as shown by the Page and Ouimet study below.ESOPs and Stock Prices in Closely Held Companies
ESOP Companies Show Strong Five-Year Stock Growth
A 2009 survey on ESOP executive compensation shows that responding companies had impressive stock price growth between 2003 and 2008:| Share price increase 20% or more | 23% |
| Share price increase 10-19% | 31% |
| 0% to 10% increase | 34% |
| Decrease | 12% |
| Total responding | 310 |
Also, this sample, while representative of ESOPs in terms of size, industry, etc., is not a random sample—it is companies willing to answer the survey. Even with all these caveats, however, this performance is very impressive.
Public Companies and Employee Ownership
The data for public companies are much more ambiguous. In "Employee Capitalism or Corporate Socialism? Broad-Based Employee Stock Ownership" (October 28, 2008), E. Han Kim of the University of Michigan and Page Ouimet of the University of North Carolina, Chapel Hill, found that ESOPs owning less than 5% of company shares have a small but positive 0.8% effect on total compensation, while in companies in which the ESOP owns more than 5%, total compensation is 5.2% higher. The more leverage associated with the ESOP, the lower the increase in employee compensation, perhaps because companies exercise restraint on total compensation in the face of greater debt. By contrast, the subsample of companies in which the ESOP was established in conjunction with declining sales had lower total compensation (2.8% for small ESOPs and 6.3% for large ESOPs).The effect on value (measured by Tobin's Q, a ratio of the company's stock value to its book equity value) followed a similar pattern. Overall, ESOPs led to an 8.12% increase in company valuation relative to the industry median. Companies with ESOPs with less than 5% ownership showed a valuation increase of 16% relative to the industry median; companies with larger ESOPs showed neither an increase nor a decrease. The impact of company value is positively correlated with greater leverage, perhaps because companies are keeping overall compensation costs more neutral.
To conduct their study, Kim and Oiumet studied public companies with ESOPs between 1980 and 2004 for which they could determine an adoption date and for which there were sufficient before-and-after data to conduct analysis over a significant time period. They found 756 public ESOPs during this time but had the needed data for only 418 of those. For the first time in ESOP studies, the researchers used the Standard Statistical Establishment List of the Bureau of the Census. The list provides detailed data on all forms of compensation, including ages, benefits, leave policy, severance pay, etc. From this, the researchers computed a measure of total compensation and benefits. These data were then paired with Compustat data on company performance. They analyzed performance for 5 years before and 10 years after the ESOP was set up, excluding the year of adoption, with a shorter time line for some of the sample companies for a minority of the companies.
A 2006 study by Robert Stretcher, Steve Henry, and Joseph Kavanaugh (the study was in submission as of this writing) looked at 196 publicly traded U.S. ESOP companies during the years 1998 through 2004. Each ESOP company was matched to a comparable non-ESOP company. The ESOP companies had returns on assets that were higher than the matched non-ESOP companies in all seven years, net profit margins that were higher in all of the five years where comparable data were available, and better operating cash flows in three of the five years where data were available. All of these findings were statistically significant (not likely to have occurred at random). ESOPs outperformed matched companies in all seven years on net cash flow to sales, in six of seven years for market to book ratio, and four of the seven for return on equity. They grew more slowly in sales and employment, but the results were only statistically significant in some years. The ESOP firms also generally did better on operating cash flow to sales and operating cash flow to employees ratios, but the results were not statistically significant.
The differences in the overall sample comparisons on key measures was substantial, with ESOP companies showing a 3.8% return on assets compared to a negative 2.72% for the matched companies. On return on equity, the ESOP companies averaged 14.3% per year, compared to 7.2% per year for non-ESOP companies. Sales and employment growth rates present a more confusing pattern, with many years not statistically reliable or appearing to have outlier results that skewed the means. Generally, however, ESOP companies grew less than half as fast as matched non-ESOP companies.
The authors note that net income is better for ESOP companies as well, although they put less emphasis on this measure because net income is determined in part by accounting practices and tax effects. Operating cash flow, they argue, presents a better picture. When operating cash flow to sales ratios are computed, ESOP companies do about the same as non-ESOP companies, but when operating cash flows to assets ratios are examined, ESOP companies do better, suggesting strongly that ESOP companies get a better return on each dollar invested because employee behaviors change.
A 1999 study by Hamid Mehran of Northwestern University for Hewitt Associates found that ESOPs in 382 publicly-traded companies increased the return on assets (ROA) 2.7% over what would otherwise have been expected. The study looked at the companies' financial returns for two years prior to the plan's implementation and four years after. Each company was compared to industry norm ROA figures for both periods. Mehran also found that for the 303 ESOP companies surviving the entire four year post-ESOP study period, ROA was 14% higher than the comparison group scores, while for the 382 companies as a group, ROA was 6.9% higher for the four-year period. Over 60% of the companies experienced an increase in their stock price in the two-day period following public announcement of the ESOP, with the average increase for all companies at 1.6%. This suggests that the stock market now reacts positively to ESOPs, a change from the pattern in the 1980s when ESOP announcements were often seen as an indicator that a company was trying to prevent a hostile takeover.
A different result was found in a study by Olubunmi Faleye, Vikas Mehrotra, and Randall Morck of 225 public companies with broad-employee ownership of 5% or more of a company's stock (When Labor Has a Voice in Corporate Governance, National Bureau of Economic Research Working Paper (No. 11254). The authors concluded that productivity, Tobin's Q (a ratio of the market value of a firm's securities to the replacement costs of its tangible assets), long-term investment, operating risk, and growth were all worse in employee ownership companies than public companies in general. The study looked at 100 ESOPs and 115 companies with other plans; plans had to be in place for at least five years prior to 1995. Data were gathered for 1995 through 2001. The authors do not control for this variable, although we know that the airline, steel, and banking industries are heavily overrepresented among public company employee ownership plans during the study period.
In 1992, Douglas Kruse and Joseph Blasi of Rutgers University, and Michael Conte of the University of Baltimore, created an "Employee Ownership Index" (EOI). The EOI tracked the average percentage increase in stock price of all publicly traded companies with a public record of 10% or more employee ownership and more than $50 million in market value. The EOI was subsequently maintained for some time by American Capital Strategies, an investment bank based in Bethesda, MD, and was published quarterly in the NCEO's Journal of Employee Ownership Law and Finance. The EOI grew 193% from 1992 through 1997, while the Dow was up 145% and the S&P 500 140%. The authors did not attribute any causal relationship to these numbers, however.
Other studies look at before and after results, with mixed conclusions. Donald Collat, in a 1995 study, found that public companies that did not set up their ESOPs in response to a takeover threat saw their operating margins improve 2.1% per year compared to their pre-ESOP performance. The study looked at companies for three years before and after the ESOP, indexing for market effects. Takeover threat ESOPs, however, saw a decline of 3.3%. In a 1996 study, Mary Ducy, Zahid Igbal, and Aige Akhigbe found that ESOP companies show a decline in operating cash flow of .2% to 2.1% in post-ESOP performance, also using a three years before, three years after measure, and again indexing for market effects. While these are the most thorough of several studies on public company ESOPs, others come to a similarly mixed conclusion.
Finally, a 1998 study by Margaret Blair, Douglas Kruse, and Joseph Blasi found that companies that are publicly traded and at least 20% or more owned by an ESOP are more organizationally stable than comparable non-ESOP companies. Looking at companies between 1983 and 1996, the study found that 74.1% of the ESOP companies remained as independent operations while only 37.8% of the comparison companies did (these figures changed to 59.3% and 51.1% for the period 1983 through 1997, however). None of the ESOP companies went bankrupt, but 25% of the comparison companies did.
These mixed results are probably explained by three factors. First, a 1997 NCEO study found that public companies generally seem to view employee ownership solely as a benefit plan, not part of an explicit organizational culture, as many closely held companies do. Second, ESOPs in public companies tend to own a much smaller percentage of company stock than ESOPs in closely held companies. Some studies have indicated this is a factor in how effective ESOPs are. Finally, in many cases, public company ESOPs simply replaced existing plans where the company contributed company stock to a 401(k) plan. Now the company used an ESOP to make this contribution instead. Hence, the "before" was really not much different from the "after," so not much could be expected to change.
Several other studies are suggestive but not as able to show causal relationships as these four. A 1990 study by the Michigan Center for Employee Ownership and Gainsharing and Michigan State University asked executives to indicate if employee ownership had had an impact on sales, profits, productivity and other measures. The results were very positive. They were the most positive, however, in companies that scored high on participative management measures. Majority employee owned companies also did better. In addition, the study found that the incidence of employee participation programs, such as work teams and advisory councils, increased 50% to 100% after an employee ownership plan was set up.
Broadly Granted Stock Options and Corporate Performance
To date, there have been few assessments of the impact of broad-based stock option plans on corporate performance. The first thorough study was done in 2000 by Douglas Kruse, Joseph Blasi, and Jim Sesil of Rutgers University, and Maya Krumova of the New York Institute of Technology, using data provided by the NCEO. The study was published in our book Stock Options, Corporate Performance, and Organizational Change.The study sample was drawn from the 1998 NCEO Current Practices in Stock Option Plan Design study. That study sent surveys to 1,360 companies that were identified as possibly having broad-based option plans, which we defined as plans in which more than 50% of full-time employees would actually receive options. We received 141 responses. For the Rutgers study's purposes, 105 companies provided usable data. The authors used a before and after approach to the data to reduce or eliminate sampling bias issues.
Results were based primarily on the 91% of the sample companies that were publicly traded. Data were gathered on productivity, return on assets, Tobins Q (a complex financial measure of return on assets that produced similar results to the return on assets measure and is not reported here), and total shareholder return. These were then compared to all non-broad based stock option companies in their industries of similar size (the full sample group) and to paired comparisons of matched non-broad based stock option companies (the paired sample).
Because few companies had discrete plan start dates early enough to perform a comprehensive before and after analysis, the researchers, as a substitute, analyzed companies in the period 1985-87 and 1995-97, reasoning that few, if any, of the companies had option plans in the earlier period and most had them in the later period. Comparisons were made with non-stock option companies for the two periods and the difference subtracted. In effect, the earlier period results provide a baseline to measure the performance in the later period. If a stock option companies had productivity 3% greater than its peers in the earlier period and 6% greater in the later period, than it could be argued that the plan improved relative performance on this measure by 3%.
The study found that productivity rates did improve with the institution of a plan. The difference between productivity scores from the for the overall sample from the pre-plan period (1985 to 1987) to the post-plan period (1995 to 1997) was 14.8% when the comparison group was all non-option companies and 16.8% when looking just at paired comparisons. Sampling error can be strongly rejected as an explanation for these results.
Return on assets showed a similar pattern. Here the stock option companies showed an improvement of 2.5% on ROA relative to the full sample in the post-plan period compared to the pre-plan period. When just paired comparisons are used, the improvement was 2.05%. Again, sampling error is very unlikely to have caused these results.
Total shareholder return, however, showed no statistically significant difference in the relative performance during the two periods, meaning any measured change could simply reflect random sampling error. The researchers thus believe that the any value consequences of dilution caused by broad-based options seems counterbalanced by increased productivity.
Looking simply at how the companies did in the period 1992 to 1997, without trying to adjust for market effects, a similar pattern emerged. Productivity growth was 1% per year greater and return on assets 5.8% greater, but shareholder return was not statistically distinguishable.
In another useful study, in 2001, Wharton professors David Larcker, Christopher Ittner, and Richard Lambert looked at options and corporate performance, using data from 159 "new economy" companies providing detailed responses on their stock plans for an iQuantic/Buck (now simply Buck) Consulting survey. They found that the performance effects of option programs depended on how the options were distributed. The study, "The Structure and Performance Consequences of Equity Grants to Employees of New Economy Firms," was published by iQuantic/Buck in 2001, and is available on line at knowledge.wharton.upenn.edu.
The researchers looked at whether stock returns subsequent to option grants improved or declined in these companies, employing a statistical model in which "return" equaled the "continuously compounded stock price return in the 12-month period following grant." The results showed that deviations from the norm for how much equity is granted do not affect abnormal stock price movements (movements away from what would otherwise have been expected). On the other hand, who gets equity does make a significant difference. Larger than usual grants to executives (CEOs, vice-presidents, and directors) did not significantly affect stock prices. Grants to managers, "individual contributors" (critical non-management employees), technical employees, and exempt non-technical employees, by contrast, resulted in significantly greater than expected stock price growth. The researchers explained that the model suggests that, for instance, "for a 20% increase in the ratio of equity to salary for similar new economy companies, there was a 5.1% increase in annual returns if the grant was to technical employees; for non-technical employees, the return was 2.7%."
Looking only at non-exempt employees (hourly employees not exempt from the Wages and Hours Act), the study found a small negative relationship between stock price and grants of more than the benchmark amounts to these lower-level employees. These results are somewhat suspect, however, in that this group of companies had very, very few such employees (the iQuantic/Buck Web site indicated that only about 2% of the work force fell into this category).
In 2005, James Sesil and Yu Peng Lin published a paper titled "Executive and Broad-Based Stock Options: Evidence From U.S. Panel Data" (Rutgers University Working Papers). They looked at 291 companies with broad-based option and executive option plans for which a start date could be identified for both plans (these dates could be different). They then looked at productivity, growth, and capital intensity changes for three years before and after the plans' start dates. To control for characteristics of the firms, the researchers use a fixed effects model, a statistical technique that holds constant heterogeneous factors of the company (things that do not change over time, such as industry). To measure productivity, an augmented Cobb-Douglas function was used. This is a model in which productivity is seen (in this augmented version) as a function of capital, labor, broad-based options, executive options, and a variable created to control for quality of management and human resources practices (it is not clear how this variable was constructed, however). The Cobb-Douglas function assumes that labor and capital returns vary proportionately to one another.
The table below provides the results for productivity, growth, and capital intensity in terms of the mean changes before and after the plans. Generally, the executive plans would have been established well before the broad-based plans.
Mean productivity, growth, and capital intensity changes in three years before and after plan introduction
| Variable | Broad-based plan, before adoption | Broad-based plan, before adoption | Executive-only option plan, before adoption | Executive-only plan, after adoption |
|---|---|---|---|---|
| Output/employee in dollars | $265,575 | $318,925 | $231,188 | $403,071 |
| Employment | 19,190 | 20,446 | 14,433 | 30,365 |
| Capital; intensity (million $) | $1,497.0 | $1,915.0 | $1,428.4 | $4,563.9 |
In "Give Everyone a Prize? Employee Stock Options in Private Venture-Backed Firms" (2005, unpublished), John R.M. Hand of the Kenan-Flagler Business School looked at data from 2004 and 2005 provided by VentureOne, a data provider on venture-backed firms. The study's conclusion about the effectiveness of broadly granted options is described below. The VentureOne survey reported on the depth of options in 1,032 venture-backed companies responding to the survey for which adequate data were available. The study found the mean percentage of employees getting options was 89%, and 74% of the companies granted options to everyone.
Hand's approach is methodologically complex and does not yield numbers that say companies that give out options broadly do this much better (or worse) than those that do not. Instead, he uses the performance data to set up a model that evaluates whether too many or too few people are getting options. He concludes that venture firms are better off erring on the side of giving out too many options than too few.
