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The Employee Ownership Update

Corey Rosen

June 30, 1995

(Corey Rosen)

Withdrawal of ESOP Valuation Guidelines Turns Out to Be False Rumor

We reported recently that the Department of Labor had withdrawn its valuation guidelines. That information was based on reports from several ESOP consultants, but it turned out to be a misunderstanding. In fact, the Department indicated that it was taking the valuation project off its list of current projects. The guidelines remain just what they were--proposed, with no prospect for becoming finalized any time in the foreseeable future.

Russian Employee Ownership Recedes Only Slightly

Most state-owned enterprises in Russia were sold to their employees in the first few years of the 1990s. According to Joseph Blasi of Rutgers, a principal advisor to the Russian government on privatization, about two-thirds of all large (over 200 employee) state-owned enterprises became majority owned by their employees. While management bought a disproportionate share of the stock, the management stake was rarely over 10%; the rest was bought broadly by employees. The owners of shares hold them as individuals and can sell them as they see fit.

Blasi reports that the percentage of companies still majority owned is about 55% to 60%. Some companies have been bought by outside investors, some by their managers. While management continues to buy shares from employees in many companies, Blasi expects there will be a residual of 10% to 20% of the companies that are privatized that will remain broadly and majority employee-owned for at least several years.

Was Kelso Right After All?

Most economists have long argued that as productivity goes up, so do wages and, ultimately, employment. Therefore, if technology increases productivity, more people will be working for more money. Since the industrial revolution, this notion has been well confirmed by actual experience.

In recent years, however, productivity has gone up faster than wages, while unemployment and, especially, underemployment, have remained high. Indeed, real wages have been stagnant for over a decade. Meanwhile, returns to capital are increasing rapidly and ownership of productive wealth further concentrating.

Forty years ago, Louis Kelso, the creator of ESOPs, predicted this would happen. Economists said Kelso was daft. Among other failings, they noted, he wasn't even a Ph.D. in economics. Now, a growing number of economists and other prognosticators are rethinking their equations. It may be, these people argue, that technology is now reducing the amount of work that needs to be performed by people (as opposed to capital). Combined with worldwide competition, this is keeping wages down and unemployment up. Hence the coincidence of an economic recovery, no inflation, and a rather dejected economic outlook from most people.

Kelso argued that the only solution was to make more people (not just employees) owners of all this very productive capital. Perhaps his ideas will now begin to get the hearing they deserved decades ago.

401(k) Plans as an Alternative to ESOPs in Small Companies

We received a letter from a company that wanted to include employees in ownership, but was reluctant to set up an ESOP because of its cost and complexity. It also wanted to keep its 401(k) plan. For companies that already have a 401(k), or plan to set one up, a simple solution is to match employee contributions in employer stock. The company could just issue new shares to the 401(k) or contribute cash to buy existing shares.

The disadvantages of this approach are that you will need to have your stock appraised annually, you will dilute ownership for existing owners unless you use company cash to buy shares, and the sale of shares to the 401(k) (if that is how you finance the match) are not subject to the tax-deferral provisions available in a sale to an ESOP (in an ESOP, sellers can defer capital gains taxes if the ESOP that buys their shares ends up with 30% or more of the company's stock after the transaction).

The 401(k) approach also means that share allocation will be based on how much employees choose to save. If a company wants a broader allocation, it could agree to contribute at least a certain amount to everyone, then match on top of that.

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