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The Employee Ownership Update

Corey Rosen

September 16, 2005

(Corey Rosen)

ESOP Company Execs Paid Less Than Their Peers

Based on a soon-to-be available NCEO survey of 204 ESOPs, executives at ESOP companies are paid significantly less than their peers. Using national data from CompData, we found, for, instance that total CEO compensation at companies with fewer than 100 employees was about $211,000, compared to $380,000 for non-ESOP companies, while for companies with more than 100 employees, the comparison was $329,000 to $380,000. Similar differences in scale were reported for other officer levels, where ESOP company pay ranged from about $100,000 for CFOs in smaller ESOPs to $150,000 for COOs, compared to a range from $163,000 to $285,000 in non-ESOP comparison companies. For companies with more than 100 employees, the range for non-CEO top executives in smaller ESOPs was between $164,000 and $226,000, compared to $218,000 to $421,000 in peer companies. The ESOP data, however, do not include the often very substantial ESOP account balances these executives may accrue.

SEC Rejects Cisco's Proposal on Options Valuation

The Securities and Exchange Commission has rejected a proposal from Cisco Systems to value its options based on a market in employee options the company would create. Under the proposal, Cisco would create a new derivative security whose terms would be the same as its employee options. Derivative securities are investments whose values is derived from their relationship to an underlying security, in this case Cisco common shares. Like employee options, the securities would have a fixed term, would have an exercise price equal to the price of common stock when the derivative security is bought, and could not be exercised until a defined period of time has elapsed. Moreover, investors could not hedge their investments against the options, effectively limiting their potential loss or gain. These options would thus be considerably more restrictive than conventional traded options and therefore would sell for a greater discount to common shares. Cisco would issue a limited number of these options and would make them available only to certain institutional investors.

The SEC was dubious that the proposal really created a valid market, but Chair Christopher Cox said the SEC would encourage other proposals to create market conditions that more closely mimicked the cost of options to employees.

IRS Says ESOP Redemptions Are Not Deductible; Limits ESOP Deductions for Foreign Companies to Parent Company, Not Subsidiary

On August 25, the IRS published REG-133578-05, proposed regulations that cover two ESOP dividend deduction scenarios. In the first, it said it would not allow companies to deduct the cost of repurchasing shares from departing employees. Boise Cascade had successfully argued that it could treat such redemptions as dividends deductible under Section 404(k) of the Code. The IRS challenged Boise, but the Ninth Circuit Court of Appeals ruled in favor of the company. The vast majority of ESOP practitioners, as well as the ESOP Association and the NCEO, regarded the Boise decision as unjustifiable. Among other problems, it would mean employees would no longer be eligible to roll over their distributions or take net unrealized appreciation on them (since they now would be classified as dividends). The IRS had long indicated it would issue regulations to prevent such a practice in the future, and this proposal does just that.

The same proposal also states that deductions for qualifying dividends on ESOP shares must be taken at the parent company level, not the subsidiary. This means that a foreign corporation that sponsors a U.S. ESOP, such as DaimlerChrysler, BP, and others, will have to try to claim the deduction under the laws of their own country, something few if, any, can do. There appear to very few U.S. ESOPs in subsidiaries of foreign companies, however.

Loren Rodgers to Join NCEO Staff

Loren Rodgers, a long-time senior principal of Ownership Associates, has joined to the NCEO staff. Loren will be working on ownership culture, research, and ESOP issues. Loren has established a strong reputation in the ESOP community for his work, including speaking, consulting, writing, and research. Cambridge, MA-based Ownership Associates is an international consulting firm specializing in corporate education and training programs, ownership culture initiatives, and employee ownership plan implementation. Loren currently also serves on the NCEO board. We are delighted and honored to have Loren join the staff.

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