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The Employee Ownership Update

Corey Rosen

December 15, 2006

(Corey Rosen)

European Commission Report Endorses Employee Ownership in New Member and Candidate States

In 1989, the Commission of the European Communities created a panel to report on the "Promotion of Employee Participation in Profits and Enterprise Results." The so-called PEPPER Report, issued in 1992, urged member states to adopt legislation and regulations to encourage profit sharing and employee ownership plans. A second report in 1997 updated these recommendations. Now PEPPER III has extended this investigation to the new EU member states as well as those seeking admission. The report strongly encourages these countries to adopt these results-sharing programs. It specifically endorses the U.S. ESOP model as a promising approach.

The paper provides considerable detail on each of the countries (the Eastern European countries, the Baltic states, Cyprus, and Turkey). While it finds that almost all the states have laws that make employee ownership possible and that almost all the Eastern European and Baltic states gave some priority to employee ownership during their privatization phase, only Slovenia, Croatia, Poland, and Hungary have any significant remnant of broad employee ownership. None of the countries except Slovenia continue to actively encourage broad employee ownership. Typically, employees were allowed to buy shares at a discount or get some number of free shares, but in most cases, they were also able to sell them soon after. The report recommends that countries look at mechanisms such as ESOPs that can encourage stable employee ownership.

Tax Bill Provides AMT Relief for Incentive Stock Option Holders

The 2006 tax bill recently passed by Congress contains a provision allowing individuals who paid the alternative minimum tax (AMT) on the exercise of stock options to take a tax credit of 20% (or, if the original credit is less than $25,000, $5,000 or the full amount of the credit, whichever is less) against ordinary income, not just capital gains losses. The 20%, however, applies to the remaining balance, not the original balance, so over five years, only about two-thirds of the amount could be reclaimed (at most). The credits can be taken through 2013. The credit phases out for incomes generally above $150,000 (single filers) or $218,000 (married filers), but the rules are very complicated. AMT amounts from three years before the current tax year are eligible, so for the 2006 tax year, the rule applies to AMT amounts in 2003 and earlier.

Incentive stock options are a preference item under the AMT, meaning that the spread on options exercised in a tax year has to be added back to calculate the AMT. If the AMT amount is larger than the ordinary tax calculation, the taxpayer pays the AMT. The difference can be credited against future tax payments when the regular calculation exceeds the AMT calculation, but losses on stock can only be offset against capital gains losses or against ordinary income at no more than $3,000 per year. That caused a problem for people who exercised an incentive option in one year and chose to hold on for at least 12 months to get more favorable capital gains tax treatment. They often had to pay the AMT on the spread at exercise. If the stock price then dropped before the sale, they could end up with phantom income. They got a credit, but they might not ever be able to use it fully. The new provision makes it possible to offset the income against ordinary income tax, making it more likely to be usable. What is more, the new provision's credit is refundable, so the amount (if any) of the credit that exceeds tax payments can be claimed as a refund.

Critics say that people knowingly took a risk in following this strategy and could have sold off some shares in the year of exercise to pay the taxes. It is unclear how many people will be able to benefit from the provision. We estimate it could be some tens of thousands, however.

Google Creates Marketable Employee Options

Google will allow employees to sell their vested stock options through an arrangement with Morgan Stanley. Only non-executive employees will be given this choice (Google provides equity broadly to employees), and only shares issued since the IPO will be eligible. Existing options will be modified, requiring Google to take a one-time charge to earnings. Once sold, the options will have a term of two years or the remaining life of the options, whichever is shorter.

Employees will be able to sell their options at a price above their current exercisable value because the purchaser will be able to hold the option for an additional period of time. Employees, however, can also choose to wait to exercise for the full length of the 10-year option. Even out-of-the-money options will have some value to buyers.

Google says the plan will make options easier to communicate, provide a better benefit to employees, and possibly reduce the number of options Google needs to issue to provide the same level of incentive. Investor groups have reacted positively.

The WorldBlu List of Most Democratic Workplaces 2007 Call for Applicants

On March 6, 2007, WorldBlu will announce the first annual WorldBlu List of Most Democratic Workplaces in conjunction with the celebration of Democracy in the Workplace Day. WorldBlu is currently inviting companies from around the world that operate using organizational democracy to apply for the WorldBlu List 2007. The definition of democracy is on a number of dimensions, and is not simply (or primarily) focused on voting or other corporate governance issues, but more on day-to-day employee involvement.

Organizations apply by having their employees take the online WorldBlu Democratic Workplace Scorecard, which measures the degree of democracy in their workplace. The WorldBlu List will be comprised of organizations that took survey and scored at the top level, identifying them as one of the most democratic workplaces in the world. There is no fee to apply. Organizations must sign up by January 1, 2007, to be eligible. The WorldBlu List of Most Democratic Workplaces seeks to shine a spotlight on champions of freedom in the workplace and inspire others in the process. To learn more or have your organization apply for the WorldBlu List, go to http://www.worldblu.com/.

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