The Employee Ownership Update
February 1, 2007
Majority of Best 100 Places to Work Have Broad Employee OwnershipOnce again, a majority (56%) of the 76 companies that have stock on the Great Place to Work Institute's Best 100 Companies to Work For" list have one or more broad-based employee ownership programs. Last year, the percentage of companies was exactly the same. Eight of the companies had ESOPs, 18 had broad-based options or other individual equity awards and an employee stock purchase plan (ESPP), 10 had just an ESPP, 5 used company stock as a 401(k) match or a stock bonus plan (one of these also had broad options, two also had an ESPPs, and one also had broad options), and two other companies had most of their stock directly owned by most of their employees. Four were majority employee owned (W.L. Gore & Associates, Quad/Graphics, Publix, and TDIndustries, and PCL Construction).
Did Accounting Rules Do In Hooker Furniture ESOP?One of the largest ESOPs in a public company was that of Hooker Furniture in North Carolina. When the plan was formed in 2000, the company had about 2,000 U.S. employees, and the ESOP owned about a third of the stock. Now Hooker has shrunk to about 1,000 employees as a result of outsourcing. Its stock has performed well since 2000, however, resulting in increasing compensation costs per employee to pay off the loan. Under ESOP accounting rules in effect since 1992, companies must show a charge to compensation as shares are released to employee accounts from a leveraged ESOP based not on what the company paid for the shares but their current fair market value. That increase in reported compensation costs, in turn, makes the bottom line look worse. The result has been that most public companies with substantial ESOP holdings terminated their plans, often by simply making stock contributions to a 401(k) plan instead. In the company's press release about the termination, it said ESOP compensation costs were now too high for the company to sustain. Whether accounting rules really caused companies to rethink ESOPs or were a convenient excuse for companies that wanted to move to less costly benefit programs is open to debate, but it is clear that since 1992, ESOPs have played a much smaller role in public companies.
SEC Approves Zions Bancorp's Market-Based Option Valuation MethodIn a January 25, 2007, letter to Zions Bancorp, SEC Chief Accountant Conrad Hewitt approved the bank's proposal to value its employee stock options based on the bank's auction of a tracking security called employee stock ownership appreciation rights (ESOARS). ESOARS pay a pro rata share of the net positive value realized by employees when they exercise employee stock options from the option grant applicable to the ESOARS issuance. As the Web site explaining the approach describes, "if a company grants 1,000,000 employee stock options and ESOARS represent 10% of the value realized, ESOARS holders as a group will receive 10% of the value realized by employees when the employees exercise the options. 'Value realized' is the amount, if any, by which the (a) trading price of the security underlying the employee stock options at the time of exercise exceeds (b) the exercise price of those options, multiplied by the number of options exercised." The options vest in three years. The idea is that the ESOAR price is a market-derived value for employee stock options rather than one derived by a formula.
The auction is available to any buyer who registers with Zions Bancorp for the offer. The buyers may be restricted as to the number of units they can buy. The market price for the bids that are accepted is based on the lowest price that clears the market given the number of total units available. In the first auction, there were 57 bidders. A market clearing price of $7.50 resulted in 21 bidders being accepted. That turned out to be about half of what a Black-Scholes formula would have indicated for employee options.
The SEC had turned down an earlier, similar proposal from Cisco, largely because it was structured in a way that left the agency concerned there would not be enough buyers to create a real market. Subject to certain changes in the structure of the offer, the SEC said that it would allow Zion to use the price from the next auction to determine the compensation expense from the options for FAS 123(R) accounting purposes. However, each auction will be separately assessed to assure there is an adequate market that can generate real values.
As of this writing, the SEC letter was not yet public. Information about the ESOARs is available at www.esoarsauction.com/pma/faq/.