The Employee Ownership Update
November 17, 2008
New Study Shows ESOPs Increase Total Worker Compensation in Public Companies Significantly, But Not at Shareholder ExpenseOne of the most common arguments against ESOPs is that they substitute for other compensation, replacing cash or diversified retirement investments with risky stock. Existing data on closely held companies decisively refute that point, but, until now, there have never been data on ESOPs in public companies, which include perhaps half or more of all ESOP participants.
In an new study, E. Han Kim of the University of Michigan and Page Ouiment of the University of North Carolina ("Employee Capitalism or Corporate Socialism: Broad-Based Employee Stock Ownership," October 28, 2008) find that ESOPs owning less than 5% of company shares have a small (0.8%), but positive effect on total compensation, while in companies where 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 sub-sample of companies where the ESOP was established in conjunction with declining sales resulted in lower total compensation (2.8% for small ESOPs and 6.3% for large ESOPs).
The effect on value (measured by a standard measurement, 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.
Repricing Options Gaining MomentumAfter the dot-com bust, many companies decided to reprice their deeply underwater stock options, often more than once. At the time, unless companies delayed the choice to accept repriced options for six months or more, they had to show the cost of options on their income statement, something they did not have to do before. New accounting rules price options at grant, so there is not an automatic additional accounting charge to repricing, although there could be an additional charge if more value is added. In a common approach, companies offer to cancel existing options and exchange them for new options at a lower price. There are fewer new options offered, however, so that the net effect is value neutral, thus incurring no additional expensing requirement. Employees will generally see this as a positive development, even if they are getting fewer options, given that their current options have little chance of being worth anything.
While the accounting issues are less problematic than before, shareholder approval problems are moreso. Repricing generally requires shareholder approval and securities law compliance. Institutional advisors take a dim view of repricing. If they do support it, they almost always do so only if repricing does not apply to executives. There are also a number of more specific guidelines about pricing and terms that can make the changes difficult. The next issue of our newsletter will provide more details on these issues.
A story in the Wall Street Journal (11/10/2008) discusses these recent trends.
New Resource on Employee Ownership CasesCasePlace.org, a compendium of case studies for business schools and other users, has compiled a large number of employee ownership case studies. Some are from the NCEO, others are from academic journals and papers. For details, go to http://www.caseplace.org/ and search for employee ownership or ESOPs. CasePlace is a project of the Aspen Institute, and the employee ownership cases have received financial and/or substantive support from the Employee Ownership Foundation, the Beyster Institute, and the NCEO.
A Cautionary Tale About Planning for the Repurchase ObligationThe Antioch Company in Yellow Springs, OH, has filed for Chapter 11 bankruptcy. Antioch is one of the more remarkable ESOP stories. A small printing company with a long history of pro-employee policies, it set up an ESOP in 1979. In the late 1980s, it bought an album company (Creative Memories) and sales took off. In the next 25 years, employment grew from about 150 to over 1,100, and the share price went up over 2,000%. But then the album market peaked. Employees started to leave, taking advantage of the company's high price and immediate cash-out provisions. Over the next few years, about 800 employees resigned. The resulting cash drain led the company to seek a buyer, but when that fell through, Chapter 11 became the only course. The company will continue to operate, but its ESOP will be terminated. Employees, however, will receive a membership interest in a trust linked to a successor limited liability company (LLC). Antioch might have been able to deal with the problems more effectively had the repurchase obligation been more accurately reflected in stock value and if it had more flexibility in its ESOP payout schedule.
While Antioch's problems are deeply distressing to its employees and leadership, who have an unusually strong commitment to ownership ideals, it's worth remembering that it paid out tens of millions to dollars to employees over time, with account balances into six figures and even seven figures common for employees with significant tenure.