The Employee Ownership Update
June 1, 2011
Treasury Official Expresses Doubts About Floor-Price Protection in ESOPsCiting possible fiduciary and tax concerns with floor-price protection in ESOP companies, William K. Bortz, associate benefits tax counsel at the Treasury Department's Office of Tax Policy, said that the practice raised unanswered questions. The value of ESOP shares often declines significantly following a leveraged transaction, and floor-price protection is designed to insulate the people who leave the company during that often-temporary depression in the stock price. The NCEO's 2010 survey on repurchase obligation practices found that fewer than 10% of ESOP companies offer floor-price protection, and another 21% will consider doing so.
Speaking at the ESOP Association's annual conference on May 13, Bortz noted that since floor-price protection is temporary, any benefit it provides one participant is offset by reduced benefits to other participants. Bortz called this situation "a zero-sum game" and suggested that it "presents fiduciary problems." Bortz also said the question of how floor-price protection should be viewed was unanswered, suggesting that it could be considered a participant benefit, an agreement with the ESOP, or a side agreement with the employer. He noted that which of these three views of floor-price protection prevailed would affect several aspects of ESOP taxation.
Research on the Behavioral Impact of Stock OptionsHow do stock options affect employee behavior? Traditional economics suggests that holding options gives employees an incentive to promote future company success, but a new approach based on the psychology of gift exchanges suggests that exercising options creates a sense among employees of a reciprocal obligation to the company. Two researchers from the Wharton School, Peter Cappelli and Martin J. Conyon, published an extensive analysis of option awards, option exercises, and on-the-job behavior of 4,500 individual employees in a paper titled "Stock Option Exercise and Gift Exchange Relationships: Evidence for a Large US Company" and published the National Bureau for Economic Research. Their results are especially robust because the conditions under which the options were granted and the extensive data covering more than seven years in a single publicly traded company created a quasi-experiment.
Captelli and Conyon found that both traditional and gift-exchange hypotheses explained employee behavior. In particular, they noted that "[h]igher profits [from exercising stock options] in turn cause them to reciprocate with better job performance in the subsequent period." In other words, an option grant affects behavior before and after exercise. They conclude, "We find significant and economically meaningful positive relationships between the variation in profit per share of the options sold and standard measures of subsequent job performance for individual employees." Their research is available as NBER Working Paper No. 16814 (February 2011).