Archived Article
February 2015

Why Has the Total Number of ESOPs Gone Down But Participation and Assets Gone Up?

The data for ESOPs as summarized in our Statistical Profile of Employee Ownership show a large drop in the number of new ESOPs between 2002 and 2005, then stabilization around 7,000 plans. What accounts for this decline? Between 1998 and 2003, there were a number of promoters selling an S corporation ESOP arrangement that claimed to be able to funnel most or all the benefits to a few top managers. We believe as many as 2,000 of these plans were set up for at least long enough to file a Form 5500 report. Unfortunately, these were scams. While they were set up as plans, few operated very long if, indeed, they ever actually went past the initial filings stage. Congress passed legislation in 2001 providing draconian tax penalties for these plans, and the IRS issued equally strong regulations. The IRS then started a special audit program to identify these plans and shut them down. So lots of plans went away in the early 2000s, but they had few participants. Factoring that out, net plan formation has been stable fairly stable as the number of new plans has equaled terminations, most of which are because a company has a great offer, but sometimes are because companies decide they do not like the plans, face financial difficulties, or have difficulties repurchasing employee shares. About 4% of plans are terminated annually.

Meanwhile, ESOP companies have been growing faster internally. Other research shows that ESOPs companies grow about 2.5% per year faster than would have been expected absent an ESOP. Compounding that number between 2002 and 2012 yields about 2.2 million participants. ESOP companies also started doing acquisitions in the early 2000s. While there is no complete data source on this, we estimate about 50-100 companies are acquired this way each year. Finally, based on a recent NCEO survey, we believe about 300-400 non-ESOP companies are acquired each year by ESOP companies. That is about as many new ESOPs as are being set up.

The lack of net new plan growth may still be surprising in light of the impending retirement of so many baby-boomer business owners. There is a great deal of institutional inertia around setting up new plans. Business brokers and merger and acquisitions firms generally do not want to see ESOPs used for business transition because they can make much large fees on sales to third parties. Accountants largely don't understand ESOPs. While the number of new plans is important, economic impact should be measured by participants and assets, by which measure ESOP growth is very strong.