United Airlines, ESOPs, and Employee Ownership

1995 was a good year for United Airlines. It was the first year under its new ESOP, which owned 55% of the company. It was also the best year for shareholders in the company's 70-year history, outperforming Standard & Poor's by 67%, increasing shareholder value by over $4 billion. Employee grievances fell 74 percent. Revenue per employee went up 10%. Surveys showed employees liked working at United, and workers compensation claims and missed work days both improved sharply. Employees were organized into system-wide "best of business" (BOB) teams to iron out thorny issues, such as free pass policies for travel, as well as to find ways to improve operations and cut costs.

2000 was the last year of the ESOP, and the start of a disastrous period for United. The BOB teams were long gone, having been disbanded just a year after they started. Pilots were negotiating for a new wage deal and staged a work slowdown that, combined with bad summer weather, led to horrendous delays and furious customers. The airline was starting to lose money, but ended up acceding to pilot and later machinists demands for wage hikes. Employee morale was crumbling. The next two years have only made things worse, as economic conditions and 9/11 severely damaged most of the industry. Now United is mulling bankruptcy and the trustees of its ESOP are selling some of the plan's shares in order to preserve some value if bankruptcy does occur.

What happened, and was employee ownership to blame? To listen to most analysts these days, United's woes can be traced directly to excessive union control. Although employees have just three seats on the board, they say, United can't make a move without union approval, including hiring a CEO. United's management, they contend, should have forced labor to back down on wage demands in prior contracts, and now should take a tough line on needed concessions. While it is true that United's unions bargained for, and got, a veto power over strategic decisions, that was only an obstacle in one case, the failed attempt to buy USAir. Even there, the company did get support from the machinists, enough to proceed with the effort, which was later turned down by the Justice Department for antirust reasons. In light of subsequent developments at USAir, that was probably a good thing for United. It's also true that unions have had more than the usual influence in choosing a CEO, but it is hard to see how having a CEO the employees were opposed to would have made the situation at United anything but worse.

It may be stylish these days to dismiss the ESOP at United and long for the good old days when management managed and employees did as they were told, but this explanation for United's failure just won't wash. United's pilots did get an industry-standard-setting wage increase, but that has been the pattern at each successive pilot contract at every major airline, ESOP or not. Pilots simply have enormous power at an airline. Other employees can at least be partially replaced; pilots cannot. United's management did struggle for months to resist the wage demands, even in the face of disastrous customer relations. It eventually gave in, but which major airline has not in the face of similar work actions? The machinists did get a raise, but only after not getting one for many years.

If caving in on wages cannot be laid simply at the feet of the ESOP, and the ESOP did not stop United from pursuing any business strategy its major competitors have pursued, then just what is it employee control has done that is so disastrous? Every other major airline but Southwest (which itself has broad employee ownership and much more employee influence over day-to-day operation than United ever had) is losing money. One airline is in bankruptcy (USAir) and at least one other (American) is near it, while Delta and Northwest continue to bleed money. Yet no one seems to be arguing that "investor ownership" is a failed model at these companies.

The ESOP Did Not Cause United to Fail, But It Failed to Help United Succeed

While the ESOP did not cause United to fail, the ESOP has abjectly failed to help the company the way most ESOPs do. The overall ESOP track record, both in public and private companies, is impressive. Major academic studies show that companies with ESOPs grow in sales, employment, and productivity by 2% to 3% per year faster than would have been predicted without an ESOP. In public companies, ESOPs are also associated with higher returns on assets and stock prices (these variables cannot be studied in private companies because the data are not available). But for ESOPs to succeed, companies need to combine broad ownership with an "ownership culture" that gives employees more influence in day-to-day decisions and shares corporate performance data with employees in a detailed and regular manner. United's unions pursued the ESOP not because they wanted to be owners so much as because they wanted to use ownership to prevent United from breaking up into regional carriers, diversifying out of the airline business, and outsourcing work performed by union members. They succeeded in that goal. Management also was not enthused about the ESOP per se, seeing it primarily as a way to get wage concessions. They succeeded in their goal as well. Both sides, having done that, had only limited interest in making the ESOP a permanent part of United.

Perhaps because of this indifference toward making the ESOP part of United's culture, United's plan was fatally flawed from the outset:

• Flight attendants, the face of the company to customers, never were in the ESOP. They didn't want to make concessions, and the company and other unions were not willing to include them unless they did.
• The ESOP was set up so that in five years no further contributions would be made. New employees would not be owners, and existing employees would get no more stock. So everyone knew from the outset that the ESOP could be put in the "this too will pass" category.
• Employees took substantial concessions for the ESOP, and bitterness over these givebacks never faded. Only 1% of all ESOPs require concessions. In fact, employees in ESOP companies generally are paid more than comparable employees in non-ESOP companies.
• Neither labor nor management was ever fully committed to creating an "ownership culture" in which employees could participate actively in day-to-day work-level decisions. Both sides tried out this approach in the first year, with the remarkable results noted above. But at the end of that "experiment" everyone reverted to the old ways of doing things. United's key management did not like the idea of the ESOP or employee involvement, and labor leaders had, at best, mixed feelings. Both sides had built long histories of bashing one another, and those habits were hard to change.

By contrast, Southwest, which is about 10% owned through employee benefit plans and gives options widely on top of that, says it puts "employees first, customers second, and shareholders third." Employees work in teams to make decisions, full information on corporate and work unit performance is shared, and employees are urged to use their judgment to make whatever decisions are necessary to please customers. Southwest continues to make a profit and has a market capitalization greater than the major airlines combined. Employee ownership can and does work in the airline industry. It just failed at United.