Employee Stock Ownership Plans

The following post comes to us from E. Han Kim, Professor of Finance and International Business at the University of Michigan, and Paige Ouimet of the Finance Department at the University of North Carolina at Chapel Hill.

In our paper, Employee Stock Ownership Plans: Employee Compensation and Firm Value, which was recently made publicly available on SSRN, we investigate whether adopting a broad-based employee stock ownership plan enhances productivity by improving team incentives and co-monitoring. That is, does employee capitalism work? If so, how are gains divided between shareholders and employees?

We find that small ESOPs increase productivity. Unlike Jones and Kato (1995) on Japanese ESOPs, our evidence of productivity gains is based on the effects on two main beneficiaries of such gains: employees and shareholders. Because our evidence indicates both stakeholders gain from adopting small ESOPs, we infer employee share ownership increases the size of the economic pie by improving worker productivity.

This causal interpretation is substantiated by our evidence on how the division of productivity gains is related to employee mobility within an establishment’s industry and location of work place. We find that when labor mobility increases, increasing workers’ bargaining power vis-à-vis shareholders’, employees’ share of gains increases and stockholders’ share decreases.

Large ESOPs, defined as those controlling more than 5% of shares outstanding, have a more or less neutral effect on both cash wages and shareholder value, suggesting that the average gains are limited to the value of ESOP shares granted to employees. The lower average gains are due to heterogeneity in motives for establishing large ESOPs. We identify two subgroups of large ESOPs with motives unrelated to improving group incentives and co-monitoring: cash conservation and entrenchment against threats from the market for corporate control.

Large ESOPs motivated to conserve cash are followed by wage cuts. By contrast, those motivated to thwart hostile takeover bids provide substantial wage gains, a previously undocumented cost of managerial entrenchment to shareholders. With these exceptions notwithstanding, the overall implication we draw from this study is that employee capitalism works through group incentives and co-monitoring when ESOPs are designed for that purpose.

The full paper is available for download here.

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One Comment

  1. Corey Rosen
    Posted Wednesday, August 17, 2011 at 7:23 pm | Permalink

    This is a very good study, but readers should understand that it focuses on ESOPs in publicly traded companies, and that 97% of ESOPs are in closely held companies. In these companies, which range from just a handful of employees to over 100,000, employees rarely own less than about 20% of the stock and, in about 40%, own 100% of the stock or will in the next few years.
    ESOPs in these companies are dramatically different from ESOPs in public companies in other ways as well. Most important is that ESOPs in public companies (where few plans own more than 5% of the stock) are usually used as a match to a 401(k) plan and rarely are seen as anything other than part of the benefit structure. In closely held companies, most ESOPs are viewed as an integral part of the culture. Many of these companies practice open-book management and have a high degree of employee involvement in day to day work decisions.
    These ESOPs have performed exceptionally well, as research by Joseph Blasi and Douglas Kruse of Rutgers as well as the National Center for Employee Ownership (NCEO) has shown. Blasi and Kruse found that these ESOPs grow about 2.5% per year faster than would have been expected in sales, employment, and productivity (they looked at pre- and post-ESOP performance indexing out for industry effects). The NCEO found almost identical results. The NCEO also found that employees receive about 2.2 times the corporate contributions to their retirement plans in ESOP companies as in non-ESOP companies, and that closely held ESOP companies are more likely to have a second and diversified retirement plan than other companies are to have any retirement plan at all. ESOPs also have broader employee coverage than 401(k) plans, where employees (Unlike in ESOPs) have to contribute something to get something.
    Details of the research on this subject can be found at http://www.nceo.org/main/article.php/id/3/.