RSM Resources

Companies with employee stock ownership plans (ESOPs) stay in business longer, are more profitable and have lower rates of employee turnover compared with similar companies without them, studies and anecdotal evidence show.

Consider the example of Roseville, Minn.-based Twin Modal, a freight transportation and logistics service, which grants its employees a stake in the company through an ESOP.

"I truly believe that Twin Modal wouldn’t be the company it is without an ESOP," says Shelly Olsen, an employee-owner of Twin Modal, named Company of the Year by the ESOP Association of Minnesota. "Our profitable growth is the key to our wealthy retirement."

According to the National Center for Employee Ownership (NCEO), a not-for-profit research organization, the United States has 11,500 companies that offer ESOPs or other profit-sharing plans that invest primarily in company stock — up from 8,080 in 1990. While the vast majority of companies with ESOPs are privately held, they offer an employee benefit that buys and sells company stock through a trust, enabling employees to become owners. It’s a powerful tool for enhancing employee recruiting and retention. The ESOP also offers tax benefits and can be used in succession planning or to raise capital and finance company growth.

Increased performance
American companies perform better when granting stock incentives to all employees, not just senior executives. That’s according to Joseph Blasi and Douglas Kruse, professors of human resource management at Rutgers University, in their 2003 book, In the Company of Owners: The Truth About Stock Options (and Why Every Employee Should Have Them).

The authors examined 70 studies during the past 25 years and found that ownership and profit-sharing programs improved company performance. They learned:

• Companies with ESOPs are more likely to stay in business than comparable firms without ESOP plans. Seventy percent of the ESOP companies studied remained in business as the same entity compared with 55 percent of the non-ESOP companies.
• In the year ownership programs were added, companies increased productivity by an average of 4 percent, a gain they maintained over time.

An NCEO study supports that position, reporting that, in the three years after adopting an ESOP, companies experienced 2.4 percent greater annual sales growth and 2.3 percent more annual growth in sales per employee compared with the three years before the ESOP. Similarly, companies that combine an ESOP with a collaborative management style grow 8 percent faster than similar organizations without those benefits, according to earlier NCEO studies.

Experts say anecdotal evidence also supports these findings. Additional gains from an ESOP benefit plan include:

• Changes in employee outlook and attitude. Owning stock in their company can make a difference in how employees see their jobs. Employees say that owning stock makes them think and act like owners.
• Longer-term focus and improved retention. Employees feel fairly rewarded for their efforts, and the potential financial rewards show workers they’re valued. Gradual vesting can provide an incentive for employees to stay with the company for the long term.
• Management confidence. Managers say they can better rely on employee-owners to make decisions that are in the best interest of the company.
• Smarter purchasing decisions. Because employees demand greater value when it’s their money, they are more careful how they spend company dollars.
• Teamwork. Employees say work environments with ESOPs are more positive and cooperative, because there’s a shared sense of responsibility and recognition of common goals.

Setting up an ESOP
David L. Wray, president of the Profit Sharing/401(k) Council of America, says employers should be clear about their ESOP goals before launching such an incentive. If the goal is a broad initiative to get employees at all levels to think like owners, an ESOP may be the solution.

Properly evaluating, implementing and communicating an ESOP plan can take six months to a year. Therefore, employers would be wise to plan ahead, particularly when considering an ESOP as part of an ownership and management succession plan. When establishing an ESOP, an independent appraiser first must value the company’s stock. Then the ESOP’s effect on existing shareholders is evaluated. They’ll want to know how the new plan will affect the value of their existing stock, the governance of the company, continuing access to capital, and future exit strategies or other transition options, among other things. [BP1] Other matters to decide include eligibility, contribution methods, allocation approaches, and how to handle stock buy-backs when an employee leaves or retires.

Companies considering an ESOP should recognize it as a hybrid of a retirement plan and an equity incentive plan. It can be a key part of a strategy to retain employees and develop a productive workplace. Therefore, the type of decisions made for a regular retirement plan, such as a 401(k), may not be appropriate for an ESOP. The ESOP may be aimed more at long-term employees who can affect company value. Contributions may be discretionary based upon performance goals. Allocation methods may be pro-rata based on compensation or may take into account years of service or other criteria. Gradual vesting is a common option, with many plans using the longest legal vesting schedule, resulting in full ESOP ownership after five to seven years.

Experts say companies with ESOPs should also examine the merits of employee participation in company management. According to the NCEO, just 20 percent of private companies grant full ESOP voting rights to employees. Most often, the management team retains voting rights or restricts voting to electing board members or other limited transactions. On the other hand, ESOP participants without full voting rights still can gain a sense of ownership and adopt related attitudes and behaviors.

Because the ESOP is a trust, the company will need to appoint a trustee, someone who can accept the fiduciary responsibility of administering the ESOP. This may be a group of employees from the company or a professional trustee such as a bank. Of course, granting employees company ownership through an ESOP often requires securing financing. Whether leveraged or not, it will require submitting a formal plan to the Internal Revenue Service.

Finding a balance
No company is immune to downturns, and employees who have a large portion of their retirement savings in company stock assume a certain amount of risk.

Ryan Till, a sales representative at Anson Industries Inc., a Chicago-based construction firm, told The Wall Street Journal that his company’s employee ownership plan keeps him motivated. But he acknowledges having a hefty 75 percent of his net worth invested in company stock.

Many companies combine an ESOP with a 401(k) plan to give employees options for their retirement investments, and they let employees decide whether to invest at all in an ESOP and at what level. Experts recommend companies educate their employees about the benefits of diversifying their retirement portfolios.

Creating a culture of ownership
An ESOP can contribute to a collaborative, engaged workforce where employees at all levels have access to necessary information and can influence decision-making. For example, a 2003 National Bureau of Economic Research study found that employees of companies that share operational information and give them a voice in decision-making are four times more likely to speak with an underperforming colleague and twice as likely to report the underperformer to a supervisor. It is important to note not all information must be shared. While employees should have access to information that is relevant to their specific duties, information such as wages should remain confidential.

The influence of an ESOP isn’t limited to nonmanagement workers. Experts say business leaders and supervisors who are heavily invested in their company’s ESOP are less likely to take big, risky bets — not just because of their personal investment, but out of a sense of obligation to fellow employee shareholders.

Ongoing communication is essential in creating a culture of ownership. Keeping employees informed and enthusiastic requires multiple methods and vehicles. It begins with orientation and continues through regular employee meetings and newsletters or other media that connect individual and company performance, including share price. The educational process is important for employees to value their stock and understand that what they do every day affects company revenue and costs.

Managers who help their employees see the connection between their efforts and the success of the organization will maximize their ESOP plan and reap the rewards.