Professor wants to abolish ESOPs
The ESOP Association estimates that 10 million U.S. workers, about 10 percent of the private-sector work force, participate in employee stock ownership plans at 11,500 companies. Many people would look at those numbers and see upbeat, motivated employees, their incentives fully aligned with the employers’ goals.
Sean Anderson, a visiting law professor at the University of Illinois, looks at ESOPs and sees a disaster waiting to happen. In an upcoming article, he says Congress should ban employer stock from all company-sponsored retirement plans. Here’s an Anderson quote, from a U of I News Bureau summary of the article:
ESOPs have a lot of intuitive appeal — the idea of having workers own a piece of the company they’re working for. But they’re Enron on steroids. At the end of the day, they put workers at terrible risk and more often than not work as a tool that benefits the company, not employees.
ESOPs prevent workers from diversifying their retirement savings, and workers don’t even control the price at which they invest. The news release explains:
Most ESOP companies are privately held, so the share price for ESOP stock transactions is determined by company-hired valuation firms with an incentive to set high prices that net extra cash for the business or its insiders rather than low prices that benefit employees.
My guess is that any proposal to abolish ESOPs would run into a firestorm of criticism from many of those 10 million employee-owners. I’ve talked with people who get a special sense of pride from working at an employee-owned company like Graybar Electric or McBride & Son Homes. Any reformer would also have to contend with the ghost of Louis O. Kelso, the Cold-War-era economic thinker who conceived of ESOPs as a way to keep workers engaged with capitalism and opposed to communism.
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David Nicklaus has covered St. Louis business for more than 25 years. His column appears three days a week on the Post-Dispatch business page. 
This is unfathomable. The 2008 Economic Performance Survey conducted by the Employee Ownership Foundation found that 92.4% of individuals reported that creating employee ownership through an ESOP was “a good business decision that has helped the company.” In addition, statistics show that a majority of ESOP companies have other retirement plans, such as defined benefit pension plans or 401(k) plans, to supplement their ESOP.
Having employees own directly, or indirectly, stock in the company where they work is a very traditional and honored policy in the U.S. Research shows that ESOP companies have employee owners that are highly motivated and that the ESOP improved productivity.
Employee-owned companies have been listed in the top 100 companies to work for by Fortune magazine, have been named the Best Small Business of the Year by the U.S. Chamber of Commerce, and have been listed among the Top Small Workplaces.
Only a neophyte in retirement income policy would call ESOPs the greatest threat to retirement savings. Considering half the American workforce has no employer sponsored retirement savings plan at all, then being diversified in nothing is nothing.
There is a privately held prominent retailer in St. Louis that has an ESOP. As the article indicates, they use a company-hired valuation firm that minipulates the value of the stock as the owner desires. In reality, the ESOP is a joke and has no value. The employees are unaware and have a false sense of financial wealth. In the event that the employee wishes to cash in his shares upon termination of employment, it takes 2 years to get his money. The owners are aware and do not care.
There are many possible reactions to Mr. Anderson’s uniformed article but I will only address those on which I, as the Chair of the Valuation Advisory Committee of the ESOP Association, am qualified to comment.
First and foremost, the insinuation that the valuation firm has any sort of incentive to establish a high price is confused. Valuation firms do not receive incentive compensation based on completion of a deal or the deal value. Mr. Anderson is confusing ESOP valuation work with that of investment bankers, who do receive contingency compensation. Appraisers must declare in their valuation reports and opinions that they have no direct or indirect interest in the company they are valuing. Contingency fees are expressly forbidden in ESOP advisory work.
Second, the valuation firm is hired by the ESOP’s Trustee, as directed by the proposed guidelines of the Department of Labor, not the company. The valuation firm provides financial advisory support solely to the Trustee, who is entrusted with making that final determination of stock value. The Trustee is typically a person or institution that is independent of the company.
I understand why it might appear to someone not strongly familiar with this field why ESOPs seem, on their face, a bad idea for retirement. However, the data on ESOPs in closely held companies reveal a very different set of facts.
First, the biggest problem with the retirement system is that most employees (over half of full-time workers) in the private sector have no retirement plan of any kind. So they are 100% diversified in zero. The smaller the company, the less likely it is to offer any plan at all. If an ESOP induces a company to set up a retirement plan when it would otherwise have none (because the ESOP helps the owner make a tax-favored transition, usually), then that is a step forward.
Second, if the ESOP were the only retirement plan, then it is more of an issue if, in fact, the choice is between an ESOP and some other plan (which is very rarely the case). But, in fact, various studies show that ESOP companies are much more likely to have a secondary (and diversified) retirement plan than comparable companies are to have any kind of plan at all. Joe Blasi and Doug Kruse at Rutgers, in particular, have done a lot of work on this. The crux of your argument is that ESOPs substitute for better plans; in fact, they add to them rather than replace them in all but a few cases.
Third, ESOPs are funded at higher levels than typical other plans (usually 401(k) plans these days). The typical company contribution to a 401(k) plan is 3% of pay — and remember, it is a match. That means many lower-paid employees who do not defer at all get zip, while the highest paid employees, who tend to defer the highest percentage (not just absolute dollars) of pay get the biggest benefit from the match. By contrast, ESOP rules require a company contribution based on relative pay or a more equal formula to all employees meeting the basic service requirement (the same as for 401(k) plans) regardless of whether they put anything in or not. So ESOPs are more favorable to these lower-paid workers. The median corporate contribution to ESOPs is about 6% per year based on data from the DOL 5500 firms, and the mean about 8%, so employees are getting much larger annual contributions.
Fourth, as ESOPs mature, for various reasons, they tend to diversify. The typical ESOP holds about 80% of its assets in company stock, and that percentage often declines over time. At 55 with 10 years of service, employees can also start diversifying more shares.
So where does that leave us empirically? Data from a comprehensive Washington state study showed that ESOP participants have about three times the retirement assets as comparable employees in comparable companies, and their diversified assets were about the same — so the ESOP was gravy. So would you rather be 100% diversified in $25,000 or 33% diversified in $75,000? Remember, being 100% diversified in $75,000 is not a real-world option.
Finally, on valuation. Valuation firms’ greatest fear is litigation. One or two successful DOL or employee lawsuits can ruin a firm. If anything, this has made valuation firms pretty conservative in their approach. Business owners often tell me the valuation was disappointing. The standards here are pretty strict. Moreover, remember that a high valuation means employees also get paid out at that price — you can;t manipulate things to get the owner a high price and the employees a different one. So there tends to be an equilibrating factor at work here.
You can see more data on these issues on our Web site at http://www.nceo.org/library/corpperf.html and http://www.nceo.org/library/kruse_testimony.html.
I don’t know much about ESOPs, so thanks for the posts. Let’s see, I have three detailed and verifiable posts filled with facts, statistics, and sound data, and one about a mythical not-named company that is all insinuation and scare tactics from a poster too yellow to leave their real name.
Looks like I have learned the truth about ESOPs. Thanks J, K, and Corey, and thanks for nothing “Bunny”…LOL
I very much agree with Corey’s, Katherine’s, & Michael’s comments.
What is disturbing to me is that there seem to be two groups that are traditionally cited in the media about ESOPs. First is the academics like Professor Anderson, which are usually people that don’t teach about ESOPs, don’t know about them (e.g. see how often you can find ESOP in the index of any popular business textbook), have never worked in one, and have probably never visited one.
The other group is composed of bureaucrats that, again, don’t know much about them (but usually a bit more than the academics), have never worked in one, and have probably never visited one.
Unfortunately they are used as sources because their words are provocative, and that is considered newsworthy in today’s press. We don’t read the positive comments from real employee owners, or from professionals that provide services to ESOPs, because these testimonials are “good news”, a.k.a. boring in today’s press. It’s typical today to only see the “bad news”.
Here’s a problem with ESOP’s that I personally experienced. The “stockholders” aren’t really “owners” in the true sense because they have no voting rights with which to influence the management of the company or its policies. If they are unhappy with the way that the company is being run (for example, in the case of the company that I worked for, fraudulent billing of clients and other unethical practices) and they complain, management simply fires them. Thus, the structure is really the complete opposite of a true stockholder-owned company, in which the stockholders have the right to fire the management.
Wow, Mr. Anderson obviously does not understand how ESOPs really work. They are by no means close to an Enron situation. The stock that the employees have in an ESOP company is given to the employee. That’s right the employee does not have to pay for the stock, it is contributed to them on behalf of the company. So I guess I’m a little confused on what risk the employee has when they have a basis in the stock of ZERO? Please tell me what other retirement plan our employees can participate in that they will have NO COST associated with their retirement investment? On top of that what other investment does an employee have any control over how that investment performs? With our ESOP the employees understand that their performance everyday has an impact on the value of our stock and thus can increase their retirement benefit. In addition, every plan has a diversification policy that allows all participants to diversify out of company stock. With that said, I think that Mr. Anderson needs to do a little more research before he comments on something in the future.