Employee Ownership Through ESOPS:A Bad Bargain-BECKER

Recently Sam Zell, a leading Chicago businessman, arranged to buy the Tribune company, owner of the Chicago Tribune, Los Angeles Times, other newspapers, and many TV and radio stations. Aside from the low price that he paid, which reflected the rapidly declining fortunes of the print media and conventional TV stations, the most noteworthy aspect of the deal is that he plans to take the company private through the creation of an ESOP, or employee stock ownership plan. The number of American ESOPs has grown substantially during the past 30 years, and they are currently estimated to hold more than ¬Ω trillion dollars in assets and cover over 10 million workers. Probably the main reason for their growth is that ESOPs had during this period sizeable tax advantages that include deductibility from federal taxes not only of the interest payments but also of much of the principal used to finance creation of an ESOP. The argument made for these special privileges is that employee ownership is a good thing for workers that should be encouraged, but is that true? In reality, the creation of an ESOP is often a management tool to fend off unfriendly takeover bids. This was certainly the case behind the pilot-led ESOP created by United Airlines, and may have played a role in the ESOP to be created at Tribune company. ESOPs that help keep poorly performing management in power would contradict the claim that this organizational form improves rather than contributes to poor performance. Employee ownership is said to induce employees to work harder because they then have a financial stake in the company where they work. If that were true, owners would not need a tax advantage to create a sizable employee ownership since they would subsidize stock ownership by employees in order to improve productivity. Employees in a small closely held company with few workers may feel part of a family and work harder when they own an interest in the company. But in large companies with thousands of employees, such as Tribune company and other ESOPs like Science Applications International, ownership is not likely to be a strong motivating factor because hard working employees would then mainly benefit the many other employees and stockholders. Between 1995 and 2000 United Airlines was an ESOP with employee representatives on its board. Soon after 2000 the company entered bankruptcy with employees and management not known either for their great effort. Careful studies that compare the productivity of employee-owned companies with those owned by general stockholders are limited in number and scope, and advocates of ESOPs often get quite emotional in reacting to criticisms of the concept. Still, there is little hard evidence indicating that ESOPs are better run than normal companies. Reputable studies of employee ownership in the United States and other countries generally indicate that both profits and productivity remained about the same after companies introduced employee ownership. This is not surprising since most ESOP-owned companies are not run by employees, and for the reasons I gave employee ownership does not usually better motivate workers of larger companies. However, the most powerful argument against the view that employee ownership improves efficiency is that new firms would tend to take this form if it improved efficiency, and many older firms would convert to employee ownership on their own, even without tax advantages from doing so. Yet despite the competitive nature of American industry, with substantial rates of entry and exit of companies, less than 10 percent of employees in the United States work in firms that have ESOPs despite the considerable tax advantages to this organizational form. This more than all the highly imperfect comparisons between the performance of ESOPs and other companies is persuasive evidence that ESOPs would not usually be more efficient. Indeed, given the tax advantages, there would be many more ESOPs if they were equally efficient. Various types of employee-ownership of enterprises are found in many other countries. Usually they are the result of legislation that either forces or encourages this form of ownership through regulations and tax advantages, sometimes when public enterprises are privatized. The evidence on their efficiency as determined by their spread and performance in these countries is similar to that for the United States: even with special privileges, employee ownership has not become the dominant organizational form of enterprises. This suggests again that employee-owned companies would tend to under perform more conventional ownership structures that have stockholders who either manage the enterprise, or are largely independent of both employees and managers. The biggest and most obvious drawback of employee ownership from the perspective of the financial wellbeing of employees is that they hold their assets in one basket, the company where they work. Even without ownership of equity the wealth of experienced employees is still poorly diversified since it is largely in the form of human capital whose value depends on the success of the company that employs them. When the company does well, earnings from their human capital tend to rise more quickly, while the opposite occurs when the company does poorly. Ownership of shares in the company exacerbates the economic dependence on the company's performance since now the value of the financial assets of employees also rises and falls with the company's fortunes. The same problem arises with the many corporate pension plans that mainly hold bonds and stock that they have issued. When the company does poorly, the value of pension assets, and thus of the retirement incomes of employees, go down along with earnings, employment and profits of the company. Forcing top management to hold much of their financial assets in the stock of the companies they run through stock option and stock ownership plans reduces their financial diversification too, but that may be beneficial to the company's performance since the decisions of CEOs and others at the top do greatly impact company performance. As I indicated earlier, that is not the case for typical employees of large corporations. The disadvantages of being poorly diversified is not simply hypothetical, but was sadly brought home to employees of companies like Enron and United that had substantial stock ownership by employees. After these companies went into bankruptcy, mainly due in Enron's case to mismanagement and corruption, many employees not only lost their jobs but employees lost much of their other wealth as well.

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