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Intriguing ESOP Benefits: Thoughts on Recent Research

ESOPs (Employee Stock Ownership Plans) are IRC section 401(a) qualified defined contribution plans which allow employees to own stock in the company for which they work. ESOPs may be sponsored by public companies or closely held corporations.  According to The National Center for Employee Ownership (NCEO), there are over 6,400 ESOPs in the U.S., with about 10% found in publicly traded companies.

ESOPs may be used to accomplish a variety of purposes. Due to certain tax benefits Congress established in exchange for employers economically sharing ownership with employees, ESOPs are most often employed as an estate planning tool for owners of private, closely-held businesses.  Periodically an ESOP is used to provide selling shareholders some liquidity to diversify their investment assets or because an outright sale may not have been feasible due to market or economic conditions.  A small percentage of ESOPs, perhaps 5%, are established to help the company grow. 

With increasing frequency in what may ultimately be shown to be a more compelling motive, there is another reason more companies are opting to implement an ESOP:  ESOPs have been demonstrated to help a business and society as a whole by driving employee engagement. 

Under-Recognized ESOP Benefits

There is growing enthusiasm about ESOP benefits, which traditionally have not been a significant consideration when considering implementation of an ESOP.  These benefits have been proven out by an expanding body of research.  These benefits ultimately are reflected in strengthened profitability, employee/labor stability, and socially significant economic growth.

  • Strengthened Profitability: Profitability is strengthened when an ESOP is used to heighten employee engagement and even more so as employees behave as owners.  The impact of customer-facing employees who exhibit increased engagement is reflected in reduced customer turnover and increased product cross-sales. In a 2011 survey completed by the Employee Ownership Foundation, over 70% of ESOP-owned firms reported increased productivity than the previous year. Both revenues and expenses are affected as employee engagement strengthens, with productivity level increases of 4%-5% or higher[1].
  • Employee/Labor Stability: A study of ESOPs established by S-Corporations indicates that ESOPs demonstrated substantially more employment growth than private businesses. Among surveyed firms in the U.S., 60% showed increased employment during the period 2001¬2011, compared to roughly no change in total private, nonfarm employment during the same period. In addition, S-Corp. ESOP companies regained momentum faster than private companies after the recession that began in 2008[2]. Of the most recent findings, the majority of ESOP-owned firms during the COVID-19 pandemic outperformed other firms at retaining jobs at a four to one rate and were significantly less likely to reduce employees’ hours or pay.[3]
  • Socially Significant Economic Benefits: More retirement security for workers. In a study of employee ownership’s role in supporting asset/wealth accumulation, researchers found that ESOPs can reduce wealth inequality by providing an opportunity to build wealth unavailable through income alone. Of the low to moderate-income workers surveyed, their ESOP account offers them substantial asset accumulation with a median ESOP account value of $165,000 compared to the typical American household with $17,000 in savings. Those workers closest to retirement (ages 60 to 64) have 10 times higher wealth than the average American in that age group.[4] There have been similar positive findings as it relates to wages and compensation in employee-owned companies.

Implementing an ESOP is not enough for a business to experience heightened engagement. Aside from structuring the ESOP appropriately, the value of the ESOP must be clearly communicated to employees to maximize the benefits to the company and employees. By building an ownership culture, companies can help employees become more engaged, work as a team, and drive growth as employees think and act like owners. The ESOP Association reports that 58% of companies surveyed have implemented an employee communications program[5], which shows that employee-owned companies can maximize the value of their ESOP by taking a few easy steps toward improving communication.

In Conclusion

ESOPs may be used for traditional purposes such as to manage taxes, estate planning, or reward employees who helped create a business. With effective and purposeful communication, ESOPs can drive additional value to companies and their employee owners leading to strengthened profitability, employee/labor stability, and socially significant economic growth.

To learn more about the benefits of an ESOP, contact a member of First Midwest’s ESOP Finance Group.

This article was written by First Midwest's ESOP Finance Group.

[1] Source: Research Evidence on Prevalence and Effects of Employee Ownership, Douglas Kruse, Ph.D., National Center for Employee Ownership, 2002.

[2] Source: “An Analysis of the Benefits S ESOPs Provide to the U.S. Economy and Workforce,” Alex Brill, Matrix Global Advisors, July 26, 2012.

[3] Source: “Employee-Owned Firms in the COVID-19 Pandemic…,” Employee Ownership Foundation and Rutgers School of Management and Labor Relations, 2020.

[4] Source: “Building the Assets of Low- and Moderate-Income Workers and their Families | The Role of Employee Ownership,” Joseph Blasi and Douglas Kruse, Rutgers School of Management and Relations, March 2019

[5] “2019 ESOP Economic Performance Report,” The ESOP Association, 2019.

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