An employee share ownership plan (or "stock ownership", abbreviated to "ESOP") is the practice of companies giving staff members shares in their company as part of their salary.
An Employee Share Option Plan (ESOP)[1] is a defined contribution employee benefit plan that allows employees to become owners of stock in the company they work for. It is an equity based deferred compensation plan. Under the ESOP plan, companies provide their employees the opportunity to acquire the company's shares at a reduced price over a period of time.
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There are a variety of mechanisms for employee ownership:
The tax rules for employee ownership vary widely from country to country. Only a few, most notably the U.S. Ireland, and the UK, have significant tax laws to encourage broad-based employee ownership.[3]
Employee ownership appears to increase production and profitability, and improve employees' dedication and sense of ownership.[4][5][6][7][8] The key variable in making it work is a high degree of involvement in work-level decisions (employee teams, instance). Involvement in governance has no consistent effect, and some have argued that democratic leadership can lead to slow decision-making. Employee stock ownership can increase the employees financial risk if the company does poorly.,[9] but the data from ESOPs in the U.S. show that ESOP participants have three times the total retirement assets (including 401(k) plans) as comparable employees in non-ESOP companies and have diversified holdings at least as large.[10]
Notable employee-owned corporations include the John Lewis Partnership retailers in the UK, and the United States the 150,000 employee supermarket chain Publix Supermarkets. The most celebrated (and studied) case of a multinational corporation based wholly on worker-ownership principles is the Mondragon Cooperative Corporation.[11] Unlike in the United States, however, Spanish law requires that members of the Mondragon Corporation are registered as self-employed. This differentiates co-operative ownership (in which self-employed owner-members each have one voting share, or shares are controlled by a co-operative legal entity) from employee ownership (where ownership is typically held as a block of shares on behalf of employees using an Employee Benefit Trust, or company rules embed mechanisms for distributing shares to employees and ensuring they remain majority shareholders).[12][13]
Different forms of employee ownership, and the principles that underlie them,[14] are strongly associated with the emergence of an international social enterprise movement. Key agents of employee ownership, such as Co-operatives UK and the Employee Ownership Association (EOA), play an active role in promoting employee ownership as a de facto standard for the development of social enterprises.[15]
Most features of employee-owned corporations described in this article are not specific to any one nation. The information on taxation and stock trading refers to United States law and may differ elsewhere.[16]
There are several rationales for employee-owned corporations in the U.S. First, there are substantial tax benefits for employee ownership companies. Employee stock ownership plans (ESOPs) are set up by companies as a kind of employee benefit trust. An ESOP is a type of employee benefit plan designed to invest primarily in employer stock. To establish an ESOP, a firm sets up a trust and makes tax-deductible contributions to it. All full-time employees with a year or more of service are normally included. The ESOP can be funded through tax-deductible corporate contributions to the ESOP. Discretionary annual cash contributions are deductible for up to 55% of the pay of plan participants and are used to buy shares from selling owners. Alternatively, the ESOP can borrow money to buy shares, with the company making tax-deductible contributions to the plan to enable it to repay the loan. Contributions to repay principal are deductible for up to 25% of the payroll of plan participants; interest is always deductible. Dividends can be paid to the ESOP to increase this amount over 25%. Sellers to an ESOP in a closely held company can defer taxation on the proceeds by reinvesting in other securities. In S corporations, to the extent the ESOP owns shares, that percentage of the company's profits are not taxed: 100% ESOPs pay no federal income tax, but the profit distribution to the participants is taxed, just as in any S-corporation. Employees do not pay taxes on the contributions until they receive a distribution from the plan when they leave the company; even then they can roll the amount over into an IRA.
Stock acquired by the ESOP is allocated to accounts for individual employees based on relative pay or some more equal formula. Accounts vest over time, usually following one of two formulas: in the first, vesting starts at two years and completes at six; in the second, participants become 100% vested after four years. When employees leave the company, they receive their vested ESOP shares, which the company or the ESOP buys back at an appraised fair market value. ESOP participants must be allowed to vote their allocated shares at least on major issues, such as closing or selling the company, but are not required to be able to vote on other issues, such as choosing the board.
Employees also can acquire stock through grants of stock options, the right to buy shares at a price set today for a defined number of years into the future. There are no special tax benefits associated with most forms of stock options, however. Employees can also become owners by purchasing shares in a stock purchase program, usually at a discount, by buying stock in their 401(k) savings plans, or by companies making matches of company stock to employee deferrals into these plans. Stock in 401(k) plans can be bought with pretax income, while company contributions are tax-deductible.
Altogether, there are about 11,500 ESOPs covering 11 million employees, almost all in closely held companies. The other forms of ownership generally occur in public companies, and another estimated 15 million employees participate in one or more of these plans (see data from the National Center for Employee Ownership).
Diversification has been cited as an issue, and there are examples to support this belief. Employees at companies such as Enron and WorldCom lost much of their retirement savings by over-investing in company stock in their 401(k) plans, though these specific companies were not employee-owned. Studies in Massachusetts, Ohio, and Washington state, however, show that, on average, employees participating in the main form of employee ownership, employee stock ownership plans (ESOPs), have considerably more in retirement assets than comparable employees in non-ESOP firms. The most comprehensive of the studies, a report on all ESOP firms in Washington state, found that the retirement assets were about three times as great, and the diversified portion of employee retirement plans was about the same as the total retirement assets of comparable employees in equivalent non-ESOP firms. Wages in ESOP firms were also 5% to 12% higher. National data from Joseph Blasi and Douglas Kruse at Rutgers shows that ESOP companies are more successful than comparable firms and, perhaps as a result, were more likely to offer additional diversified retirement plans alongside their ESOPs. The data is also available at www.nceo.org and [1].
In some circumstances, shares in ESOP trusts accrue disproportionately to employees who enrolled earlier. Newer employees at ESOP companies can be left without much opportunity to participate in the program, as a large portion of the shares have already been allocated to longstanding employees.[17]
Employee ownership in 401(k) plans, however, is more problematic. About 17% of total 401(k) assets are invested in company stock—more in those companies that offer it as an option (although many do not). This may be an excessive concentration in a plan specifically meant to be for retirement security. In contrast, it may not be a serious problem for an ESOP or other options, which are meant as wealth building tools, preferably to exist alongside other plans. Detailed data on 401(k) plan investments are available at www.ebri.org, the home page of the Employee Benefits Research Institute.
ESOPs in the U.S. are not subject to the accounting rules for stock option plans and other equity instruments. ESOPs in the U.S. are a specific kind of plan set up by U.S. law. The term "ESOP" is often used generically for employee ownership, especially in India, where it refers to employee stock option plans. That can cause a great deal of confusion and readers should be aware of just how the term is used. In the U.S., ESOP companies take a compensation charge for contributions to the ESOP when they are made.
Stock options and similar plans (stock appreciation rights, phantom stock, and restricted stock, primarily) are common in most industrial and some developing countries. Only in the U.S., however, is there a widespread practice of sharing this kind of ownership broadly with employees, mostly (but not entirely) in the technology sector (Whole Foods and Starbucks also do this, for instance). The National Center for Employee Ownership estimates over 13 million employees are in these broad-based plans in the U.S. However, the largest value of holdings of these assets remains with executives, and in other countries, these plans are rarely granted broadly.
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