Ideas in Development

Posner goes on to argue that there is little but weak evidence to support the notion that employee ownership of this kind increases productivity whatsoever.

An employee has no incentive to work harder just because he owns stock in his employer, since his efforts, unless he is a senior executive, are unlikely to move the price of the stock.  Nor is employee stock ownership likely to forge sentimental ties between employees and employers that might cause the former to work harder, although it may alleviate union pressures for wages or benefits. ¹

Posner’s comments attracted numerous responses, mostly from those who support ESOPs as a viable investment and business practice that benefits both employees and companies alike.  But before we begin to tear apart Posner’s argument, let us briefly discuss ESOPs, which are the dominant form of worker ownership in the United States.  (Worker cooperatives are fairly rare.)

So what are we talking about when we say “ESOP”? 

In theory, ESOPs instill a sense of ownership in workers and full accountability in management and ownership.  The ESOP model is a distinctly different model from the mainstream business model where the employee is simply a single element in the production process, and in theory have little leverage in the company.  Following the mainstream model, adding a machine to the production process means increased per-unit productivity which in turn raises the overall profit margin.  This raises the bottom line for the company and means greater profits, but there is no guarantee that the worker will gain any benefits whatsoever from this improvement.  The excess capital will most likely be reinvested in the company or reused to absorb and offset other costs.  But if the employee has a share of the company, if he literally owns a percentage of the business, he would benefit in two ways: a) he would benefit directly from a rise in stock prices, and b) he would have more influence into company decisions-- management executives would be more accountable to the worker in the decisions they make. ²  “The ESOP is the only existing method by which ordinary people can ‘earn’ shares in the company for which they work without reducing take-home pay, relying on their largely non-existent savings, or becoming personally obligated to repay a loan to purchase company shares.” ³

Today ESOPs are used by thousands of companies throughout the U.S.  Data from the 2006 General Social survey show that “20 million Americans own stock in their company through a 401(k) plan, ESOP, direct stock grant or similar plan, while 10.6 million hold stock options. That means that 17% of the total workforce, but 34.9% of those who work for companies that have stock, own stock through some kind of benefit plan, while 9.3% of the workforce, but 18.6% of those in companies with stock, hold options.” ⁴  In 2005 there were 9,225 companies with ESOP programs in the US, the total growth of assets in ESOP plans in 2005 reaching $600 billion. ⁵

Now let’s dig into the debate by examining Judge Posner’s central claims against ESOPs.

Argument 1: ESOPs are bad because they encourage employees to put all eggs in one basket, and discourage diversification.

Although it is true that ESOPs make the employee a shareholder in his or her own company, there is no rule that says “you have an ESOP with your company, therefore, you cannot invest anywhere else.”  To make this argument shows a general lack of understanding as to how ESOPs function.  With ESOPs, money from an employee’s future earnings is invested in company shares.  This money goes directly into investment before it sees your bank account, therefore it is not a part of your general investment portfolio (investing in an ESOP does not take money out of the pot you might use to invest elsewhere).  ESOPs do not take a slice out of your financial pie, they borrow on your future (larger) pie in order to expand your current one. 

In addition, some ESOPs offer as an option diversification of investments within the ESOP portfolio which allows the employee to diversify their future earnings investments.  “The law allows them (the employee) to require the trustee to use 25% of the value of their account to buy a diversified portfolio of investments when they have participated in the plan for at least 10 years and reached the age of 55.  Five years later, employees can ask that 50% of the account be diversified.  Companies have the option of paying the employees the required percentage of their accounts and letting them choose their own investments.” ⁶ 

According to Doug Kruse of Rutgers University, “about 70-75% of participants in plans that are heavily invested in employer stock [ESOPs, 401(k) plans, and profit sharing plans] are in companies that also maintain diversified pension [or other retirement] plans, indicating that such plans tend to supplement rather than substitute for diversified plans.” ⁷  Though there has been legislation put forward that would enable ESOP employees to further diversify their ESOP portfolio, to argue that ESOPs ‘under-produce diversification’ is disingenuous.

Argument 2: “The tax advantages of the (ESOP) form do not represent a social benefit, but merely a shift of tax burdens to other taxpayers.” 

This, again, is a misreading of the definition and application of Employee Stock Option Programs.  As argued by Norman Kurland in Owners at Work, “Contrary to the judge’s assertion, the taxpayer does not subsidize the cost of workers’ shares.  The cost of shares is construed as deferred compensation and the deduction from corporate income is no different from that allowed for any other wage or salary expense…. Workers pay ordinary income taxes on all distributions from an ESOP.  This a tax deferral, not tax avoidance.” ⁸  All ESOPs are simply a Trust, i.e., a sum of investments that are managed by a company trustee until either retirement or departure from the company.  In terms of its tax obligations, ESOPs are therefore no different from 401Ks, pension plans, or any other type of tax-deferred retirement plans that put away money for use by the employee upon retirement or leaving the company. ⁹ 

Argument 3: “Nor are we aware of an argument for subsidizing the ESOP form, as the tax law does, rather than letting the market decide whether it has economic advantages over alternative forms of business structure.”

Posner cites in his criticism of ESOPs Congressional intent in authorizing and promoting ESOPs (and his reluctance towards such policy) as good economic policy to provide retirement security for employees and better-performing companies in general.  He leaves out, however, Congress’ advocacy of ESOPs as excellent tools for corporate finance. ¹⁰

In general, the reasons for subsidizing ESOP programs are the same for supporting any program that improves business: what is good for business is good for government.  What is more, ESOPs are not only good for business but are good for workers as well.  It is a mechanism for broadening wealth ownership within a company, creating opportunity for capital accumulation for all workers.  Capital accumulation in turn provides greater economic security for workers and lowers their economic risk factor.  In turn this creates a worker that is more eager to do their job, thus allowing them to contribute more to the company, creating better working environments and greater productivity.  In this case, what is good for workers is also good for business, and what is good for business is good for government. 

Posner’s critique here of ESOPs is more a question of philosophical beliefs over what is the role of government in business and the private sector.  

Argument 4: Evidence for the claim that holding stock in one’s company will induce one to be more productive is “weak and makes no theoretical sense.”  Employees will not work harder simply because they are part-owner in the company.

It is here that Posner’s argument seems to minimize the employee’s ability to understand her own leverage; to assume that a worker would not work harder as a result of company ownership implies that the worker is only good for her labor and cannot understand the implications (or handle the responsibility) of having shares in the company. 

Numerous personal testimonies surfaced in response to Posner’s claim that ownership did not lead to empowerment.  Says Ben Wells, “One doesn’t need to look very hard to find thousands of ESOP employee-owners who know that their actions, combined with their co-workers, can and will produce great results… Motivated employees are better employees, and make a better business.  Can they overcome any obstacle?  Of course not.  But this motivation is the reason that ESOP companies tend to be more successful, and therefore less risky, than other companies.” ¹¹

Furthermore, ESOP advocates do not claim that ESOPs single-handedly raise production levels as a direct correlation to employee ownership and empowerment.  There are many factors that enter into employee empowerment that add up to create a given work environment and define relationships between management, board members and laborers.  To form a more nuanced understanding, argues professors Kruse and Blasi of Rutgers University, one must “look more closely at the corporate culture and employment practices to figure out what about the employee ownership might explain performance effects…” ¹²  In addition, research conducted from 1999-2007 supports the claim that employee ownership along with other forms of shared capitalism are associated with positive performance. ¹³

It is hard to tell what Judge Posner’s intentions were in making such statements regarding the viability of ESOPs in his 2006 Summers v. State Street decision. ¹⁴ It should be noted that the defendant in the case, United Airlines ESOP, represents only one ESOP in a company that falls into the category of the larger companies that use ESOPs.  These companies, as we discussed earlier, do tend to hold a larger portion of their investments in company shares than smaller ESOP companies do.  In addition, it is logical to conclude that there are many factors that affect productivity and the level of ownership felt by the employees in a given company, and that many of these other factors (workplace environment, local branches with local decision-making, collectivity, person-to-person business transactions) are managed differently in smaller firms than larger firms such as United Airlines.   As Keith Robertson argues, “most ESOPs are in small, privately held companies, not huge, publicly traded enterprises like United Airlines.  The operation of these two types of businesses is markedly different.  Judge Posner’s lack of knowledge and experience in this area is apparent, as he discounts the social and economic benefits to be gained from successful, local businesses, as well as how market economics affect small companies much differently than large ones…” ¹⁵

Perhaps Posner’s comments do apply to the United Airlines ESOP and the case of Summers v. State Street, but does this mean that all ESOP programs are bad?  I don’t think so.  Needless to say, the jury is still out as to whether ESOPs are the best form of employee long-term investment plans or a premier tool for building assets for average employee—even if the Judge has spoken. 

Will Gordon, when he is not acting in a movie (“The Bronx is Burning”), or playing professional baseball in Lithuania, or coaching in France, or substitute teaching at a Quaker school in North Carolina, can be found at CFED-Durham, copy-editing Bill Schweke’s prose and providing research assistance.