How can employee ownership be significantly expanded? The Lake Quinsigamond Group, an informal network of advocates and activists, has recently revised and updated its white paper for broad circulation. The full text–including all policy proposals, an executive summary and a checklist–appears here.

Group members have already begun discussing the proposals with Washington policy analysts and legislative aides on both sides of the aisle. The immediate goal is to launch conversations about how to expand employee ownership; the group ultimately hopes to develop broad congressional support for the proposals, and for employee ownership in general.

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Turning Employees into Owners

Rebuilding the American Dream

A White Paper

March 2019

Contact: Michael Quarrey, Vice President, Web Industries, Marlborough MA.[email protected]

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EXECUTIVE SUMMARY

The Challenge. Despite today’s low unemployment, the US economy is not serving its citizens well. Most Americans have seen their incomes stagnate. Most have little economic cushion. Opportunities for good jobs and advancement have declined, particularly for the two-thirds of the adult population without a college degree. Many Americans’ sons and daughters will fare no better economically than their parents.

The Solution. Find ways to broaden and deepen employee ownership. When employees own a significant stake in the companies they work for, policies that promote corporate growth also promote economic fairness.

Employee ownership is now firmly established in the US economy and has a proven track record of performance. Companies with significant employee ownership:

• Offer better pay and benefits
• Grow faster, innovate more, and enjoy higher productivity
• Survive longer, and are less likely to lay people off in a downturn
• Provide greater opportunity for young workers
• Provide an ownership stake that significantly supplements other retirement income

Since the first enabling legislation in 1974, employee ownership has grown steadily to include 9% of the private-sector workforce. The opportunity now is to expand it to 20%, 30%, or more.

How to get there. Employee ownership is a big idea, capable of transforming the US economy. Since 1974, Congress has passed many provisions to encourage it, all with widespread bipartisan support. Today’s leaders have an opportunity to broaden and deepen that support through education, advocacy, and new policies. For example, Congress could:

• Level the playing field for corporate divestitures and sales of companies by private equity firms, so that many more employees have an opportunity to buy the company they work for through an employee stock ownership plan (ESOP).
• Employee Ownership Investment Corporations, modeled after Small Business Investment Corporations, could help provide capital for sales to an ESOP.
• An Employee Equity Loan Program could guarantee loans for ESOP transactions. Both measures would have no budgetary impact.
• Tax incentives would encourage corporate and private-equity sales to an ESOP.
• Opportunity-zone regulations can ensure that employee-owned companies are eligible for the full benefit of recent Opportunity Zone legislation.
• Encourage publicly traded companies to offer stock to employees at a discount.
• Require companies that receive various forms of special treatment from the government to establish employee stock-ownership plans or programs.

The private sector, too, can continue to launch initiatives aimed at spreading employee ownership. One innovative move would be to establish a revolving fund that buys healthy companies and sells them over time to an ESOP, using the proceeds to buy more companies, and so on.

All such measures would go far toward revitalizing the middle class and assuring good jobs and opportunity for millions of American working people.

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Turning Employees into Owners:

Rebuilding the American Dream

We Americans believe that ours is the land of opportunity. We celebrate business pioneers, from Thomas Edison to Steve Jobs. We admire men and women who rise from poverty through enterprise and diligence. Over the years, this has made America the preferred destination for millions of immigrants whose ambition and talents find their fullest expression here. Our high rates of entrepreneurship reflect this dynamism.

Today, however, our engine of opportunity is sputtering. New-business formations are flat or declining. For many, our economy isn’t delivering the income growth, job security, and middle-class standard of living that were once the reward for a lifetime of hard work. The American dream once promised that children would do better than their parents. But despite our booming stock market and low unemployment, we are experiencing the opposite. We are moving from a fluid land of opportunity into a stratified society characterized by growing disparities of wealth and income.

Among our concerns are the following:

1. A lack of good jobs. About two-thirds of Americans still do not have a college degree. With the decline in manufacturing jobs, people without college educations or special skills have difficulty finding rewarding employment. Even in today’s low-unemployment economy, millions of jobs pay less than $15 an hour, provide few benefits, and offer little or no security. Walmart, the country’s biggest private employer, raised its starting wage in 2018 to just $11 and now pays its hourly employees an average of $13.79, or not quite $29,000 a year for full-time work.

• Little or no economic cushion. The median wealth of American families in 2016 was about $78,000. But wealth ownership is highly concentrated. The top 0.1% of households own as many assets as the bottom 90%. The top tenth own 84% of all US-owned stock, including shares held in 401(k) accounts and pension funds. About half of Americans own no stock. A Federal Reserve survey in 2018 found that four in ten US adults would have trouble coming up with $400 in an emergency. About half of Americans 55 and older have no retirement savings. Among those who do, the median amount is enough to generate only about $400 a month. Bureau of Labor Statistics data show that just over half of full-time workers participate in any kind of retirement plan; the proportion decreases as you go down the wage scale.

• Stagnant incomes. Between 1979 and 2015, the US economy grew nearly 160% in real terms, and GDP per capita was up about 80%. According to the Congressional Budget Office’s conservative figures, people at the very top of the income scale—the famous one percent—increased their pretax income 233%. Meanwhile the lower four-fifths of the income distribution gained 32%. In short, the incomes of most American households rose less than half as much as GDP per capita.

• High returns to capital, low returns to labor. Another set of figures illustrates a similar discrepancy: from 1973 to 2018, inflation-adjusted wages for nonsupervisory workers were essentially flat. Meanwhile, a dollar’s worth of stock grew (in real terms) to $14.09. So those working for a living have seen their incomes stagnate, while those with significant income from capital ownership have done very well. This is a recipe for widespread discontent and frustration.

• Declining opportunities. Migration from lower-income groups toward higher-income groups is becoming increasingly difficult, even for talented young people. Rates of social mobility, which regularly increased until around 1980, are now declining. More of the children of the poor are staying poor, while more of the offspring of the well-to-do are remaining well-to-do. Again, a recipe for discontent.

• Distant and disconnected ownership. Too many companies—notably those controlled by financial owners such as private equity firms—are treated like pawns on a financial chessboard, not as pillars of local communities. They are acquired, divested, and moved from one absentee owner to another. They may be shut down even when profitable—if, for example, relocating their assets or brands to offshore production promises more profit. These are the companies that should be the economic bedrock of communities and the source of employment for millions of Americans, especially in rural and small-town America.

• Declining innovation. In 2018, the United States dropped out of Bloomberg’s list of the world’s ten most innovative economies. Increasing market dominance by supersized companies, especially in technology, has led to a broad slowdown in spending on innovation throughout the economy.

These are familiar indictments, and there is no lack of proposed solutions from both true-blue liberals and bright-red conservatives. Unfortunately, our political system seems to be in perpetual stalemate; both federal and state public policy measures have had little effect. Existing elements of the social safety net—including food stamps, subsidized housing, and Medicaid—help many low-income people, but by themselves are wholly inadequate to take care of the estimated 80% of the population who live from paycheck to paycheck.

But the authors of this white paper are convinced from experience that there is an enterprise-friendly, nongovernmental solution to many of these ills—one that enjoys bipartisan support. It’s called employee ownership.

Revitalizing the middle class

At the moment, close to 7,000 US companies have an employee stock ownership plan, or ESOP, that owns anywhere from a small minority to 100% of the firm’s shares. An estimated 2,000 of these companies are wholly owned by their employees. The ESOP world includes giants such as Publix Super Markets (190,000 employees), midsize companies such as W.L. Gore & Associates (9,500 employees), and smaller firms such as King Arthur Flour (300 employees). Many other companies do not have an ESOP but provide their employees with significant numbers of shares through stock or option awards. A few hundred enterprises are wholly owned by their workers through a co-op structure.

Academics and other researchers have studied the effects of ESOP ownership over many years, and their findings are remarkably consistent. Employee ownership companies outperform similar companies with conventional ownership. They put more money in the hands of their workers. For example:

• Better corporate performance. Adjusting for changes in overall industry growth, ESOP companies grow about 2.5 percentage points per year faster in sales, employment, and productivity after they set up an ESOP than would have been expected if they had not set up an ESOP. Other studies have found productivity increases of up to 4-5%, on average, in the year an ESOP is adopted.  
• Higher survival rates. A study tracking the entire population of ESOP companies over ten years found that privately held ESOP companies were only half as likely as non-ESOP firms to go bankrupt or close, and three-fifths as likely to disappear for any reason.
• Fewer layoffs. Nationally representative surveys consistently show employee-owners less likely to report being laid off in the previous year. In 2014, the layoff figure was 9.5% for all working adults compared to 1.3% for employee-owners.
• Better employee compensation and benefits. One study found employee-owners earning between 5% and 12% more in median wages compared to employees in matching non-ESOP companies. The same study found that ESOP participants have 2.5 times as much in retirement plans and 20% more financial assets overall than employees of the comparison group of non-ESOP companies. Higher compensation and retirement benefits mean fewer demands on public social services.
• Greater opportunity for young workers. A recent survey, which looked at workers’ economic circumstances over time, compared people age 28 to 34 with employee ownership to their peers without. The study found that those with employee ownership enjoyed 92% higher median household wealth, 33% higher income from wages, and 53% longer median job tenure.
• Higher levels of innovation. Companies with broad-based employee-ownership programs are more likely than others to introduce high-engagement, team-based management practices. These practices create more opportunities for idea generation and internal entrepreneurship than conventional top-down management.

Since the first ESOP legislation in 1974, employee ownership has grown steadily to include 9% of the private sector workforce. What if the proportion could grow to 20%, 30%, or more? That would be a big step toward boosting productivity, overcoming the stagnant-wage problem, building stronger communities, and revitalizing the middle class.

The challenge—and the opportunities

Employee ownership is a big, bold idea, a market-tested concept that is capable of transforming the American economy. Political leaders who espouse it have a range of options. They can visit and celebrate employee-owned companies and the employee-owners who work there. They can use their bully pulpits to educate voters about all the ways in which our economy is failing its citizens, and all the ways in which employee ownership can remedy the situation. Where policy is concerned, they have several choices: new regulations, new agencies, new investment institutions, and new tax incentives, all designed to foster and support this form of ownership. In what follows, we will explore just a few of these possibilities. We will look at how companies currently become employee owned, how many more could become so, and the obstacles that get in the way of these transitions. We will also propose some specific legal structures and incentives that could overcome these obstacles and thereby lead to a substantial increase in the number and influence of employee-owned firms.

Sale of a company to an ESOP. In the United States, ESOPs are by far the most common form of employee ownership. Legally, they are government-regulated retirement plans, and they have enjoyed broad bipartisan support in Congress. Thanks to previous legislation, individual company owners who sell their businesses to the employees through an ESOP gain certain tax advantages on the proceeds. An S corporation that is partly or wholly owned by an ESOP pays no current federal income tax on the corresponding portion of its earnings.

Most existing ESOPs were established when individual owners decided to sell part or all of their businesses to employees through this mechanism. Contrary to a common belief, employees almost always pay nothing for the stock they receive in their ESOP account. The transactions are typically funded by company cash or bank loans; often, the seller takes back a note for part of the selling price. If there are loans or notes, the debt is paid off from the future earnings of the company, as in an ordinary leveraged buyout. ESOPs without leverage are funded by annual contributions from the company.

As baby-boom entrepreneurs begin to retire in large numbers, more individually owned companies will come up for sale. According to estimates, at least 150,000 of these companies are candidates for ESOPs. But not all companies that are offered for sale are owned by individuals. Two other categories of sellers account for a large number of transactions and a great deal of economic value:

• Corporate divestitures. In 2016, public companies in the United States divested more than $75 billion worth of subsidiary divisions, most of that total bought by domestic acquirers. As far as we know, none of these companies were sold to employees. This shouldn’t be surprising: corporate divestiture teams are unlikely to be familiar with ESOPs, and there are no specific incentives that might induce them to consider this option.

• Private equity sales. U.S. private equity firms today actively manage more than $3 trillion in corporate assets. The usual goal of such firms is to turn over 100% of their assets every 5 to 7 years through the sale of portfolio companies to new owners. Few of these sales have resulted in employee ownership.

These numbers are a reminder: every business that doesn’t close its doors will eventually be sold. It will be sold to public investors, to an investment firm, to another company, to a group of individuals such as a management team, or to its employees. The numbers are also a reminder that employee ownership could be scaled up quickly if the right institutions and incentives were in place.

The obstacles, and how to overcome them. There is a significant disparity between a prospective ESOP buyer and other buyers, such as private equity funds and corporate acquirers. For example:

• Corporate and other buyers typically have ready cash available for the purchase—an appealing factor for sellers. ESOPs, by contrast, must usually borrow much of the necessary capital from a bank. Because it is difficult to finance 100% of a deal, ESOPs typically must find other sources of capital, such as seller financing, or they must buy out an owner over time. Neither of these approaches is attractive to a corporate seller.
• Corporate and other buyers may have synergies that allow them to pay a relatively high price; ESOPs face legal constraints that may make it impossible for them to pay the same amount.
• Corporate and other buyers may be able to provide the management and functional resources that enable the new company to operate independently; ESOPs spinning off from a corporate parent may find that task more difficult.

New institutions, along with new tax and regulatory policies, could level this playing field. For example:

****Proposal: Employee Ownership Investment Corporations (EOICs). Like existing Small Business Investment Corporations, or SBICs, EOICs would be privately funded. They would be designed to address the gaps in capital required for employee ownership transactions, especially those involving corporate divestitures. EOICs would provide subordinated “first dollars in” to a deal—funds that serve the same function as equity in the eyes of other lenders. Where the resulting ESOP owns at least 30% of the company’s stock, such financing would be eligible for federal guarantees, strengthening the EOIC’s borrowing capacity to finance the remainder of the deal.  

The EOIC proposal above is budget-neutral to the federal government, and the idea stands on its own without further incentives. To incentivize private investment in EOICs and accelerate the growth of employee ownership, however, Congress could also provide EOIC investors with a 50% reduction in taxable interest income from such investments. This incentive is analogous to that provided in prior legislation, repealed in 1992, that gave banks a 50% exclusion of interest income from loans to ESOPs. That provision dramatically raised the profile of ESOP lending in the banking community. The current proposal, however, focuses specifically on subordinated debt, thereby addressing a key obstacle to establishing ESOPs in divestitures and private equity transactions.

****Proposal: The Employee Equity Loan Act. A new Employee Equity Loan Program (EELP), housed within an appropriate branch of the federal government such as the Economic Development Administration of the Commerce Department, could also provide such guarantees, again at no net cost to the federal government. Qualifying loans supported by this program would be sized and priced to compete with private equity buyout funds.

EELP loans could be sourced through the existing network of financial institutions that have staffs trained in administering government loan guarantee programs. Unlike existing programs, however, these loans would specifically target middle-market businesses ($50 million to $500 million in revenue). They would also require that the proceeds be used to purchase stock either from the selling owner or from the company making the loan application. The purchased stock would have to be contributed to a legal trust, such as an ESOP, formed for the benefit of the company’s management and employees. (A download of this proposal, described in greater detail, can be found here.)

Tax policy has also been widely used to achieve certain social objectives, including existing support for ESOP transactions and ESOP-owned companies. Additional tax incentives could have a significant effect on the behavior of corporations and private equity firms that are selling operating businesses. The impact of trillions of dollars in employee-owner equity after a decade or more of corporations and private equity firms selling to ESOPs would be enormous.

****Proposal: divestiture incentives. Grant an exemption in taxable gains, up to responsible fiscal limits per transaction, for corporations that divest operating units into employee ownership. Include provisions to ensure that employees receive a meaningful share of ownership in the ESOP, and regulations to prevent governance and financial abuse by market manipulators. Add a minimum holding period for the sold shares or assets and a clawback of avoided gains by the seller if the acquiring firm fails to retain a significant percentage of employee ownership over a meaningful period. Such measures would help compensate the seller for potentially lower sale prices. The welfare of employees is often a consideration in corporate divestitures, and many large companies might divest to ESOPs if appropriate incentives were in place.

****Proposal: private equity incentives. Grant an exemption in taxable gains, up to responsible fiscal limits per transaction, for private equity and investment companies that sell portfolio companies to ESOPs. Include provisions to ensure that employees receive a meaningful share of ownership in the ESOP and to prevent governance and financial abuse. Add a minimum holding period for the sold shares or assets and a clawback of avoided gains by the seller if the new firm fails to retain a significant percentage of employee ownership over a meaningful period.Include a clawback provision if initial performance under the ESOP falters.

****Proposal: ESOPs in Opportunity Zones. Opportunity Zones are a new policy designed to promote economic growth in distressed communities through tax incentives. Provisions implementing the idea were included in the Tax Cuts and Jobs Act of 2017. A conventional opportunity-zone investment involves acquiring equity in a business or building located in such a zone; an investor who holds the property for at least ten years and then sells it enjoys significant tax relief on the proceeds. Private equity firms and other investors specializing in ESOPs have designed transactions where an employee stock ownership trust purchases a company in conjunction with private equity capital, typically reorganizing the company into a 100% ESOP-owned S corporation and structuring the investor’s interest as (for example) subordinated debt or warrants. We believe that the currently proposed Opportunity Zone regulations, when finalized, should make clear that such investments qualify for the full benefits of the legislation.

Employee ownership in publicly traded companies. The case of publicly traded companies is different. Some smaller ones could be sold to their employees through a buyout. But most will continue to be publicly traded, and many of these have already created a variety of methods to get shares into the hands of their employees. Procter & Gamble’s employees own an estimated 15% of the company’s shares. Southwest Airlines’ employees own a significant chunk of theirs. Many high-tech companies, including Google and Microsoft, distribute shares, stock options, or both to a broad base of employees. Simple changes to the tax laws could encourage more companies to spread the wealth in this manner.

****Proposal: Support for employee stock purchase plans. Many public companies currently offer stock to employees at significantly discounted rates. Employees specify a payroll deduction over an offering period of three months to two years, at which point they can use that money to buy shares at a discount (normally 10% but sometimes considerably more). Because of the programs’ structure, employees have an opportunity to build significant equity stakes in addition to their pension or 401(k) benefits. Yet only about a third of eligible employees participate. Some may live paycheck to paycheck. Many may not understand the program. If companies seeded the first two years of participation in the fund by giving everyone a $1,000 grant to buy shares, employees would likely see the “guaranteed win” nature of the offering and participate at much higher rates. To encourage this, the government could provide a tax deduction for these grants. 

Employee ownership in companies enjoying government-funded privileges. Every year, the U.S. government and the governments of the nation’s 50 states take measures that affect the American economy. They pass tax laws and regulations. They provide tax credits, incentives, and subsidies of various sorts. Every one of these measures can be used to encourage employee ownership and contribute to the public goods of building a stronger, more equitable economy. Consider the 2018 corporate tax cut, for example. Suppose that the reduction in corporate taxes had been linked to the creation of an ESOP or another broad-based plan to encourage ownership. That would have provided the same boost to business investment and economic growth, while sharing the benefits beyond current shareholders to millions of employees.

As Rutgers professor Joseph Blasi and his coauthors put it in a recent paper, “A Congress or Administration that wants to support broader employee share ownership and profit sharing in economic rewards could develop a checklist on any major program or legislation that is proposed to examine its likely effects on, and capacity to increase, financial participation and capital ownership and access to income on capital of employees and citizens in our economy.” That is the most reliable route to a stronger economy.

****Proposal: employee ownership requirements. Companies enjoying “corporate welfare” benefits should be required to adopt employee ownership programs through ESOPs, broad-based stock grants, options, or similar mechanisms so that over time a meaningful percentage of their equity is held by their employees.

Private sector initiatives. Today, a wide variety of companies and nonprofit organizations have created a fertile ground for employee ownership initiatives. The National Center for Employee Ownership, the ESOP Association, and Employee-Owned S Corporations of America have built networks of employee ownership practitioners and advocates. State-level organizations in Ohio, Vermont, Pennsylvania, and other states educate local business leaders and policymakers about employee ownership opportunities. The Institute for the Study of Employee Ownership and Profit Sharing (Rutgers University) and the Beyster Institute (University of California at San Diego) lead academic research and analysis in the field. Many financial institutions specialize in ESOP-related transactions. A large group of attorneys, bankers, consultants, and other experts help company owners establish and maintain successful ESOPs.

But there is much more that could be done by business leaders and philanthropists. They could help establish more state centers. They could finance marketing campaigns to broaden public awareness of employee ownership. Most dramatically, they could act directly to increase the number of large, successful employee-owned companies.

****Proposal: Private revolving fund(s) to create ESOPs. Private philanthropy is a longstanding tradition in America; those who have benefited most from the system give back in ways that promote the general welfare. We can think of no more effective way to leverage the power of capitalism to spread prosperity than to create more employee ownership. Wealthy individuals, for example, could establish a revolving fund whose sole purpose is to buy companies from private owners, corporations, or private equity firms and then sell these companies to the employees over time using an ESOP. The fund can use the proceeds from its sales to buy more companies and sell those, too, to an ESOP, and so on. This effort requires no act of government. It might work through a charitable trust set up for this purpose, thereby providing additional incentives for the funders.

A note on risk.  All stock ownership involves some risk. ESOPs are often thought to increase the risk because employees have “all their eggs in one basket.” When employees hold shares in the company where they work, the risk does not go away, but they are usually well placed to make sure that the basket is in good shape. Indeed, many rank-and-file employees at successful ESOP companies have already acquired a surprising degree of financial security, some with more than a million dollars in their retirement accounts.

To be sure, a lack of diversification in an investment portfolio does entail risk. This risk is moderated with ESOPs when, as is nearly always the case, employees are granted the shares and do not purchase them with wage cuts, savings, or retirement-plan funds. Moreover, employees in an ESOP company may actually face less overall risk than employees of a non-ESOP company. The proper comparison is between employees with ESOP accounts and employees with either a conventional retirement plan, such as a 401(k), or no plan at all (a group that includes about 60% of US private-sector workers). Consider the following facts from the nonprofit National Center for Employee Ownership:

• Based on Department of Labor filings, companies on average contribute 50% to 100% more to ESOPs annually than non-ESOP companies do to 401(k) plans.
• Most of the money in the typical 401(k) plan comes from the employee. With few exceptions, all the assets in an ESOP come from the company. The employees do not have their own money at risk.
• Research by the Department of Labor shows that ESOPs not only have higher rates of return than 401(k) plans, but are also less volatile.
• ESOP companies lay people off less frequently than non-ESOP companies.
• ESOPs cover more employees, especially younger and lower income employees, than 401(k) plans.
• ESOP companies are somewhat more likely to offer secondary retirement plans than conventional companies are to offer any plan.

To mitigate the remaining risk of ESOPs, future proposals can incorporate measures to reduce that risk without materially sacrificing the potential returns on the ESOP’s investment in employer stock. These measures could include public or private insurance, hedging arrangements, or other risk-pooling mechanisms.

In conclusion, we invite you to join us, and to imagine a new land of opportunity—an America transformed by more and more employee ownership. This would be a country where policies to promote corporate growth are automatically good for working people, because working people would own an ever-greater share of corporate stock. The solution to our problems is not less capitalism. It is more capitalists.

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CHECKLIST OF PROPOSALS IN THIS WHITE PAPER:

Policies that level the playing field for sales of companies to ESOPs by corporations or private equity firms, including:

___Creating Employee Ownership Investment Corporations (EOICs),  preferably with tax incentives for investors, to provide “first dollars in” to an ESOP-related transaction

­­­­­­­­­­___Providing government-guaranteed loans for ESOP transactions through a new Employee Equity Loan Program

Tax policies that encourage employee ownership, including:

___Capital gains tax relief for corporate divestitures to an ESOP or similar structure

___Capital gains tax relief for sale by private equity firms to an ESOP or similar structure

___Clarification that ESOP-related transactions in an Opportunity Zone qualify for the full benefit of Opportunity Zone legislation

___In publicly traded companies, support for employee stock purchase plans, possibly through a tax deduction for companies that “seed” the programs

___Requirements for minimum levels of employee ownership in companies that enjoy government-funded privileges

___Private-sector initiatives, including the creation of revolving funds to buy companies and convert them to employee ownership

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The Lake Quinsigamond Group is an informal collection of activists and advocates for employee ownership. It includes the following members:

John Case, Editor, Employee-Owned America
Gellert Dornay, Founder and Director, Axia Home Loans
Jared Kaplan, Founder and CEO, Delaware Place Advisory Services
Christopher Mackin, President, Ownership Associates
Michael Quarrey, Vice-President, Operations, Web Industries
Stephen Ringlee, Managing Director, Centesimus Capital
Loren Rodgers, Executive Director, National Center for Employee Ownership
Corey Rosen, Co-founder, National Center for Employee Ownership