“All truth passes through three stages,” wrote the nineteenth-century philosopher Arthur Schopenhauer. “First, it is ridiculed. Second, it is violently opposed. Third, it is accepted as being self-evident.” The idea that employees should own a good part of the company they work for was indeed both ridiculed and opposed before it became the quasi-mainstream notion that it is today. But it didn’t proceed smoothly through Schopenhauer’s stages. It has regularly cropped up and faded away. It has undergone periodic reinvention. Today’s most common form—the employee stock ownership plan, or ESOP—owes its existence not to any deep historical roots but to a small band of devotees who rallied around the ideas of an iconoclastic lawyer and self-taught social theorist named Louis Kelso. Thanks to their efforts, the ESOP is now well ensconced in the United States, both in policy and in practice.

Louis Orth Kelso was an American original, the kind of grand contradictory character who crops up repeatedly in the history of the United States. Born poor, he made good. A successful lawyer and investment banker, he sought to transform the economic system that had been so rewarding to him. His several books are by turns inspiring, illuminating, impossibly grandiose, and utterly impenetrable. The economic world view he espoused attracted that band of devotees and generated a good deal of attention from pundits and politicians, yet was ignored or dismissed—indeed, ridiculed—by conventional economists. A charming, witty, persuasive man, he was also single-minded and opinionated. He suffered fools poorly—and “anybody who disagreed with him was by definition a fool,” as one erstwhile colleague remembers. A 1970 article in the Nation by the journalist Robert Sherrill, though generally admiring, was headlined “Louis Kelso: Nut or Newton?” Like Sherrill, much of the world didn’t quite know what to make of him.

As with many minor luminaries, what we know of Kelso’s early life was what he himself told us. He was born on December 4, 1913, in Denver. His grandparents on both sides were of pioneer stock, but his father, a musician, was not of a practical turn of mind, and it often fell to his mother to support the family with the little grocery store she managed. (As best she could: “The railroad tracks ran alongside the store and the hobos dropped off at night and robbed the place too regularly to permit profit,” wrote Sherrill, presumably reporting Kelso’s recollections.) Kelso was going on sixteen when the stock market crashed in October 1929, and he came to adulthood in the heart of the Great Depression. Bright and inquisitive, he wondered how on earth this catastrophe could be happening. Why were factories running at half speed, their unused machinery rusting?

“Why were millions of threadbare and ragged people foraging in garbage cans or standing in soup lines,” he wrote, “when farmers could grow mountains of food and fiber on land now lying idle and manufacturers were as eager and able to make clothing and every other useful thing as storekeepers were to sell them? Why did growers saturate entire orchards of sweet ripe oranges with gasoline before throwing them into rivers to float past starving children? Why did trains meant to carry people rattle along with coaches almost empty, while freight trains were loaded down with homeless, jobless vagrants?”

His elders weren’t much help: “They took it for granted that a capitalist economy would sooner or later collapse.” President Hoover counseled patience, reminding the nation that the country had been through fifteen major depressions in the last century. Kelso was like an ambitious young scientist who learns that the authorities have given up on the single most important problem in his field. “Brash young man” that he was, he recalled, he decided he would figure out the answer.

So Kelso read, worked, and put himself through school. Landing a scholarship to the University of Colorado, he presented himself to the chairman of the economics department and said that he planned to study the causes of the Depression and what could be done about it. It was a touchy subject—economists didn’t really know what was responsible for the Depression—and the chairman didn’t take kindly to the cheeky fellow who figured he already had the inkling of a solution. (“He said, ‘You’re just the type of young man we don’t want,’ ” recounts Kelso’s widow, Patricia Hetter Kelso. “‘You are a troublemaker.’ So he kicked him out.”) Instead of economics Kelso studied business and finance, earned a law degree, and began practicing. When war broke out, he enlisted in the navy and was commissioned as an officer in naval intelligence. “He was trained for a secret mission behind Japanese lines,” writes Stuart M. Speiser, a lawyer-turned-author who is as close to a biographer of Kelso as we have, “. . . but he was shipped to the Panama Canal Zone and put in charge of processing counterespionage information from Latin America.” That undemanding job gave him the opportunity to produce a book manuscript, which he titled The Fallacy of Full Employment.

The “theory of capitalism” and The Capitalist Manifesto

But when the war was over, Kelso decided against trying to get his new book published. He needed to earn a living. Maybe he was even a little uncertain as to whether he was on the right track. “I said to myself, ‘Louis, you’d better settle down and practice law, which is what you’re trained to do, and let the country recover from the war,’” he remembered later. “‘Stick your manuscript in the closet, and if after 25 years you still think the thesis is valid, dig it out, update it, and publish it.’” The “closet” was a bank vault, and there the manuscript stayed until 1955, when Kelso happened to get into a discussion with the philosopher Mortimer Adler.

That year, Kelso had been attending a series of lectures by Adler on the Great Books. Great Books was a popular reading program that Adler had helped to develop and that had made his name about as close to a household word as most philosophy professors ever get. Now, invited to a weekend party by a mutual friend, the two men were arguing about what they called the “theory of capitalism.” Kelso charged Adler with ignorance of the theory. Adler suggested there was no such theory and that he of all people ought to know. Kelso responded that Adler may have thought he had read everything in the field, but he hadn’t—the manuscript in his closet, for example. Irritated—and worried that this mouthy amateur would now present him with a huge dog-eared manuscript—Adler asked for the “five-minute version” of Kelso’s ideas. Kelso began expounding. When he had finished (again, by Kelso’s account), Adler “jumped about 12 feet off the ground. ‘There’s no justice!’ he said. ‘I’ve spent 22 years studying this subject, and you stumble across the answer with no effort at all.’” In just a couple of years, the two men had written a book they titled The Capitalist Manifesto, based partly on Kelso’s unpublished manuscript. They sent it off to four publishers. All accepted it; Random House published it in 1958. Thanks in part to Adler’s name, the book promptly made the best-seller list—though the “academic economics establishment,” as Speiser notes, “practically ignored it.”

To read this modest-sized volume today—and not many people do, since it is long out of print—is to step back into another era. That sense of time warp stems partly from the book’s cold war–inspired title and language, and partly from its 1950s-style technological innocence (“It seems certain that atomic energy will be the basic source of industrial power for the production of wealth in the future”). It also stems from the presentation itself. The Capitalist Manifesto’s arguments are abstract and almost startlingly dry (“Concretely stated, if A, B, C and D are four persons or families in a society having only four independent participants in the production of wealth; and if, through the use of the productive property they own, A, B and C contribute to the total wealth produced in the ratio 3, 2, 1, then the distributive shares they should receive, according to their just deserts, should also be in the ratio of 3, 2, 1 . . .”). Its proposals are laid out in mind-numbing detail (“Effective security flotation procedures during the transition period may require the establishment of preferential opportunities for investment by households whose aggregate capital interests are subviable”). A cynic might suggest that not everyone who bought the book actually plowed his or her way through it.

But the reviews were favorable, and there was a powerfully simple idea lurking amidst the verbiage. It was an idea that defined the book’s appeal and that would eventually make Kelso into a nationally known figure.

In the 1950s, Americans were worried not only about the Russians but about being thrown out of a job. Unemployment wasn’t unusually high, to be sure. But the nation’s economic future seemed uncertain. Automation was making its way into industry. Economists and others were arguing that machines would eventually take over nearly all manual work. What were people to do? The Depression was fresh in every middle-aged adult’s memory; equally dismal times might lie ahead. But wait—here was this smart guy Adler (and somebody named Kelso) with a solution! Yes, these authors said, the pace of automation was likely to increase. But no one should fear it, because it held the potential of releasing everybody from mind-numbing manual work. The key was to break the link between a person’s income and survival on the one hand and his or her job on the other. No one should have to live on labor income alone. If more people enjoyed what the rich already enjoyed, namely ownership of capital and the income that flowed from that ownership, they would get along just fine. If you have enough stock, after all, you don’t worry about unemployment. And if everyone had an income regardless of whether or not they were working, they could continue to buy things. The economy would be that much less likely to collapse.

Could the idea be implemented? Sure, said the authors. The rules governing ownership and capital accumulation are just social inventions. Social inventions can be changed. If we really want a just, democratic society—not to mention an economy that isn’t prone to depression—we can create mechanisms by which ordinary people can build up capital and eventually live off it. We can figure out policies that enable the process. We can write tax laws that facilitate it. Indeed, we can begin right now, with the “transitional programs” that the authors spelled out in so much detail. The programs’ objective was simple, they said: it “should be to maintain a steady decrease in the proportion of households that are entirely dependent on wages and a steady increase in the number that are able to live on capital earnings.”

That, so it seemed, was an idea that anybody could get behind. Forget socialism, Adler and Kelso were arguing. Let’s turn everybody into capitalists.

Kelso’s plans and programs

Capitalism in Kelso’s view had always been marked by a maldistribution of income. The rich got richer because they enjoyed the fruits of capital ownership. The not-rich struggled to get along, because they lived only on the fruits of their labor. With automation, the return to capital could only increase, and workers could lose what little income they had. Governmental attempts to redistribute income through social programs were ineffectual. The only solution was to broaden the base of capital ownership.

As to how that might be possible, Kelso’s brilliant insight was to see that individual savings alone would never be sufficient—especially if, as he predicted, real wages began to stagnate. Few wage earners could ever hope to accumulate enough capital to replace their labor income just by stashing a little away each year. That was the trouble with the stock-ownership plans of the 1920s: they expected workers to buy stock, albeit at a discount, a little at a time, through payroll deductions. Kelso had another idea. Look at what happens, he suggested, when a company owner wants to expand his business. The owner borrows money, buys physical capital such as machinery or buildings, and pays off the loan with the profits that the new capital generates. Every year U.S. businesses added billions of dollars’ worth of new physical capital. Suppose the laws were changed, suggested Kelso, so that people with no ownership got a chance to buy shares of stock representing that new capital. They could borrow the money to buy the shares and pay the loan off over time with the dividends from the stock. To ensure that dividends would be sufficient for this purpose, Kelso advocated a law requiring corporations to pay out all their earnings as dividends and to raise new capital through debt (which in turn could be funded by an ESOP).

Presto—the rich would still get to keep what they had, but now the not-rich would be able to accumulate capital of their own as the economy grew. And nobody would be getting a handout, because all the stock would be paid for through future earnings.

In his books, Kelso spelled out only some of the practical details as to how all this could be accomplished. He left many others to be worked out in the future. But he was very much proposing a broad-based governmental initiative, open to all needy citizens, and very much not proposing shared ownership at the company level, which by definition would be open only to that company’s employees. The ESOP—mentioned only briefly in The Capitalist Manifesto and not at all in Kelso and Adler’s next book, The New Capitalists—was at first a bit player on Kelso’s grand stage. Oddly, it wound up as the star of his show and was arguably his greatest legacy.

How that happened reflects one more contradiction in Kelso’s multifaceted character. A determined visionary and big-picture thinker, he was at the same time a practical lawyer and an opportunistic political operator who never let his theories get in the way of what could be done right now. In 1955, for example, he was a junior partner in a San Francisco law firm. One of the firm’s clients was part owner of a company called Peninsula Newspapers, Inc. (PNI), which published several small papers. Kelso learned that this client and the other owners of PNI wanted to sell the company to its employees. He also learned that the employees liked the idea and were working hard to make it happen. A man named Gene Bishop, who coincidentally had been Kelso’s commanding officer in the navy, was now second-in-command at PNI and was spearheading the effort on the employees’ behalf. The parties had engaged Crocker Bank to scrutinize the relevant finances. Could Bishop and his colleagues put together the capital they needed to buy the paper through savings, payroll deductions, second mortgages, investments from relatives, and so on?

Alas, the bank’s conclusion was negative. There just wasn’t enough money to be found. If the employees borrowed what they needed, they could afford to pay only the interest, not the principal. “When Gene Bishop passed my office that day,” Kelso remembered, “I said to him, ‘Hey, Gene, are you a newspaper owner now?’ He said no and told me the story. I said, ‘Gene, I think it’s very possible you were given bad advice.’  . . . He said, ‘Listen, this is a life-and-death matter for me. I’m not going to stay with this newspaper if it’s going to be sold to Hearst or some other chain. I like it the way it is.’” So Kelso said he would look at the file and see what he could come up with. Next day he reported his conclusions to Bishop. “‘Gene,’ I said, ‘this thing will fly like a birdie. You don’t have to take anything out of your pockets or out of your paychecks. You don’t have to mortgage your house. You don’t have to do any of those things. Five or six years downstream, the employees will own the business free and clear. And the present owner will have his money and his interest.’ Gene thought I was kidding, but I was not.”

The secret, of course, was for the buyers to pay for their ownership out of the company’s future earnings. It is a familiar principle today, since it is the basis for most of the leveraged buyouts (LBOs) that have taken place in the last few decades. But in the mid-1950s it was an astonishing notion. Kelso set up profit-sharing trusts to borrow the money to buy the business from the retiring owners. Employees’ individual accounts were credited with share ownership as the trusts paid off the loans. “Kelso’s blueprint was a smashing success,” reports Speiser. The newspaper company prospered. The trusts paid off the original owners even faster than Kelso had allowed for. By 1974 PNI’s balance sheet showed shareholders’ equity of more than $6 million. When the employees did finally sell to another newspaper publisher, they realized a huge return on their minimal investments.

So Kelso spent the 1960s and early 1970s organizing more such buyouts. (They came to be known as Kelso Plans, a label he found distasteful.) He also continued with his contradictory life. He was a successful San Francisco lawyer and later an investment banker. He was a member of the best clubs, a director of several companies, a frequent attendee at the annual summertime Bohemian Grove retreats, known for attracting the cream of the (male) establishment. His habitual dress included a well-tailored suit and a blue bow tie with white polka dots. On the other hand, he was devoted to spreading what he was ever more frequently calling his “revolution.” He wrote more books, collaborating now not with Adler but with his young research associate Patricia Hetter, whom he later would marry. He gave numberless speeches and wrote (again with Hetter) many articles. He whispered in the ears of powerful businessmen, believing he could persuade them to implement his notions. “His idea was to start the capitalist revolution through the business system,” says Patricia Hetter Kelso. But the ears, however attentive to Kelso they might be at the moment, were seemingly deaf to what he was arguing for.

So Kelso decided to launch an attack on Washington, hoping there might be a way to line up political leaders behind his ideas. Granted, he had had only spotty success with this approach so far. Barry Goldwater, the Republican candidate for president in 1964, “listened politely” to Kelso at the Bohemian Grove that year, but deferred judgment on the ideas to his economic adviser, Milton Friedman. Like nearly all academic economists, right and left, Friedman thought Kelso was far more nut than Newton. Gerald Ford, then a congressman, got excited about Kelso’s ideas and set up a meeting in 1965 with a Republican task force; later that year, Kelso spent several hours with Richard Nixon, who declared himself “no economist” but added, “politically I could sell this to the American people in six months.” Neither meeting led to anything. Undaunted, Kelso in 1968 set up a Washington-based organization he called the Institute for the Study of Economic Systems and hired an idealistic young attorney and civil rights activist named Norman Kurland to head it.

Kurland and Kelso put together a board for their institute, making a point to include representatives from the left (longshore union leader Harry Bridges, future D.C. mayor Marion Barry) and from the right (the chairman of Arthur Andersen, actress Shirley Temple Black). They set about raising money, though without much success. (“By 1970 Kelso could no longer pay me,” remembers Kurland.) Kurland began casting about, both for receptive ears and for legislation that he could push in a Kelsonian direction. Sen. Paul Fannin of Arizona was intrigued enough to sponsor Kurland’s “wish list” legislation, dubbed the Accelerated Capital Formation Act, and invited Kelso to make a presentation to several members of the Senate Finance Committee. But the legislation went nowhere. In 1972, Kelso and Kurland testified on legislation to save the financially troubled railroad system in the eastern United States, proposing that it should be owned by its employees. Sen. Mark Hatfield of Oregon liked the idea, agreed to sponsor legislation to this effect, and was joined by four other senators. But it was still a rearguard action unlikely to garner much support.

At that point Kelso tried a different tack. He wanted more than anything else to get to Russell Long, the Louisiana senator who was chairman of the Finance Committee and one of the most powerful men anywhere in government. Long, he thought, not only might be receptive, he also was in a position where he could get something done. So Kelso began nosing around to see who might know him. Kelso’s friend Henry McIntyre, a fund-raiser for Planned Parenthood, had an idea: his organization’s national chairman, a Louisiana physician named Joe Beasley, might know Long. Sure enough, Beasley did. But he recommended that they approach Long by way of his legislative assistant, Wayne Thevenot.

Beasley called Thevenot—the name is pronounced TEV-uh-no—and sent him a copy of a 1968 Kelso and Hetter book called Two-Factor Theory: The Economics of Reality. (The original and much better title of the 1967 hardback edition had been How to Turn Eighty Million Workers Into Capitalists on Borrowed Money.) Then Beasley started calling. Had Thevenot read it? When he still hadn’t, some months later, Beasley said he was flying to San Francisco and invited Thevenot to join him, at Beasley’s expense. Thevenot agreed: “It was the last part of that proposal that caught my attention,” he said later. He took the book with him to read on the plane. He didn’t like it. “There was obviously something wrong with it. It was too damned easy,” he told Speiser. But after two days of listening to Kelso’s persuasive voice, he changed his mind and suddenly had all the passion of the newly converted. “I just became totally sold on the idea,” he recalled. He went back to Washington to try to persuade his boss, Russell Long.

Long was the son of Huey Long, the legendary Louisiana “Kingfish” who wanted to make every man a king. More than just Finance Committee chair, Russell was a brilliant politician in the mold of Lyndon Johnson, both well liked and well respected by senators on both sides of the aisle. What he supported tended to get passed. What he didn’t support tended to get buried. As for his politics, Long wasn’t the soak-the-rich radical his father had been—indeed, he was often perceived as just another southern Democrat whose prime concern was the health of the oil and gas industries—but he still had several populist bones in his body. So Kelso’s ideas didn’t require a hard sell from Thevenot. “I didn’t have to go very far because Long started tracking on it right quick,” remembered Thevenot. “. . . He said, ‘I’ve got to meet this guy Kelso.”

On November 27, 1973, they met. Kurland had picked Kelso up at the airport the day before. On the way in, they had heard the well-known newscaster Eric Sevareid supporting Sen. Hatfield’s Kelso-like proposal for the railroads. It seemed a favorable omen. Next day, they went to the Senate, where Long was engaged in a debate on campaign reform, and waited in the gallery. At seven o’clock Long sent for his limousine. The four men—including Thevenot—went to the tony Montpelier Room in Washington’s Madison Hotel for dinner.

Dinner lasted three or four hours. Kelso outlined his ideas. Long listened and then began to talk. He told anecdotes about Huey. He expounded notions of his own. His father had been a “Robin Hood” populist, he said. He himself wasn’t a Robin Hood populist, but he liked the idea of more people becoming capitalists. Of course, he had questions and concerns. If everyone was an owner, would they be like the idle rich, never working? And if this was such a good idea, why hadn’t it already gone further? Who was against it? Kelso’s answers are lost to history. But they were evidently satisfactory, because a couple of hours into the conversation, Long’s tone changed. “Louis, you’ve made your sale,” Thevenot recalls him saying. “Now, what can I do to help you?” Kurland promptly interjected that they already had a bill, introduced by Sen. Hatfield, to apply Kelso’s ideas to the railroads. “I said, ‘We need somebody with guts to take this and make it into law,’” remembers Kurland. “He looked at me and said, ‘You bring me something tomorrow morning.’”

From that moment forward, Kelso’s ideas were a live issue in Washington and would be written into a series of legislative initiatives over a period of many years. But there was a twist: what Long had fastened onto, ironically, was the idea that workers in a company should share ownership, through ESOPs, not that the government should somehow make ownership available to citizens in general. Speiser asked him why he focused on ESOPs rather than on the more general thrust of Kelso’s writings. Long replied that ESOPs were a stepping stone, a device that “starts people thinking about the idea.” Eventually, people would have to figure out how to redistribute all the new wealth that the nation created every year, but not right away. “He doesn’t have the whole blueprint drawn up yet,” observed Speiser, whose book appeared in 1977, “but he’s going to keep on writing ESOP into every tax law in which he can find it. He’s going to try to force corporations to broaden the ownership of new capital, even if he has to do it all by himself.”

The ESOP turning point

The history of ESOPs since that time reflects, in no small measure, Long’s efforts to do exactly what Speiser predicted. He began by trying to get employee ownership into the Railroad Reorganization Act. But other senators were leery because the rail unions weren’t on board, and Congress ended up deciding only to sponsor a study of the idea. Long then inserted provisions regarding ESOPs into the Employee Retirement and Income Security Act (ERISA), the landmark legislation that has governed company-sponsored retirement accounts ever since its passage in 1974.

This was a turning point. Until then, Kelso and his associates had been setting up legal entities known as stock bonus plans, which then borrowed money to buy stock from retiring owners. They argued that the law permitted this. But most lawyers disagreed, so Kelso found it difficult to sell his ideas to many companies. ERISA—which happened to be the bill that was moving through Congress and that Long felt he could use to make such transactions legal—finally put the government’s imprimatur on Kelso’s ideas. “Before ERISA passed, you were dealing with a much higher degree of skepticism,” explains Ron Ludwig, an attorney who worked with Kelso at the time. “You had to show people and their lawyers that this was in fact legal. Once ERISA passed it became easier. They were still skeptical . . . but it was easier than dealing with no law at all.” Of course, it was simply historical coincidence that ERISA was the first law governing ESOPs. It was the “tax train leaving the station at the time,” as one expert puts it, and Long’s expertise and inclination naturally pointed him in the direction of supporting ESOPs by writing them into tax law.

At any rate, ERISA was just the start. Over the next dozen years, Long was instrumental in passing numerous pieces of ESOP-related legislation. (Many would be amendments to ERISA, while others were amendments to the tax code.) He didn’t have to do it all by himself, as Speiser had suggested he might; on the contrary, he was already inspiring a band of devotees who—if they hadn’t done so already—were now deciding to commit their lives to furthering employee ownership. Kelso, Thevenot, and Kurland, the triumvirate that had started Long down this path, continued their efforts. So did Jack Curtis, a staff member of the Senate Finance Committee, and Kelso associate Ron Ludwig. NCEO founder Corey Rosen was a staffer for the Senate Small Business Committee at the time; a young academic named Joseph Blasi was working on the House side as an aide to a newly elected representative. “The House and Senate staffers started meeting for lunches,” Blasi remembers, “and we started cooperating on bills and discussions. Out of those meetings came a lot of things . . . [including] a lot more obvious House support for Russell Long’s initiatives in the Senate.” When Jack Curtis went on to practice ESOP law, a lawyer named Jeff Gates, who had worked with Ludwig in San Francisco, took Curtis’s place on the Finance Committee staff. Gates, who later would be recognized as a leader in the field of employee ownership, liked to work on a dozen different possibilities at once. “I’d come up with fifteen ideas,” he recalls. “He [Long] would go with ten of them into the Finance Committee, hope to get eight of them out of committee and maybe three out of conference. And the last time I looked, we had twenty-five separate pieces of federal legislation.”

Today, much of that legislation has come and gone, amended beyond recognition or simply allowed to expire. The Tax Reduction Act of 1975, for example, created the Tax Credit Stock Ownership Plan, known as TRASOP, giving employers a 1 percent tax credit on certain capital investments if they contributed a corresponding amount of stock to an ESOP. In effect, the government was paying companies to print shares and give them to employees. The provision was popular with large companies, but it didn’t in fact get much stock into employees’ hands. In 1981 the Economic Recovery Tax Act phased out TRASOPs in favor of a new device known as the PAYSOP (payroll-based stock ownership plan), in which the government effectively bought a company’s stock through tax credits and gave it to employees. That, too, was popular, but it expired at the end of 1986. Meanwhile, employee-ownership provisions were inserted into various bits of special legislation. The Chrysler Loan Guarantee Act of 1979, for instance—otherwise known as the Chrysler bail-out—required Chrysler to create an ESOP and provide it with 25 percent ownership of the company over four years. Meanwhile, too, large public companies that felt themselves vulnerable to hostile takeover realized that a large block of stock held by “friendly” owners—their employees—might keep the corporate raiders at bay. ESOPs proliferated among large businesses for that reason alone.

They also proliferated for a reason Kelso had never imagined. In 1979, when Corey Rosen was working for the Small Business Committee, a man named Ed Sanders came into the office. He owned a twenty-employee plywood distributor in Alexandria, Virginia, called Allied Plywood. He wanted to sell the business to those employees through an ESOP, but he wasn’t happy with one part of the deal. If another corporation bought his company and paid him in stock, he noted—John Deere and others had made offers—he could defer capital gains tax on the proceeds. But if he sold to the ESOP, he’d have to pay the taxes right away. That didn’t seem fair. He himself would sell to the ESOP anyway, he said, but he thought that other company owners should get a better deal if they did the same.

So Rosen drafted a bill allowing for deferral of capital gains taxes for company owners who sold a certain percentage of their stock to an ESOP. Long and his staff didn’t think the provision was important. Rosen’s boss, the liberal senator Gaylord Nelson, feared it was too socialistic. (Rosen reminded Sen. Nelson that Barry Goldwater, Russell Long, and Orrin Hatch, a conservative from Utah, all backed employee ownership.) But another committee member, Donald Stewart, a liberal senator from Alabama serving out the remains of a fill-in two-year term (he was not reelected), did introduce the bill and got Long, Nelson, and a bipartisan group of House and Senate members to go along with it. And though it didn’t pass right away, the provision survived; in 1984, almost as an afterthought, it was tossed into a late-night conference-committee agreement on a tax bill that contained a number of ESOP amendments, including eliminating the PAYSOP. In fact, Long made the requirements even more lenient than Rosen had suggested. That provision—deferring taxes on the sale of private-company stock to an ESOP—has been a key incentive for the creation of thousands of such plans.

So ESOPs spread, and the community of people interested in them grew in number and in influence. Kelso himself continued to lead the charge. He gave more speeches, wrote more books, and coauthored more articles. He was admiringly profiled on television by Mike Wallace on 60 Minutes in 1975 and by Bill Moyers on World of Ideas in 1990. (The 60 Minutes profile included scornful comments from the noted economist Paul Samuelson, who thereby seemed to be ridiculing just about the best idea to come down the pike in a long time.) A trade organization, the ESOP Association, came into existence. Rosen left the government and, with Karen Young, created the National Center for Employee Ownership (NCEO) as a center for research, information, and advocacy.

To be sure, the spread of employee ownership provoked some opposition. Labor unions strongly disliked the idea at first, perhaps wondering whether workers who were also owners would really need a union. Some Reagan administration officials also wanted to get rid of ESOPs. Most people, of course, just ignored the whole thing—or if they knew about it, wrote it off as of marginal importance. It continued to grow, nevertheless. Over time, law firms, consulting firms, and business-valuation firms began to specialize in ESOP work. Banks learned how to do ESOP-related lending. Articles began to appear on companies that were owned by their workers; the companies themselves began mentioning their ownership in their ads. By 1990 thousands of companies had ESOPs covering millions of employees, a constituency that Congress was loath to antagonize. To all appearances, employee ownership in this particular guise was here to stay.

Excerpted from Equity: Why Employee Ownership Is Good for Business (Harvard Business School Press, 2005), copyright © Corey Rosen, John Case, and Martin Staubus. Sources can be found in the book.

The post How Louis Kelso Invented the ESOP appeared first on Employee Owned America.

Editor’s note: The following article was written in 2003, soon after United Airlines filed for bankruptcy. It remains the definitive account of United’s ill-fated ESOP. 

The filing for bankruptcy of United Airlines ranks eighth out of the top ten bankruptcies on record since April of 1987. United’s filing lacks the audacity  of WorldCom (# 1) and the mendacity of Enron (# 2). It is not, however, without its own distinct charms.

Perhaps the most talked-about distinction of the United Airlines story is the fact that it took place at a company that was ostensibly owned by its workers through an ESOP, or Employee Stock Ownership Plan. So instead of revelations about expensive shower curtains or images of finely dressed executives in handcuffs doing the perp walk for the television cameras, the opinion pages have been filled with admonitions concerning the grave error that United symbolizes. This is what happens, we are told, when one lets the “hired help” inside the boardroom.

United Airlines is thoroughly unlike most of the 11,000 ESOP companies that dot the landscape of Middle America. There is nevertheless a cautionary tale to be told about how employee ownership was mismanaged at United Airlines. It is a story that could prove useful, not only for other worthwhile efforts at workplace participation but also for similar efforts that may materialize sooner than might be expected in the airline industry. Back during its salad days in the mid-1990s, my consulting firm played a modest role in stoking the ownership fires at United. As will become clear, this was an assignment that lacked a crucial ingredient – an interested customer.

If proportionality matters, it must be stated at the outset that the story of United’s failure relies as much, if not more, upon a generic set of flawed business assumptions shared by each of the major airlines than it does upon the alleged foibles of employee ownership. Those flaws that spill over the headlines today left these airlines vulnerable to competition from upstart low-cost airlines. They began to suffer as far back as early 2000 from a weakening economy and a gradual loss of high-end business travelers seduced by lower fares. Those factors were compounded by the effect September 11 had on air travel in general. As a result, each of the major airlines has been stripped of their respective fig leaves. It just so happens that United has an unusual leaf.

The official public launch of the United ESOP in July of 1994 was an event almost as newsworthy as recent reporting has been about its demise. Television ads urged the public to “Fly Our Friendly Skies.” The image portrayed was that of 85,000 conscientious employee-owners who had thought it over and decided to throw their lot in with the ranks of America’s self-made entrepreneurial heroes. The truth, as we shall see, was a bit more complex.

Early commentators were predictably divided. Lee Iacocca, a prime beneficiary while at the helm of Chrysler Motors when it received one of the largest government bailouts in history that happened to include a substantial ESOP stake for union workers, as well as a board seat, was dismissive. He told the Los Angeles Times that “it would never work.” Speaking for a hopeful Clinton administration, then Secretary of Labor Robert Reich hailed the news of the buyout as a “historic” event. Somewhat surprisingly, the dean of American anti-utopian thinking, George Will, weighed in on the side of the United employee buyout. He wrote that the United experiment heralded “a promising new chapter in the history of capitalism [that could] diminish some of the forms of social strife that have fueled modern liberalism.

Behind the hoopla and early opinion however, was a challenging set of facts. In 1994 when the United ESOP deal was launched, union and  non-union employees sacrificed a combined $4.88 billion of their compensation and benefits to “purchase” a majority stake at United. They did so voluntarily—the unions voted for it—but under duress. In the early 1990s Southwest Airlines, the first of the low-cost innovators, had begun the revolution that they and their imitators have continued to successfully wage to this day. United was the first major airline that was forced to meet this model head on in the marketplace. It had to adapt, particularly on the west coast, or face ruin.

Though the competitive facts were clear, the United “solution” was surprising. Perhaps most surprising of all was where it originated. Though most commentators mistake this important fact, the employee ownership solution at United did not originate with management. It was conceived in the late 1980s under different economic circumstances by the pilots union, the Air Line Pilots Association (ALPA). It was finally implemented in 1994 at a time when there was an indisputable need for a restructuring of its labor contracts. Rather than have that difficult fate shoved down their throats, the pilots, and eventually the machinists union, the International Association of Machinists (IAM), decided to take the initiative. Employee ownership was the tool they chose to secure something material—in this case a 55% equity stake—in return for their dramatic sacrifices.

Employee ownership at United was never, however, solely about economics. It was also about voice. The idea of employee ownership at the airline first arose in the wake of the 1985 pilots union strike. Once that strike was settled, the pilots union leadership began to take a longer view. An early inspiration for that view came from none other than F. Lee Bailey, the famed defense lawyer, amateur pilot, and, at least in this case, union sympathizer. During the strike  Bailey had occasionally been invited to address nationwide teleconference gatherings of rank and file pilots to help maintain morale.

At one such meeting after the strike was settled, Bailey issued a challenge to the pilots. The complaints he had heard during the strike and since the settlement had a common source—mistrust of United’s management team. Unlike other groups of unionized employees, Bailey argued that well-compensated pilots had it within their power to take charge of their work lives. If during future negotiations pilots were willing to part with a percentage of their compensation and benefits, those concessions could be traded for stock in United. Sufficiently large concessions could translate into a majority stake. Majority shareholders would be represented on the corporation’s board of directors and would have the power to replace management.

Sitting in the audience during Bailey’s speech was the chairman of the ALPA Strike Committee, Captain Rick Dubinsky. It was Dubinsky and his allies who took the ownership idea to heart and set off on a seven-year quest  to implement it. The 1994 ESOP was actually the fourth attempt to bring employee ownership to United. As indicated, the immediate circumstances surrounding the purchase were not propitious. There was little doubt that, with the shadow of Southwest Airlines looming, dramatic wage concessions were going to be necessary. The question quickly became, what kinds of conditions and what kinds of new powers would the unions exact in return for those concessions?

Meanwhile a relatively new and equally unpopular management team lead by Stephen Wolf sent an unambiguous message by firing 5,000 machinists union members with the stroke of a pen. Until that point in time the machinists union had been critics of an ownership strategy. With 5,000 members now lost, the machinists became converts. The traditional tools of collective bargaining were not going to get those jobs back. Nor could the traditional tools of collective bargaining deter management from carrying out its radical downsizing agenda. After a period of  negotiation with the pilots the machinists signed on to the ownership plan.

United’s flight attendants union, the Association of Flight Attendants (AFA), was also an early participant in ownership discussions. The flight attendants union’s withdrawal from the plan was later widely cited as a fatal flaw obstructing efforts to create a new ownership culture at United. Flight attendants’ objections to participating in the ownership plan revolved around two issues. First, they believed that, as a group, relatively low-paid flight attendants were least able to afford the kinds of concessions that would be necessary for them to join the party. Second, they were discouraged when the union-selected management team in waiting, Jerry Greenwald and John Edwardson, sent signals that they would not accede to the flight attendants’ position in a long-brewing controversy concerning seniority and the company’s requirement that overseas flights be staffed with more foreign language speaking cabin crews. Unhappy with the position of the new management team, seeing that the pilots and machinists were likely to go forward without them and that the concessions made by those groups could help stabilize the company, the flight attendants withdrew from the talks. Their contract would remain in place, undisturbed.

Indeed, the $4.88 billion in concessions offered by the pilots and machinists unions alone was enough to persuade United’s existing shareholders to part with 55% of their equity. The managerial coup d’état that would accompany the transition was deliberately downplayed so as not to excite the stock market or the public. Stephen Wolf exited quietly with a handsome severance package. Messrs. Greenwald and Edwardson took center stage. For the first time in the history of American industrial relations, labor had bought the rights to install a new management team at a major U.S. corporation.

Stepping out into the early years of (what turned out to be) a record-setting, decade-long economic expansion in 1994, buoyed by the ESOP-induced lower labor costs and the beginning of a bull market on Wall Street, the United model looked promising. Stock prices grew steadily, turnover was down, and so was absenteeism. In early 1996 a beaming Jerry Greenwald looked out at the world from the cover of Business Week under the title “United We Own.” He was surrounded by a group of happy workers. All seemed well.

What would only become clear two to three years later, however, was the degree to which employee ownership had become an empty slogan at United with little if any policy substance to back it up. Though other, larger factors eventually contributed more to United’s plight than the neglect of employee ownership, three related factors can be identified that undermined a notion that once held such promise:

First, the “owners” fired their architect. The Master Executive Council of the Air Line Pilots Association, the de facto board of directors of the pilots union at United, did what unions often do. They voted out their leaders. Only a few weeks into the life of the United ESOP, the plan’s visionary founders, Roger Hall and Rick Dubinsky, were sent packing. Interpretations as to why vary. It is safe to say, however, that the 1994 vote within the pilot group to approve the 24% wage and benefit concessions that it cost to adopt the ESOP was a close and controversial one. As a result, alternative leaders were standing at the ready. Subsequent pilot union regimes chose not to be openly hostile toward the ESOP. Nor, however, did they exert much effort to unpack the potential of the ownership idea. Like all new political administrations they had their own priorities. Instead of employee ownership, the next new big thing for them would be “interest-based bargaining”—a high-minded approach to contract negotiations where participants talk together before they bargain, revealing the interests underlying their respective bargaining positions. Like some kind of fateful intra-Christian rivalry, the insurgent, interest-based pilot leaders, metaphorically clothed as Franciscans, trumped Dubinsky’s ESOP Jesuits. Meanwhile, the management team of Greenwald and Edwardson waited patiently for their labor patrons to weigh in on how to follow through on the ESOP dream. No sound would be forthcoming. The chief institutional sponsors of the ownership idea, the pilots, had moved on. The machinists, who in the late 1990s actually began to step up to the plate with their own rank-and-file-inspired “active ownership committee,” were distracted in those early, formative years by the threat of a raid from a rival union. Even though they  were founding partners of the United ESOP, they contributed little to the early discussion of what to make of employee ownership. The flight attendants, by their own choice, watched from the sidelines.

Second, over time, ESOP critics in management prospered. Then-CEO Jerry Greenwald and president John Edwardson at first gamely addressed the vacuum in leadership caused by the ouster of the pilots union’s ESOP visionaries. An early spurt of energy involving cross-functional “task teams” brought pilots, machinists, non-union managers, and even “non-owner” flight attendants into new conversations about how to solve business problems. The idea of employee ownership was used to help motivate these conversations. (From 1995 to 1996, the consulting firm of which I am president, Ownership Associates, provided consulting service to United Airlines. Our introduction to the United community was unorthodox. We were introduced to the company by the unions at United.) Still, the idea of employee ownership lacked a strong institutional constituency. Meanwhile, a cluster of old guard management officials who openly criticized the original move to employee ownership gained strength.

Marketing was the first casualty of these politics. The Chicago-based Leo Burnett advertising agency, whose original television ads featured the Fly Our Friendly Skies message, was replaced by a Minneapolis agency that counseled against stressing ownership in favor of an obtuse, trance-inducing campaign called “United Rising.” To say that this new ad campaign was a failure in the marketplace would be an understatement. Even more significant was the early selection of the new vice president of “people,” once known as the vice president of human  resources. By virtue of their role on the United board of directors, labor, in particular the pilots union, exercised extraordinary influence over this pick. Their choice, to no one’s surprise, was a champion, in fact the “guru” of the then ascendant theology of interest- based bargaining. His name was William Hobgood. In a meeting in his office a few months after his appointment, this new official congratulated this author on his work assisting with the spread of the ownership idea at United. He then proceeded to advise me that he personally was not enthusiastic about employee ownership. He recommended an article on the topic he had authored while teaching at Baylor University. I sat across from the newly installed vice president of the people division of the largest employee-owned company in history who, incredibly, was making no secret of his antipathy toward employee ownership. Not a good omen. I wondered what kind of meal might be served on the flight home.

Third, occupational silos defeated dreams of ownership-induced harmony. There are not many industries that are more occupationally segregated than the airline industry. Pilots, mechanics, ground personnel, and flight attendants, over 85,000 in total at United, travel in parallel universes, loyal primarily to their individual craft. The fact that United’s flight attendants withdrew from the ESOP at its inception was a huge setback to the idea of employee ownership at the airline. As the employee group with the greatest exposure to customers, flight attendants could have helped rally the traveling public to a new message of service from an airline with a difference—employees with an ownership stake. It did not happen. United did not “rise.” Solidarity among the airline’s three major union groups was lacking from the start. Had further efforts been made early on to institutionalize a coalition among those groups, a solution may have presented itself to get the flight attendants on board. Three union representatives on the board of directors would have encouraged unity. Instead there was dissension.

Most of the other 11,000 ESOP owned companies in the United States have it easy by comparison to United. Ownership through ESOPs most often takes place as part of a slow, deliberate march of succession from the owners of small to mid-sized privately held companies to their employees. Typically, employees do not give up any pay or part with any at-risk cash to make this happen. Employers get a tax break for selling to their employees and employees get a piece of the action in return. United was an exception to this mainstream story, but a big and bold enough exception to raise hopes and expectations across the land.

Because the United ESOP was a new idea and because it arrived wrapped in the bad news of concessions it was a difficult message for union leaders to embrace. Difficult, but not impossible. Just as the paint was really beginning to peel in early 2001, Captain Rick Dubinsky, newly re-installed by a fickle rank and file as chair of the pilots union at United, gave a speech that summarized the United ESOP experience to date. In the speech, he made use of a rich metaphor. He referred to the United ESOP as an oversized $4.88 billion gift, fitted with a red ribbon, that had been sitting in the center of an extremely large stadium surrounded by 85,000 participants. In the seven years that had passed since he and his colleague Roger Hall had delivered it to the stadium, no one had figured out how to untie the ribbon and open the box.

A second strategic point he made in that speech was retrospective and structural. If he were to be able to redesign the United ESOP structure, Dubinsky claimed he would have pushed for a complete “go-private” strategy where the ESOP would hold 100% of the shares. Maintaining the “hybrid” ownership structure that combined an ESOP with public shareholding contributed to a schizophrenic culture. The ongoing presence of a large (45%) stake for public shareholders left the company open to a generally unhelpful stream of criticism from stock analysts. It also provided a cover for management in particular to not take the idea of employee ownership seriously. The hard work of creating an ownership culture could always be deferred or deemphasized because of alleged demands from the public market.

Without leadership from both the unions and management, the United ESOP was fated to become what it is now—an oversized target for organizational cynics who wish to return to the glory days when workers, unions in particular, stayed out of management’s hair. Gordon Bethune, the class-conscious CEO of Continental Airlines, spoke well for this school of thought when he recently described United as an airline where “the inmates were running the asylum.” Bethune’s comment is particularly interesting given the fact that during one of the previously uncompleted ESOP attempts at United in 1990, an attempt that was designed to produce 100% employee ownership, he had apparently dropped by the “asylum” himself. Union leaders were glad to explore Bethune’s serious interest at that time in filling the second highest management post at United. Unfortunately, the financing required for that deal evaporated during the weekend after Iraq invaded Kuwait and the specter of sky-high oil prices scared away potential lenders. Gordon was forced  back into the shadows.

Cynics notwithstanding, the airline industry is not likely to have seen the last of employee ownership or ESOPs. Indeed, it is a little-known fact is that Southwest Airlines, the poster child for successful airline operations in the current era, relies heavily on stock options as a means of compensation for its heavily unionized workforce. Ownership has worked for employees at Southwest as a compensation strategy. It is unclear whether it has been accompanied by the kind of corporate governance voice that was a distinguishing characteristic of the United model. Whatever their differences, United, Southwest and cases that preceded them in the steel industry and elsewhere have shepherded in a new awareness of risk and reward in the union world. Ask a union worker to take a pay cut when his company is under duress and it is only the most accommodating or clueless among them who will not ask for equity in exchange.

Away from the klieg lights, in the American heartland, employee ownership has made steady and sure progress. Research shows that ESOPs with active internal employee communications and culture change efforts outperform their competition as much as 8-11% in sales. If employee ownership is to blame in the United case, as its critics claim, is it not equally legitimate to accuse the conventional model—investor ownership—for the failure of other airlines? Continental has failed twice under that model, US Airways once, and TWA, Pan American, Eastern, Braniff and a host of other once proud airlines are gone entirely. The fact that US Airways is about to emerge from bankruptcy with four union seats on the company’s board of directors is a signal that, United notwithstanding, it will apparently not be easy to push the “hired help” out of the boardroom.

In an era chock full of unprecedented evidence of corruption and swashbuckling bankruptcies that put United to shame, it is surely a relevant question to ask who should own American corporations and who should hold them accountable. One voice tells us to trust no one but the experts. Let the mutual fund managers and Wall Street analysts make the tough calls. Another voice, weaker now, tells us to look past the excesses of the Kenneth Lays and Dennis Kozlowskis of the world and trust senior management to do the right thing. A third direction, however, is to go where United ultimately decided not to go—internally, to the employees whose wisdom or folly can truly make a difference.

Unless we have arrived at the end of history in our thinking about corporations, these remain unsettled questions. It is likely that the contest concerning the nature and structure of the American corporation will carry on. Employee ownership will continue to be a contestant.

Christopher Mackin is the President of Ownership Associates of Cambridge, MA. From 1994 to 1996, Ownership Associates advised United Airlines on the implementation of its employee ownership plan.

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