Why ESOP?

[Dan Bell <dbell@kent.edu>]

Two separate issues are:

1. Does broad ownership of productive capital make a
   difference?

2. What is the impact of the leveraged ESOP as a mechanism
   to broaden ownership, on those original shareholders who
   have not cashed all of their chips in?

Michael Harrington asks:
>but in general I ask myself why I'm so willing to
>support stock option dilution in the companies in which I am a shareholder?

I hope to hear more on issue 1 from those of you who are
able to shed some light; in the meantime, let me list
some reasons why shareholders may be willing to accept
"dilution" when they set up an ESOP.

Case 1: Employers are continually updating their
compensation packages, changing the hourly wage, adding
and withdrawing various benefits. They are looking for
the right mix to motivate their employees to maximum
performance. In this scenario, the ESOP is just another
cost of doing business.

Case 2: Small closely held businesses do not always have
a market for the shares of the owner. An ESOP creates a
captive market. With the ability to defer
capital gains tax indefinitely, the additional value received by
the exiting shares of the seller, and the creation
of a future market for the remaining shares, may offset the
dilution of the remaining shares. When multiple shareholders
are involved, it is often required to give all shareholders
the opportunity to tender their shares to the ESOP, and
then accept the tenders proportionally, so that all have
the opportunity to benefit equally as described above.

Case 3: Remaining shareholders have a longterm horizon and,
while experiencing a short term dilution in value, may expect
the value of their shares over the long term to actually be
greater than without the ESOP. This would be consistent with
the reality that ESOP companies which do concentrate on
building a culture of ownership among their employees may
require 5, 7 or 10 years to achieve real success that shows
up dramatically in share value.

>From the state's perspective, one can also look at the lost
taxes being offset by a number of things. Where a plant
shutdown is avoided, the state saves a lot of money that
it otherwise would have spent at the same time that it
would have lost a source of tax revenue.

Where there is no immediate threat of shutdown, the state
gains in supporting a vehicle which will increase the
wealth of individuals who may not receive an adequate
income from social security in the future. This reduces
their potential dependency on state support later.

The tax incentives are also an investment in anchoring
capital within the geographical boundaries of the state
authority, since employees are unlikely to relocate the
business they own.

At least at the micro level, there are many factors which
need to be examined to determine whether anyone is worse
off in a particular ESOP transaction.

Dan Bell
--
Dan Bell
International Program Coordinator
Ohio Employee Ownership Center
Kent State University
Kent, OH 44242
(330) 672-3028
(330) 672-4063 fax
dbell@kent.edu
http://www.kent.edu/oeoc/