ESOP’s fables

In the context of the feisty share ownership debate, I thought it might be worth posting two 2008 economics papers on the topic.

My quick read of the evidence: employee ownership exposes workers to more risk (if the firm goes under you lose your job and your investments). For the firm, it has advantages, including less absenteeism, better morale, and higher productivity. It’s quite clear to me why firms like ESOPs, but less obvious that workers should love them.

Risk and Lack of Diversification under Employee Ownership and Shared Capitalism
Joseph R. Blasi, Douglas L. Kruse, Harry M. Markowitz
Some analysts view risk as the Achilles Heel of employee ownership and to some extent variable pay plans such as profit sharing and gainsharing. Workers in such "shared capitalist" firms may invest too much of their wealth in the firm, contrary to the principle of diversification. This paper addresses whether the risk in shared capitalism makes it unwise for most workers or whether the risk can be managed to limit much of the loss of utility from holding the extra risk. We create an index of financial security based on worker pay and wealth, and find that workers who feel financially insecure exhibit fewer of the positive outcomes associated with shared capitalism, and are less interested than other workers in receiving more employee ownership or even more profit sharing in their workplaces. This response is substantially lessened, however, when accounting for worker empowerment, good employee relations, and high-performance work bundles that appear to buffer worker response toward risk and increase interest in shared capitalism plans. We also discuss portfolio theory which suggests that any risky investment — including stock in one’s company — can be part of an efficient portfolio as long as the overall portfolio is properly diversified. We show that given estimates of risk aversion parameters, workers could prudently hold reasonable proportions of their assets in employee stock ownership of their firm with only a modest loss in utility due to risk. A good strategy for firms is to personalize individual portfolios on the basis of worker characteristics and preferences, developing investment strategies that would diversify each worker’s entire portfolio in ways consistent with individual risk preferences.

Creating a Bigger Pie? The Effects of Employee Ownership, Profit Sharing, and Stock Options on Workplace Performance
Joseph R. Blasi, Richard B. Freeman, Chris Mackin, Douglas L. Kruse
This paper uses data from NBER surveys of over 40,000 employees in hundreds of facilities in 14 firms and from employees on the 2002 and 2006 General Social Surveys to explore how shared compensation affects turnover, absenteeism, loyalty, worker effort, and other outcomes affecting workplace performance. The empirical analysis shows that shared capitalism has beneficial effects on all outcomes save for absenteeism and that it has its strongest effects on turnover, loyalty, and worker effort when it is combined with: a) high-performance work policies (employee involvement, training, and job security), b) low levels of supervision, and c) fixed wages that are at or above market level. Most workers report that cash incentives, stock options, ESOP stock, and ESPP participation motivate them to work harder. The interaction of the effects of shared capitalism with other corporate policies suggests that the various shared capitalist and other policies may operate through a latent variable, "corporate culture".

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3 Responses to ESOP’s fables

  1. Timothy Watson says:

    Andrew, I agree with you about ESOP’s and risk from an employees perspective.

    I think the reason the Unions like ESOPs is their Fabian political leanings.

    They are seen as a way of introducing Mondragon style cooperatives as a third way alternative to private or public employment.

    My issue with this view is that a minor employee share placement does not equate with a Mondragon style collective where employees effectively buy an equity stake in the company on becoming employees, and receive dividends on their investment rather than wage income.

    Small employee share placements simply amount to employees putting more of their eggs in the one basket, and outweigh any potential ownership benefits where employees are not the dominant owners of stock.

  2. ChrisPer says:

    I particpated in about 6 issues of the BHP share scheme in the 1990s. We were either lent part or all of the purchase price of 1000 shares and thus got the gains for free. Those gains over my 15 years in that company amounted to roughly a year’s salary extra income.

  3. Patrick says:

    The real risk is the Centro-type situation where senior executives buy shares through shares schemes to demonstrate ‘loyalty’.

    This is of course fundamentally irrational from a pure investment theory perspective.

    In Centro’s case this was compounded when several staff refinanced the company’s loans with lower-interest secured loans. I am not quite sure how they ever went in for that.

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