Employee Stock Ownership Plans (ESOPs)

Employee stock ownership plans (ESOPs) are employee benefit programs that make a company's employees owners of that company's stock. Two features of ESOPs make them unique among qualified employee benefit plans. First, ESOPs are required to invest mainly in the employer's stock. Second, these stock plans can borrow money from or on the credit of the employer, allowing ESOPs to serve as a tool of corporate finance.

ESOPs are the main form of employee ownership in the United States. At the end of 2004, the approximately 11,000 ESOPs in the United States owned an estimated $600 billion in assets and covered 10 million employees. Most U.S. ESOPs are large enough to exert a major influence on company strategy and culture, and about 2,000 ESOPs have total ownership of their companies. ESOPs also operate in Canada, the United Kingdom, Europe, India, Egypt, South Africa, Argentina, Japan, and elsewhere.

ESOPs are deferred compensation plans, with employer contributions growing tax-free until the [Page 702]employee leaves the company. At that time, the employee can roll the proceeds from the ESOP into another tax-advantaged retirement plan, such as an individual retirement account. ESOPs are “defined contribution” plans, meaning that the employer makes yearly contributions without specifying the resulting benefit in advance. ESOPs are called “qualified” plans because their sponsors can qualify for tax benefits by following laws designed to protect participants' interests.

ESOPs differ from cooperatives, collective ownership, and ownership by trade unions. ESOPs give individual employees ownership while professional managers accountable to a board of directors handle day-to-day operations. The company remains private and for-profit. ESOPs also differ from stock option benefits and 401(k) plans.

Companies use ESOPs for a variety of purposes. The most common use is to transfer ownership of closely held companies. In such cases, an ESOP provides tax advantages, a ready market for the owner's shares, and the opportunity to transfer ownership gradually. These features make ESOPs valuable planning tools as business owners near retirement. Companies also use ESOPs to borrow money at a lower after-tax cost. Many companies use ESOPs to motivate and reward employees. Research suggests that ESOPs boost employee loyalty and productivity when combined with management styles that encourage employee input.

A small but highly publicized number of ESOPs are formed to defend against potential or imminent takeovers. Such ESOPs generally fail to stand up in court because they appear to entrench management rather than serve the interests of employees. For similar reasons, setting up an ESOP to fend off unionization is considered an abuse.

ESOPs embody an economic theory called “ownership economics,” “binary economics,” or “economic democracy.” This theory supports the ownership of productive assets by a broad-based group of citizens rather than by the state or by a wealthy minority.