Joe Sixpack's Grip On Corporate AmericaAaron Bernstein
Last year was a bad one for employee stock-ownership plans. First, Congress abolished some of the juicy tax breaks that made ESOPs popular. Then, the recession dried up the loans many companies use to fund their plans. The most telling sign came in the fall, when UAL Corp.'s unions couldn't line up the funds necessary to buy the airline through an ESOP.
But don't be misled. Employee ownership of Corporate America is thriving, and it goes far beyond ESOPs. In fact, new research shows that if all worker-owned stock is counted, employees have more than $150 billion worth--and control an average 12% of the 1,000 largest U. S. companies whose employee shareholdings exceed 4%. These figures, which are three to four times previous estimates, suggest that employee ownership is reaching a critical mass that may soon affect how companies are run--perhaps to the surprise of management. "We really haven't thought about issues like employee representation on the board," says Barbara Yastine, the investor-relations director at Primerica Corp., which is nearly 10% employee-owned. "That's not a bridge we've crossed yet."
HIDDEN STAKES. The best evidence of the suprising size of employee holdings comes from The New Owners, a new book by Rutgers University management professors Joseph R. Blasi and Douglas L. Kruse. Drawing on more than 20 sources, from filings at the Securities & Exchange Commission to news clips, they found at least $100 billion in worker-owned stock at public corporations where employee shareholdings exceed 4%. Of this, only $53 billion is in ESOPs, which are trusts that hold stock for workers. The rest is in pension and savings plans, and even in retiree medical plans, which some companies are funding with stock.
The authors estimate that employees hold an additional $20 billion or so in companies where worker ownership is under 4%. What's more, they say, non-ESOP stock-purchase plans, which don't have to be reported to anyone, probably contain $35 billion more of employee-owned stock. Much of this is invisible to everyone except management, so the size of collective employee holdings isn't obvious. "The rational investor really can't figure out how much employee ownership there is in a public company," says Blasi.
The growth of employee ownership is being fueled by the advantages companies reap. Employee motivation was the reason Primerica set up a non-ESOP stock-bonus plan in 1989 for 1,500 middle managers. The company uses its shares, bought on the open market, to pay up to 50% of annual bonuses. So far, Primerica, which isn't in Blasi and Kruse's data base, has distributed 8.7 million shares to employees--8% of its total. In May, it authorized a 2 million-share buyback that will leave employees with 10% of the company.
Paying workers with paper can be cheaper than using cash. Sequent Computer Systems Inc. has had several non-ESOP stock plans since it went public in 1983, and today, it is 23% employee-owned. When the computer industry hit hard times this year, the Beaverton (Ore.) company docked its 1,700 employees a week's pay, saving nearly $2 million. As partial compensation, Sequent gave them stock options that Robert S. Gregg, Sequent's chief financial officer, says will make up for the $1,000 average wage loss only if the company's stock, now at 15, doubles. "We are not expecting it to double, but it was a way to mitigate the pain," says Gregg.
WIPEOUT. ESOPs continue to spread, too, partly because they still confer some tax breaks. For instance, companies can still deduct from their taxes dividends paid on stock held in the plan. Morgan Stanley & Co. says about $10 billion went into ESOPs in 1990. That's down from $18 billion the previous year. But 1989 may have been an aberration. Takeovers were in full swing, and many companies were setting up ESOPs ahead of the impending changes in the tax code. Indeed, 1990's investment in ESOPs was 50% higher than 1988's, which was 45% above 1987's.
As employee ownership spreads, its ramifications may, too. There can be a downside for workers, such as those at Carter Hawley Hale Stores Inc. More than half of the department-store chain's 24,000-strong work force pumped thousands of dollars into a savings plan that was billed as a way to support the company after it fought off two takeover attempts. The plan invested exclusively in Carter Hawley Hale stock, giving employees a 40% stake. But in February, the recession prompted the company to file for bankruptcy. Its stock plunged from $14 a share in 1989 to less than $2 today--nearly wiping out employee holdings.
Many employers are trying to minimize the risk by using convertible stock in employee-ownership plans. Convertible shares are usually less volatile than common stock, and they often have a floor value below which the price can't fall. Morgan Stanley says 56% of the ESOPs set up in 1990 used convertible preferred shares, up from 20% in 1988. "They behave more like a fixed-income instrument, so they're less risky," says Paul J. Mazzilli, who heads Morgan Stanley's ESOP strategy group. "But you're still in trouble if the company goes bankrupt."
Employee ownership cuts two ways for employers, too. Workers could provide a source of the patient capital that management has cried out for in the past decade: Workers tend to focus on job security and may therefore be more willing than other stockholders to forgo large quarterly profit hikes so a company can invest for the long term. But one largely unexamined question is whether, in return, employees will demand more input into management decisions. Increasingly, the courts have said that to count in a merger vote, employee-owned stock must be voted by the employees themselves. Adam D. Chinn, an ESOP specialist at the New York law firm Wachtell, Lipton, Rosen & Katz, estimates that perhaps 75% of employee-owned shares can now be voted by the people who hold them.
PROXY APPEALS. It's starting to become clear that managers can't take this for granted. One example: When Grand Metropolitan PLC took over Pillsbury Co. in late 1988, Pillsbury employees voted half of the 1.9 million company shares in their pension plans for Grand Met. Why? Pillsbury's plan to spin off its Burger King franchises angered employees of that division.
There is no legal reason why employee input should be limited to takeovers. In 1989, after Polaroid Corp. set up an ESOP that transferred 19% of the company to employees, a middle manager was named to its board of directors to represent employees. That could be just the start. "As outsiders become more conscious of how much stock employees control, you may see investors targeting employees in proxy fights," says Corey Rosen, director of the National Center for Employee Ownership. "Employees could be given a critical role in corporate governance."
Indeed, employee ownership shows no signs of slowing. Companies are finding new ways to use stock plans all the time, and existing plans are steadily buying more shares. If the next decade brings increases like the past one did, the old socialist dream of employee ownership will become more of a reality than anyone ever imagined.