Introduction to ESOPs
Employee Stock Ownership Plans (OSEPs) are basically employee benefit plans that are often structured to supplements an organization’s retirement plan. An ESOP involves transfer of company shares to the employees. The underlying rational for the establishment of the ESOPs is the idea that an organizations productivity and performance can be improved by motivating employees through offering them a stake in its ownership. However, a research conducted by Borsdadt and Zwirlien (1995) found no evidence to support the proposition that offering employees a stake in company ownership promotes their productivity which in turn promote its performance.
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Structure of the ESOPs
The ESOPs are set up through an employee’s trust fund whereby the cash is directly contributed by the employees for buying company stock or shares are contributed directly transferred to the plan or the plan borrow money to buy the shares. The company provides the money for repaying the loan that is used to purchase shares. The cash contributed to buy the shares by the company is exempted from taxation. Also, the cash contributed by the employees to buy the shares exempted from taxation up to when the individual employee receive shares either on leaving the company or at retirement. The employee sells the shares back to the company on or sells them in stock market. Owners of a private company have the opportunity of getting tax exemptions for profits earned from selling to ESOP as long it is reinvested in other companies’ securities.
Execution of the ESOPS
ESOPs require the implementation of best practices in corporate governance in order to safeguard the employees’ interests. Therefore, an institutional trustee manages the ESOPs trust. The trustee is appointed by the company board of directors and acts as the legal shareholder of the shares owned by the employee. The trustee is charged with the responsibility of managing the initial transaction as well as the continued administration of the plan. The trust attends the shareholders meeting on behalf of the employees and votes according to the number of the shares held by the trust. The ESOPs may have board representation although it is not a mandatory requirement. As such, the ESOPS trustee does not have an active role in the operation of the company. The ESOPs trustee relationship with the company board of directors can be defined in two different ways; the trustee can be the board of directors (Atkins, 2011) can direct either independent from the board in terms of making decision or it. However, the Trustee is not obliged to abide by board of directors directives, which jeopardize the interest of the employees participating in an ESOP.
Advantages of ESOPs
One of the main advantages of implementing ESOP to a private company is tax benefits. Three tax deductions were created by the Congress to act as incentive for promoting the adoption of the ESOPs by the companies. The principal as well as the interest payments for the loan borrowed to finance ESOPs is deducted from the taxable corporate profit. Secondly, half of the interest earned by the bank financing the ESOP is exempted from taxation. Lastly, divided that are earned by the ESOP holders is exempted from taxation. Such tax benefits accrue value for a private company in the form low cost of borrowing and reduction in corporate tax, which both increase cash flow. A healthy cash flow is essential for efficiency in business operations.
ESOPs are also effective tool for bargaining wage concessions with the employees. This is particularly important during financial distress. The employees are offered a stake in the company on condition they accept conceding to wages demands. This helps the company to avoid costly industrial actions and assist in retaining valuable employees especially in Knowledge and services based organizations. The employee in such instances is allowed a large stake in the company ownership thus providing them with an opportunity to participate in the decision-making processes.
The ESOPs are also used for other strategic purposes by the company management. Critics to the ESOPs, questions their ability to act as incentive for increasing the performance of the employees. According to Ellerman (2000), the significant increase in the adoption of ESOPs is mainly aimed at accruing tax benefits, enhancing profitability in the short run or act as defense against hostile takeover rather than promoting employee’s performance and productivity. According to empirical evidence gathered by Bhagat, Brickley and Lease (1990), the ESOPs are positively received by the employees since they enhance their retirement package.
Company that has Implemented ESOP
Microsoft Corporation is a good example of a company that has successfully adopted ESOP. As a result the company has been able to maintain it highly skilled employees who find it difficult to move due to the stake their have in the ownership of the company. The company has also been able to prevent hostile takeover since the employees hold a significant proportion of the shares. The company also benefits from corporate tax exemptions with respect to ESOPs dividends and other related transactions. The company is not only globally competitive but it is also highly ranked by employees and labor organizations.
Artkins, M. (2011). Understanding ESOPs. Financial World Magazine. Available http://www.financierworldwide.com/article.php?id=7868
Bhagat, M., Brickley, J. & Lease, R (1990). Incentive Effects of Stock Purchase Plans. Journal of Financial Economics, 14 (2), 195-215.
Barsdadt, L & Zwilein, T. (1995). ESOPS in Public Held Companies: Evidence on Productivity and Firm Performance. Journal of Financial and Strategic Decisions, 8 (1), 143-167
Elllerman, D. (2000). ESOPs for Privatization and Restructuring. World Bank