An Employee Stock Ownership Plan (ESOP) in the United States is a defined contribution plan, a form of retirement plan as defined by 4975(e)(7)of IRS codes, which became a qualified retirement plan in 1974. It is one of the methods of employee participation in corporate ownership.
ESOPs are regulated by the Employee Retirement Income Security Act (ERISA), a federal law that sets minimum standards for investment plans in private industry. Internal Revenue Code section 404(a)(3) provides for an annual limit on the amount of deductible contributions an employer can make to a tax-qualified stock bonus or profit-sharing plan of 25% of the compensation otherwise paid or accrued during the year to the employees who benefit under the plan.
The Oakland, California-based think tank National Center for Employee Ownership estimates that there are approximately 11,300 employee stock ownership plans for over 13 million employees in the United States. Notable U.S. employee-owned corporations include the 170,000 employee supermarket chain Publix Supermarkets, Hy-Vee, McCarthy Building Company, WinCo Foods, environmental consulting firm Citadel Environmental Services, Inc., and Harpoon Brewery. Today, most private U.S. companies that are operating as ESOPs are structured as S corporation ESOPs (S ESOPs).
According to The ESOP Association, a national trade association based in Washington, DC, The most common reason for establishing an ESOP is to buy stock from the owners of a closely held company. Many closely held companies have little or no succession plan in place. As a result, the day a founder or primary shareholder leaves the business often results in significant adverse consequences for the company, the employees, and the exiting owner. ESOPs offer transitional flexibility that can facilitate succession planning. Founders and main shareholders can sell to ESOPs all of their shares at one time, or percentages of their shares on the schedule of their choosing. The transition in leadership, therefore, can occur as quickly or slowly as the owner wishes.
Like other tax-qualified deferred compensation plans, ESOPs must not discriminate in their operations in favor of highly compensated employees, officers, or owners. In an ESOP, a company sets up an employee benefit trust that is funded by contributing cash to buy company stock or contributing company shares directly. Alternately, the company can choose to have the trust borrow money to buy stock (also known as a leveraged ESOP, with the company making contributions to the plan to enable it to repay the loan). Generally, almost every full-time employee with a year or more of service who worked at least 20 hours a week is in an ESOP.
The United States ESOP model is tied to the unique US system encouraging private retirement savings plans and tax policies that reflect that goal. That makes it difficult to compare to other tax codes from other nations.
Most private US companies operating as an ESOP are structured as S corporation ESOPs (S ESOPs). The United States Congress established S ESOPs in 1998, to encourage and expand retirement savings by giving millions more American workers the opportunity to have equity in the companies where they work.
ESOP advocates credit S ESOPs with providing retirement security, job stability and worker retention, by the claimed culture, stability and productivity gains associated with employee-ownership. A study of a cross-section of Subchapter S firms with an Employee Stock Ownership Plan shows that S ESOP companies performed better in 2008 compared to non-S ESOP firms, paid their workers higher wages on average than other firms in the same industries, contributed more to their workers' retirement security, and hired workers when the overall U.S. economy was pitched downward and non-S ESOP employers were cutting jobs. Scholars estimate that annual contributions to employees of S ESOPs total around $14 billion. Critics say, however, that such studies fail to control for factors other than the existence of the ESOP, such as participatory management strategies, worker education, and pre-ESOP growth trends in individual companies. They maintain that no studies have shown that the presence of an ESOP itself causes any positive effects for companies or workers.:27 One study estimates that the net US economic benefit from S ESOP savings, job stability and productivity totals $33 billion per year.
A study released in July 2012 found that S corporations with private employee stock ownership plans added jobs over the last decade more quickly than the overall private sector.
A 2013 study found that in 2010, 2,643 S ESOPs directly employed 470,000 workers and supported an additional 940,000 jobs, paid $29 billion in labor income to their own employees, with $48 billion in additional income for supported jobs, and tax revenue initiated by S ESOPs amounted to $11 billion for state and local governments and $16 billion for the federal government. Also, the study found that total output was equivalent to 1.7 percent of 2010 U.S. GDP. $93 billion (or 0.6 percent of GDP) came directly from S ESOPs, while output in supported industries totaled $153 billion (or 1.1 percent of GDP).
In a US ESOP, just as in every other form of qualified pension plan, employees do not pay taxes on the contributions until they receive a distribution from the plan when they leave the company. They can roll the amount over into an IRA, as can participants in any qualified plan. There is no requirement for a private sector employer to provide retirement savings plans for employees.
Some studies conclude that employee ownership appears to increase production and profitability and improve employees' dedication and sense of ownership. ESOP advocates maintain that the key variable in securing these claimed benefits is to combine an ESOP with a high degree of worker involvement in work-level decisions (employee teams, for instance). Employee stock ownership can increase the employees' financial risk if the company does badly.
ESOPS, by definition, concentrate workers' retirement savings in the stock of a single company. Such concentration is contrary to the central principle of modern investment theory, which is that investors should diversify their investments across many companies, industries, geographic locations, etc.:8–11 Moreover, ESOPs concentrate workers' retirement savings in the stock of the same company on which they depend for their wages and current benefits, such as health insurance, worsening the nondiversification problem.:8–11 High-profile examples illustrate the problem. Employees at companies such as Enron and WorldCom lost much of their retirement savings by overinvesting in company stock in their 401(k) plans, but the specific companies were not employee-owned. Enron, Polaroid and United Airlines, all of which had ESOPs when they went bankrupt, were C corporations.
Most S corporation ESOPs offer their employees at least one qualified retirement savings plan like a 401(k) in addition to the ESOP, allowing for greater diversification of assets. Studies in Massachusetts, Ohio, and Washington State show that on average, employees participating in the main form of employee ownership have considerably more in retirement assets than comparable employees in non-ESOP firms. The most comprehensive of the studies, a report on all ESOP firms in Washington state, found that the retirement assets were about three times as great, and the diversified portion of employee retirement plans was about the same as the total retirement assets of comparable employees in equivalent non-ESOP firms. The Washington study, however, showed that ESOP participants still had about 60% of their retirement savings invested in employer stock. Wages in ESOP firms were also 5-12% higher. National data from Joseph Blasi and Douglas Kruse at Rutgers shows that ESOP companies are more successful than comparable firms and, perhaps as a result, were more likely to offer additional diversified retirement plans alongside their ESOPs.
Opponents to ESOP have criticized these pro-ESOP claims and say many of the studies are conducted or sponsored by ESOP advocacy organizations and criticizing the methodologies used. Critics argue that pro-ESOP studies did not establish that ESOPs results in higher productivity and wages. ESOP advocates agree that an ESOP alone cannot produce such effects; instead, the ESOP must be combined with worker empowerment through participatory management and other techniques. Critics point out that no study has separated the effects of those techniques from the effects of an ESOP; that is, no study shows that innovative management cannot produce the same (claimed) effects without an ESOP. :36
In some circumstances, ESOP plans were designed that disproportionately benefit employees who enrolled earlier by accruing more shares to early employees. Newer employees, even at stable and mature ESOP companies can have limited opportunity to participate in the program, as a large portion of the shares may have already been allocated to longstanding employees.
ESOP advocates often maintain that employee ownership in 401(k) plans, as opposed to ESOPs, is problematic. About 17% of total 401(k) assets are invested in company stock, more in those companies that offer it as an option (although many do not). ESOP advocates concede that it may be an excessive concentration in a plan specifically meant to be for retirement security. In contrast, they maintain that it may not be a serious problem for an ESOP or other options, which they say are meant as wealth building tools, preferably to exist alongside other plans. Nonetheless, ESOPs are regulated as retirement plans, and they are presented to employees as retirement plans, just like 401(k) plans.
ESOPs and 401(k)s are both retirement plans subject to the Employee Retirement Income Security Act (ERISA). While similar in some ways, the plans also have notable differences. These differences can form a strength: Businesses that offer both an ESOP and a 401(k), as 93.6 percent of The ESOP Association's members do, can offer the best of both plans to their employees.
Because ESOPs are the only retirement plans allowed by law to borrow money, they can be attractive to company owners and managers as instruments of corporate finance and succession.:14–16 An ESOP formed using a loan, called a "leveraged ESOP", can provide a tax-advantaged means for the company to raise capital.:14–15 According to a pro-ESOP organization, at least 75% of ESOPs are, or were at some time, leveraged. According to citing ESOP Association statistics as cited in.:14–16 In addition, ESOPs can be attractive instruments of corporate succession, allowing a retiring shareholder to diversify the company of stock while deferring capital gains taxes indefinitely.
Company insiders face additional conflicts of interest in connection with an ESOP's purchase of company stock, which most often features company insiders as sellers and in connection with decisions about how to vote the shares of stock held by the ESOP but not yet allocated to participants' accounts.:16–19 In a leveraged ESOP, such unallocated shares often far outnumber allocated shares for many years after the leveraged transaction.:19–21
This is a timeline of significant events in the development of ESOPs as a financial instrument, as well as some of the key personalities involved in developing the basic concepts, laws and organizations related to ESOPs in the United States: