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10Questions: Driving Performance Through ESOPs « Back
August 2012
 
J. Michael Keeling, President and Chief Staff Officer of The ESOP Association, speaks with Alexander P. Moss, a principal at Praxis Consulting Group, Inc., about driving performance through ESOPs.




10QUESTIONS: ESOP SERIES

Part 1: Buying and selling ESOP corporations

Part 2: Driving performance through ESOPs

Part 3: Exercising fiduciary duties for ESOPs


Keeling: Based on your experience, what are the overall benefits of employee ownership under an ESOP structure?

Moss: It is inevitable that every firm will be sold; eventually, the owners today will not own the firm forever. The central questions are: to whom will they sell, when, and for whose benefit? The ESOP provides a critical and simple answer for selling shareholders, particularly in private – not publicly traded – firms: the ability to liquidate their ownership interest, while preserving the health and independence of the organisation, and while sharing the future opportunity with those who will contribute to creating that value. This is very attractive to certain sellers, and without this combination of benefits, far few sellers would be attracted to employee ownership. From the perspective of the company itself, and its employee owners – the beneficial buyers – ESOPs provide a separate and quite powerful opportunity. It is clear from both published academic research and anecdotal reporting by ESOP-owned firms that these firms are generally able to outperform marketplace competitors. However, the performance benefits of employee ownership are not solely associated with the simple fact of sharing stock ownership. Rather, it is the combination of stock ownership along with meaningful opportunities for employee-owners to drive operational performance that leads to the most dramatic performance gains. That people who are properly incentivised should perform better should not surprise us. The ESOP provides a long-term equity structure to accomplish this, embedded within the formal US retirement scheme under ERISA.

Keeling: In what ways does the financial structure of an ESOP corporation help to drive operational performance?

Moss: The ESOP provides a highly structured mechanism for distributing increased equity value to employees who participate in the plan, over an extended period of time. For all of their complexity and imperfections, the retirement regulations under which ESOPs operate are extremely well tuned to ensure that all participants benefit fairly. This has two primary and specific consequences. First, all participants receive shares of stock in their employer firm, as part of their retirement compensation benefits. The ESOP therefore provides a broad-based sharing mechanism that gives employees as a whole an opportunity to share the financial benefits of ownership. And opportunity is the key – the ESOP in no way guarantees the future value of those benefits. Second, the value of benefits that participants receive is dependent on the growth in the equity value of the firm. When properly communicated and executed, this provides a powerful incentive and reward for employee-owners to engage in behaviours that actually drive increased long-term share value. When the dust settles, ESOPs provide a compelling combination of fairness and accountability, for employee-owners, above and beyond the liquidity and financial planning benefits that ESOPs provide to selling shareholders.

Keeling: How important is it to set expectations and align shared visions among the company’s employees? What strategies are most effective in this respect?

Moss: Is it absolutely essential. Virtually every employee-owned firm wrestles with misperceptions at all levels regarding the meaning of shared ownership. Is the ESOP ‘only a retirement plan’? It can be used that way, but only at the expense of leaving the performance opportunity unclaimed. Is the ESOP a 1-person/1-vote democracy? Almost never – though there are a small number of highly successful ‘democratic ESOPs’. What is this ‘retirement plan plus ownership structure’, and what does it mean for our company? This is a messy question with answers that vary dramatically from firm to firm. For most, the challenge is to define ‘shared ownership’ in a way that is meaningful and inspiring to employee-owners, that provides real opportunities for increased engagement in daily decision-making, and that clarifies and reinforces the appropriate authority boundaries that any organisation requires to operate successfully. Of course, where those boundaries lie also varies widely from firm to firm, so the essential question is: ‘What forms of engagement in which kinds of decisions will work best in our own company context?’ Firms engage in a range of strategies to clarify these issues, from organisational assessments to senior leadership retreats to whole-company visioning and planning processes, among others. What is most essential is to build an authentic and commonly shared set of expectations regarding ‘what contributions are expected of me (‘what do I give’), and what I can expect to receive (‘what do I get’), now that I am a co-owner of the firm’.

Keeling: In your view, do employees in ESOP corporations often feel more engaged in executing the business strategy than employees in a more traditional business model?

Moss: On a good day, in a well-managed ESOP, certainly. And it is also the case that not all days are good, nor are all ESOPs routinely well-managed. Shared ownership through the ESOP is an opportunity, not a guarantee or entitlement. Employee-owners want the opportunity to understand core business strategy – where the organisation is headed and why – as well as how their work ties to the greater success of the organisation, how the firm makes money, reinvests, and builds share value. And they want to act on that knowledge: to improve their core business processes, to feel that they are making a difference. These are powerful motivators, and innumerable stories of successful employee-owned firms in action illustrate the point better than we can possibly summarise in a few words here. Yes, employees in ESOPs often feel deeply engaged in executing business strategy. Turning the question around, most of us intuitively understand that most employees are not actually freeriders, in spite of the dire warning of economists. Sure, there are a few out there. But if we build our systems primarily to prevent the freerider problem, rather than primarily to enable and inspire people to perform, then we will get what we have designed, and shame on us for aiming low.
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