ESOPs More Valuable Than Just a Retirement Savings Vehicle

Studies have shown that companies that sponsor employee stock ownership plans (ESOPs) see positive results for revenue and employee productivity, but more recent studies show ESOPs provide greater retirement savings for employees and can reduce wealth inequality.

Loren Rodgers, executive director of the National Center for Employee Ownership (NCEO) in San Francisco, says, “It looks like there’s been an uptick in ESOP activity according to our service provider friends.” He says there are segments of the market that have different reasons for offering an ESOP to employees. The No. 1 reason, according to Rodgers, is the seller wants to get ready to retire and isn’t comfortable with a profit maximizer or a competitor taking over the business because he knows at least some of the executive team will lose their jobs and he wants to preserve the legacy of the company.

In another segment, a buyer is hard to find—either the company serves a small niche and there’s not much interest except by employees, or a female or minority-owned business wants to keep it so. The third segment just sees offering an ESOP as a business strategy to make employees owners.

In 2017, the NCEO reported that as of 2014, there were 6,717 ESOPs in the United States, holding total assets of more than $1.3 trillion, and covering more than 14 million participants. According to Rodgers, one reason there are thousands of ESOPs is the sellers get tax benefits—a major tax advantage is sheltering the corporate income from taxes.

ESOPs provide higher retirement savings

In 2018, the NCEO reported that ESOP participants have an average retirement balance of $170,326, more than twice the $80,339 that other workers have saved. Even for ESOP employees making less than $25,000 a year, their balances average $55,526, compared to the $22,447 that their counterparts have saved at other companies.

Rodgers explains that employees have double the retirement savings balance for two reasons: Almost always the ESOP is added to another retirement savings vehicle, and for those using an ESOP as an ownership transition vehicle, they sell shares at a higher price.

In addition, NCEO research finds the larger retirement savings balance may be due in part to a larger than average contribution rate by employers. “On average equities are among the highest performing class of securities, so employees can see a greater growth of assets,” Rodgers says.

In addition, the average tenure for employee owners is about 20% higher than for non-employee owners, NCEO research found.

Rodgers adds that employee-owned companies tend to provide a more generous benefit package overall—health benefits, flex time, parental leave, tuition reimbursement—benefits that help with employee’s financial lives.

Closing the wealth gap

In the first-ever national study of low-income and moderate-income workers at employee-owned companies, researchers discovered ESOPs enable families to significantly increase their assets, shrinking—though not eliminating—gender and racial wealth gaps. The research by the Rutgers Institute for the Study of Employee Ownership and Profit Sharing suggests employee ownership can reduce wealth inequality in the U.S.

According to the study report, “Building the Assets of Low and Moderate Income Workers and their Families: The Role of Employee Ownership,” analysis from the study suggests that employee-owned firms stitch together five specific elements that work in tandem to enable workforce asset building, including: Building ESOP account equity and financial knowledge; Expanding workforce capabilities through on-the-job training, external education, and internal mentoring; Enabling asset preservation and personal investments; Increasing access and inclusion by gender, race and ethnicity; and Improving health and well-being through quality of work life experience and balance.

Douglas Kruse, distinguished professor and associate director of the Rutgers Institute for the Study of Employee Ownership and Profit Sharing (also a former senior economist in President Barack Obama’s White House Council of Economic Advisers), based in New Brunswick, New Jersey, says unlike defined contribution (DC) retirement plans, typically only employers make contributions to ESOPs. The study report explains that companies use credit to fund the ESOP’s purchase of company shares and the company pays back the loan. As the loan is repaid, the company distributes the shares to all employees in their ESOP accounts. “This ability to build an asset without depleting resources from a family budget is critical for low- and moderate-income households,” the report says.

Because of this, according to Lisa Schur, professor, Rutgers School of Management and Labor Relations, based in New Brunswick, New Jersey, employers can include everyone in the company including the lowest-paid who may feel they do not have the resources to contribute to a DC plan.

She says the study also showed many employee-owned companies specifically have training like ESOPtober, related to employee ESOP accounts. Some companies had more formal programs set up than others. Schur says one company had the chief financial officer (CFO) talking to employees informally. “So better education is provided to employees about ESOPs than other retirement plans,” she says.

According to Kruse, the ESOP education covers fundamental ideas of retirement planning. “They teach employees ‘Here’s the amount we put in, and here’s how it may grow over time,’” he says. “But companies are careful not to make strong predictions.”

“Employee-owned companies provide more financial transparency to employees. “Education about finances, debt and balance sheets, savings, investments, returns, and profits (open book management at differing levels) all contribute to employees’ understanding of their companies, and how some of these issues translate into their own personal financial management,” the report says.

“Many employers are worried about employee engagement. We found lower-income workers are more engaged when they have ESOPs. It gets everyone thinking in similar terms about how to make the company do well,” Kruse says, citing the example of one employee suggesting that the company use Fed Ex rather than direct mail to save on costs.

Schur says the financial education didn’t just stop with employees, as some reported they taught their family members about financial issues and saving for retirement.

The study confirmed what Rodgers said about ESOP companies offering better benefits overall. Employees reported their companies provided internal mentorship and career coaching, helping them develop skills and income through advancement on the job without cutting into family time. Employees also reported being offered tuition for formal education and training.

Another way ESOPs help narrow the wealth gap is offering employees a way to pay for expenses without increasing consumer debt. According to Kruse, some employees had more confidence about borrowing from the ESOP since they had other retirement savings.

Schur says a number of employees talked about borrowing from the ESOP for a health emergency, paying for children’s education, or buying their child a car. One person put down payment on trailer. “It enables access to money for wealth transfers to families that wouldn’t have the wealth without an ESOP,” she says.

“There’s a lot of talk about growing inequality in the U.S. Besides income inequality, wealth inequality is more striking. There’s even negative wealth among workers of color. ESOPs are a way to build wealth that can make a tremendous difference in retirement security as well as possibly decreasing the wealth gap,” Schur concludes.