The Real World of Employee Ownership 9781501728242

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THE REAL WORLD OF

EMPLOYEE OWNERSHIP

THE REAL WORLD OF EMPLOYEE OWNERSHIP John Logue and Jacquelyn Yates WITH A FOREWORD BY WILLIAM GREIDER

ILR Press an imprint of Cornell University Press Ithaca and London

Copyright© 2001 by Cornell University All rights reserved. Except for brief quotations in a review, this book, or parts thereof, must not be reproduced in any form without permission in writing from the publisher. For information, address Cornell University Press, Sage House, 512 East State Street, Ithaca, New York 14850. First published 2001 bv Cornell University Press First printing, Cornell Paperbacks, 2001 Printed in the United States of America

LIBRARY OF CONGRESS CATALOGING-IN-PUBLICATION DATA

Logue,John, 1947The real world of employee ownership I John Logue and Jacquelyn Yates. p. Clll. Includes bibliographical references and index. ISBN O-R014-3349-5 (cloth: alk. paper) ISBN 0-8014-8394-8 (pbk. : alk. paper) 1. Employee ownership-United States. 2. Stock ownership-United States. 3. Employee ownership-Ohio-Case studies. I. Yates, Jacquelyn, 194 7IT. Title. HD5660.U5 Ui44 2001 331.2'164---dc21 2001001989

Cornell University Press strives to use environmentally responsible suppliers and materials to the fullest extent possible in the publishing of its books. Such materials include vegetable-based, low-VOC inks and acid-free papers that are recycled, totally chlorine-free, or partly composed of nonwood fibers. Books that bear the logo of the FSC (Forest Stewardship Council) use paper taken from (()rests that have been inspected and certified as meeting the highest standards for cmironmental and social responsibility. For further information, visit our website at www.cornellpress.cornell.edu. Cloth Printing Paperback Printing

10 9 8 7 6 5 4 ~l 2 I 10 9 8 7 6 5 4 'l 2 1

Thomson-Shore, ilie company that manufactured this book, has been an ESOP company since 1984. Ned Thomson and Harry Shore, ilie founders of the company, sold their shares of the stock to the employees in 1997. The company is currently 0R.1 percent employee owned.

To Ohio's employee owners who are building a better way of doing business every day

Contents

List ofFigures List of Tables

IX X

Foreword WILLIAM GREIDER

Acknowledgments

Introduction: From Frontier Egalitarianism to Employee Ownership

2

Xlll XV

1

The Real World of Employee Ownership in Ohio

21

Communication and Training: Building a Learning Environment

46

Karen Thomas and .Jennifer Maxwell

3

Participation: Can Workers Run the Firm?

4

Union Brothers and Sisters in the Boardroom?

110

5

Do ESOPs Mature? Modeling Performance and Profits

132

Employee Ownership and Public Policy

158

6

72

vii

CONTENTS

viii

Appendix 1

About the Ohio Survey

181

Appendix 2

Results of the 1992-93 Ohio ESOP Survey Heather Cross

190

Notes

225

Works Cited

233

Index

241

Figures

l.l. Average Annual Growth in ESOP Plan Value per Participant 30

1.2. How Ohio ESOPs Compared with Their Industries in job Creation and Retention 36 2.1. Pre- and Post-ESOP Communication 51 2.2. Post-ESOP Change-in-Communication Index 53 2.3. Financial Communication since the ESOP Was Established 54 2.4. Pre- and Post-ESOP Training for Nonmanagerial Employees 56 2.5. Post-ESOP Change-in-Training Index 59 3.1. Selection of ESOP Administration Committees 84 3.2. Nonmanagement Employees on Boards of Directors 86 3.3. Nonmanagerial Directors and Firm Performance 92 3.4. Board Selection Method and Firm Performance 94 3.5. Work-Unit/Shop-Floor Participation and Firm Performance 95 4.1. Nonmanagerial Employee Involvement and Union Relationship to the ESOP 123 5.1. Distribution of Maturity Scores 135 5.2. Organizational Development and Interest in Decision-Making 139 5.3. Organizational Development and Qualitative Impact of ESOP 140 5.4. Organizational Development and Quantitative Impact of ESOP 141 5.5. Organizational Development and Change in Profits Relative to Industry 142 5.6. Interest in Decision-Making and Performance 146 5.7. A Model of the ESOP Firm in the Business Environment 150 ix

Tables

1.1. Accumulation of Shares and Value for the Average Employee Owner at Reuther Mold and Manufacturing 16 1.1. ESOPs and Employment by Industrial Sector, Ohio and the United States 25 1.2. Comparison of Minoritv and Majority Employee-Owned ESOP Firms 39 1.3. Comparison of ESOPs in Publicly Traded and Closely Held Companies 41 1.4. Comparison of 1985-86 and 1992-93 Ohio Surveys: Sector, Coverage, and Financial Benefits 42 1.5. Comparison of 1985-86 and 1992-93 Ohio Surveys: Share of Ownership, Philosophy, ancl Employee Influence 43 1.6. ESOP Firms' Five-Year Predictions 44 2.1. Sharing Financial Statements in Public and Private ESOP Firms 55 2.2. Relationship between Communication since the ESOP, Employee Interest, and Firm Performance 61

2.3. Training Levels since the ESOP and Firm Performance 62 2.4. Post-ESOP Performance by Types of Training Used in Majority ESOPs 63

2.5. Impact on Attitudes and Performance of Change in Communication and Training 64 3.1. Structuring Participation in the Employee-Owned Firm 77

3.2. Cooperative and Consultative Management Approaches 82 X

TABLES

3.3. Impact of Boardroom Participation on Performance Indicators 93 3.4. Impact of Work-Unit Shop-Floor Participation on Performance Indicators 96 3.5. How Firms Combine Boardroom and Work-Unit/Shop-Floor Participation 99 3.6. Impact of Boardroom and Work-Unit/Shop-Floor Participation on Profits Relative to Industry 99 4.1. ESOPs in the Unionized Sector, by Union Relationship to ESOP 118 4.2. Role of the Union and Performance Indicators in the Unionized Sector 127 5.1. Maturity and Firm Performance, Measures of Association 137 5.2. Relation between Involvement and Interest in Decision-Making 145 5.3. Relations between Organizational Structure, Communication, Training, Participation Opportunities, and Employee Interest in Decision-Making 147 6.1. Ohio Network Membership and Indicators of Participation and Performance 168 6.2. Maturity and ESOP Tax Breaks 170 A. I. The Universe of Ohio ESOP Companies 182 A.2. Survey Response Rate among Ohio ESOP Companies 184 A.3. Questionnaire Responses Compared with Phone Responses 185 A.4. Comparison of OEOC Study Respondents with Ohio and U.S. IRS Form 5500 Filings 186 Appendix 2. Results of the 1992-93 Ohio ESOP Survey 190

xi

Foreword

Now that the Cold War has ended and the great ideological contest is settled between capitalism and socialism, perhaps Americans can at last look with clearer eyes at deformities within their own economic system. The most central of these is the employment system itself in which most people go to work for someone else and, unless they happen to be highly skilled professionals or independently wealthy, they consign a major portion of their lifetimes to the direction of others, forfeiting basic rights and autonomy in the process of earning a living. With few exceptions, the system works like this: capital hires labor and capital claims ownership of the final product. Can one imagine an economy in which labor hires capital? Where workers have a legal right to the profits and legal responsibility for the liabilities because they are the owners, where workers jointly manage the firm and themselves in a democratic fashion? This conception of work life is not an abstract vision beyond human possibility, because these conditions already exist for millions of Americans who work in employee-owned companies, cooperatives, or partnerships. The great goal of reform ought to be making this arrangement the common experience for Americans-or at least forcing these questions of ownership, rights, and work into what is now the sterile economic debate of American politics. For at least two generations, some Americans from the ranks of both workers and owners have been struggling to create employee ownership, not as a grand political gesture but as a practical reality in their everyday lives, in the offices and xiii

xiv

FOREWORD

factories where they work, in the companies some have founded and owned. This book recounts their progress, the enormous challenges and successes. It is an excellent starting text for people who wish to think seriously about how a general transformation might proceed. Readers who are looking for romanticized cheerleading on behalf of employee ownership will doubtless be disappointed by this report. Readers who wish to engage seriously in developing a more promising future for the American workforce will find numerous and invaluable insights to inform their own inquiries. Given the historic social weight of the status quo, no one should be surprised to learn that making a genuine conversion to worker-owned enterprises and self-management is very diflicult to do. No one should be dismayed to see that sometimes the efforts fall well short of realizing the ideal. These are human systems being altered and everyone involved, in a sense, has to learn new work relationshipsmanagers and workers alike-while also making sure the enterprise remains profitable and survives. The unambiguous message from the "real" world, however, is that people can succeed at this, not easily or perhaps right away but with hard effort and resilience and the earnest application of what they know. Employees can and do change their own circumstances and some are delivering profitably on the promise of taking responsibility for their own work. WILLIAM GREIDER

Acknowledgments

Any large-scale research project on employee ownership includes the ideas and the hard work of many people whose names do not appear on the title page or table of contents. This book is no exception. It represents the input of practically all staff members at the Ohio Employee Ownership Center (OEOC). The commentary throughout is informed by our collective experience working with Ohio's employee-owned companies. Many of the questions we raise reflect the queries we receive regularly from these companies as they seek to benchmark themselves against other firms. Although the book draws on a wealth of Ohio experience, most of the data reported are derived from a total population survey of Ohio firms that have adopted Employee Stock Ownership Plans (ESOPs). It too involved many of the staff and Kent State University faculty associates of the OEOC. The questionnaire design was done by Dan Bell, Catherine Ivancic, and John Logue, and it was piloted byanumberoffirmsin Ohio's Employee-Owned Network. Ivancic and Selma Ford compiled the list of firms to be surveyed. Data collection, coding, and inputting were done by Ford and Heather Cross and codebook design by Ford under Logue's guidance. Cross input the data, assembled and cleaned the frequency distribution tables, and did some of the analysis underlying the initial report on the survey (Logue and Cross 1993); she also had primary responsibility for Appendix 2. Chris Cooper designed several of the graphs and checked citations. Leslie Schug prepared the index. Steve Clem developed the Ohio labor market statistics used in Chapter 1. Although the primary authors were involved to some degree throughout the writing of XV

xvi

ACKNOWLEDGMENTS

this book, credit for Chapter 2 is primarily due to Karen Thomas and Jennifer Maxwell, and it is credited to them explicitly. John Logue authored the Introduction, Chapter l and the methodological appendix, and collaborated with Jacquelyn Yates on Chapters 3 and 6. Yates is the primary author of Chapters 4 and 5. Data analysis for all the chapters was done primarily by Jacquelyn Yates, whom the other authors thank. Yates appreciates the suggestions of Karen Thomas and John Logue on Chapter 3 and of Steve Clifford on Chapter 4. Funding for the Ohio ESOP survey was provided by a special projects grant from the Office of Labor-Management Cooperation, Ohio Department of Development; subsequent funding for analysis and writing was provided by an Ohio Board of Regents' Research Challenge grant awarded by Kent State University. Yates also thanks Gordon Keller, Vice Provost for Regional Campuses, and Suzanne Fitzgerald, Dean of KSU's East Liverpool Campus, for their support. Our thanks to all our funders. Opinions expressed in this book are those of the authors, not of the Ohio Employee Ownership Center or of the financial sponsors of this study. Errors in interpretation or fact are likewise our own responsibility. We have drawn on several previous publications of the survey results. In addition to the preliminary report cited above, these include Logue and Thomas 1994; Logue and Yates 1999; and Yates 2000. Our thanks to the Urban Center at Cleveland State University, Economic and Industrial Democracy, and the Journal of Employee Ownership Law and Finance for permission to reuse portions of this material in altered form. Our thanks also to Corey Rosen and Michael Keeling for answering our questions and for comments on this manuscript; to Bruce Householder, Stan Lundine, Lynn Williams, and the rest of the Steelworkers' Worker-Ownership Institute executive committee for a very practical education; to the Cooperative Charitable Trust Forum for many stimulating discussions; to an anonymous reviewer for careful reading and encouraging us to reformulate key arguments; and to Ohio's employeeowned companies for completing the survey. The authors thank Sam Cho for nourishment of body and soul. We are particularly appreciative of the patience and forbearance of our editor at Cornell University Press, Fran Benson. JoHN LocuE AND JACQUELYN YATES

Introduction: From Frontier Egalitarianism to Employee Ownership

Question: What do you regard as the biggest advantage of having an ESOP? Answers: An opportunity for individual ownership in a business that helps make up the free enterprise system. An opportunity that rewards hard work and dedication. (Company 104) The equitable distribution of capital/wealth to those whose labors go to create it. (Company 6)

Employee ownership in America has grown explosively since federal legislation created tax advantages for companies establishing Employee Stock Ownership Plans (ESOPs) in 1974. 1 Today every twelfth American worker in the private sector is a co-owner of his or her company through an ESOP. Roughly an equal number have some ownership stake-but far more limited ownership rights-through 401 (k) plans and broad-based stock options. It is one of the major economic stories of the last quarter of the twentieth century. The concept of an America in which productive assets are owned by the people who use them is as old as our country. Thomas Jefferson argued passionately that what set this country apart from the Old World and made it so suitable for democracy was the fact that the ownership of productive property was widely dispersed: farmers owned their land in the countryside; artisans owned their tools and shopkeepers their shops in the towns. Early visitors to America remarked on the same. Alexis de Tocqueville, writing about the United States of the 1830s, noted, "nothing struck me more forcibly than the general equality of condition among the people .... The more I advanced in the study of

2

INTRODUCTION

American society, the more I perceived that this equality of condition is the fundamental fact from which all others seem to be derived and the central point at which all my observations constantly terminated" (Tocqueville 1945, 1:3). The ethos of the frontier underscored Jefferson's vision: an egalitarian society in which individual merit and skill determined life chances. The land was there for the taking, and for a century every generation moved farther west. There was a nascent American aristocracy in the commercial class of the seaboard towns and the plantation owners of the South, but the former faced the vicissitudes of trade and the latter the Civil War and the expropriation of their means of production-their slaves-without compensation. The Homestead Act (1862) and the Land Grant College Act (1862) solidified expectations of economic egalitarianism. But even the American frontier was not boundless, nor was egalitarianism uncontested. The last quarter of the nineteenth century brought a massive reorientation with the rise of the modern corporation and in 1886 its recognition by the Supreme Court as a legal "person" with full constitutional protections (Santa Clara County v. Southern Pacific Railroatf), the closing of the frontier in the 1890s, and the triumph of Taylorism at the beginning of the 20th century. Railroads made possible a continental market offering previously unimaginable economies of scale. vVhen Henry Ford married Taylorism's division of labor (into its "scientifically determined" smallest practical components) to a mechanically driven assembly line, the "American Century" was launched. Those years also brought an egalitarian reaction. The People's Party (the Populists) swept the prairies and the South in protest in the 1890s. Henry George, the self-taught iconoclastic economist, excoriated the new economy, asking why increasing economic progress brought increasing poverty; his answer was to tax the unearned increment in the value of land (George 1879). Trade unions fought to defend existing rights against Taylorist encroachment, and for a brief moment before the First World War, American Socialism seemed to combine economic rebellion against the corporations with unionization and protection of individual rights. The Socialists won more votes in newly settled Oklahoma than in the industrial cities. There were moments when the concentration of ownership and the demise of local control seemed to pay off for the average American: the 1920s combined mass production breakthroughs in new industries with

From Frontier Egalitarianism to Employee Ownership

3

rapidly rising prosperity. There were also moments when it delivered the opposite-the Great Depression-and when rebellion against it swept the country: the CIO organizing campaign in mines, mills, and factories; demonstrations of the unemployed in the cities; mass resistance to farm foreclosures in the countryside. If there was any single spokesman for this homegrown American egalitarianism in the 1930s, it was not the patrician Franklin Delano Roosevelt, although his stentorian public confidence stilled the tides of discontent while the federal government cobbled together a safety net to ameliorate the symptoms of economic collapse and an interventionist economic policy to address its causes. Rather it was the rural Louisiana populist Huey Long, with his middleclass upbringing in Winn Parish-a hardscrabble agricultural area that was a citadel of Louisiana populism in the 1890s and socialism in the early years of this century, in that brief interlude of socialist revivalism that followed populism among poor farm families in the South-who carried the banner of 150 years of egalitarian protest. He preached an America in which "every man is king but no man wears a crown." We will meet his son shortly. The New Deal put Americans back to work and provided minimum guarantees to the elderly and the unemployed. Roosevelt and the New Dealers accepted the ownership structure of American industrial capitalism but sought to limit its abusive features through regulation for the common good. The massive industrialization carried out with federal dollars during World War II passed to private corporations after the war and laid the foundations for postwar prosperity; forced savings during the war created the pent-up demand for a consumer-led postwar boom. Federal programs for veterans built a new middle class from those whose childhoods had been misshapen by the Depression and who in their teens and twenties had fought and won the war in North Africa, Europe, and the Pacific. The GI Bill of Rights sent millions to college, opening the doors of higher education to the sons of coal miners, autoworkers, and the Okies who had lost their farms; it also aided veterans in starting businesses and farms. The veterans' housing loan program brought home ownership within the reach of any veteran with steady employment; a suburbia of small homes on tiny lots sucked the industrial working class out of the tenements of the cities. The American industrial colossus bestrode an economically prostrate world, and the industrial unions in steel, automobiles, electronics, and the like bargained increasingly middle-class living standards, pensions, and medical bene-

4

INTRODUCTION

fits from oligopolistic employers. The Eisenhower administration undertook the most massive peacetime public works program in history with the interstate highway system. Kennedy's New Frontier and Johnson's Great Society offered to extend this prosperity to those who were still marginal: black Americans, dwellers in Appalachia, and the elderly. The civil rights and feminist movements reshaped American attitudes toward a more inclusive egalitarianism. The promise of the American Century seemed on the way to being fulfilled. We celebrated the increasing achievement of that promise in the 1950s, 1960s, and 1970s. In political theory, Robert Dahl's "pluralism" of organized interests representing the people and checking each other offered a modern version of the mechanistic checks and balances of the eighteenth-century U.S. Constitution. In economics, the United Statesand its NATO allies in Western Europe-shared a Keynesian consensus that government, through demand-side policies and welfare-state measures, could manage the economic cycle and create a shared prosperity that would include even those marginal to the labor market. The oil shock of 1973-74 shook this pleasant consensus. It was a symptom of something bigger: the replacement of national economies (which exchanged some goods through foreign trade) by a global economy. Bringing a rude awakening to this new international economic order, oil-producing countries seized price-setting powers from the Western oil companies and raised prices dramatically, sending Western economies into a period of "stagflation"-an unhealthy combination of economic stagnation, rising unemployment, and high rates of inflation-which did not end until Ronald Reagan's brand of military Keynesianism and tax cuts tripled the American national debt but reinflated international demand. Economic globalization proceeded apace, as multinational corporations transformed themselves from companies producing the same products in many markets into integrated global producers, seeking low-cost suppliers wherever they could be found. In this globalized economy, national Keynesianism spilled over the borders and began to be too costly and too inflationary. In the American case, globalization elevated interest rates and currency values, leading to large-scale deindustrialization and growing economic polarization, rationalized through the resurrected ideology of the supremacy of markets. Later, with the rapid increase in the global mobility of capital, the economic foundations of the welfare state began to erode, threatening hard-won equality.

From Frontier Egalitarianism to Employee Ownership

5

That current of egalitarianism in American political thought and that pressure of economic globalization on Main Street America provide the context for this examination of employee ownership in America today. For a quarter-century, American tax legislation has encouraged companies to make their employees long-term co-owners through Employee Stock Ownership Plans (ESOPs) and related pension plans. 2 These plans have demonstrably broadened the ownership of company stock among company employees, though whether they are good pension plans remains much disputed. 3 This book represents our effort to ascertain what the real world of employee ownership really looks like and how it works. Our study is based on a dozen years of experience of daily work with Ohio's employee-owned companies and particularly on our survey in 1992-93 of all Ohio firms that were believed to be owned in part or whole by their employees, supplemented by analysis of data of public record provided by ESOP companies: the IRS Form 5500 filings for 1993-94. We have also drawn occasionally on a previous Ohio ESOP survey conducted in 1985-86 in order to discuss changes over time in ESOP practices. The 1992-93 questionnaire repeated the key benchmark questions from the earlier survey and added a focus on internal communications, employee training, employee participation, and changes in management practices. Some of the firms discussed have survived in style, wresting profit and prosperity out of an adverse business climate; others have not done well and only barely survived. A few firms have made breathtaking changes in internal organization and processes to create more informed, consultative, and cooperative workplaces; others have done little or nothing in this regard. Whether ESOPs have encouraged-or should encourage-democratic practices within the economy and whether they have improved the performance of American firms have been subjects of substantial debate. A number of studies in the 1970s and 1980s, done primarily by proponents of employee ownership and reaching positive conclusions concerning these issues, were based on surveys marred by low response rates. (The few who do respond in low-response-rate surveys tend to love their ESOPs.) By contrast, the best study methodologically, done by the United States government's General Accounting Office (GAO) in 1985, found little democracy and no impact on performance in companies partly or wholly owned by ESOPs and similar pension plans; it did find, however, that the companies which combined employee ownership and

6

INTRODUCTION

employee participation seemed to improve their performance (General Accounting Office 1987, 26-31). We became particularly persuaded of the validity of the hypothesis that it is the combination of employee ownership with employee participation systems, open communication about the business, and the training to use those systems and to understand the information communicated which has a positive impact on company performance. Our embrace ofthis hypothesis, which has come to inform our practice at the Ohio Employee Ownership Center, was partly based on the literature (Conte 1992; GAO 1987; Keogh and Kardas 1994-95; Michigan Center for Employee Ownership and Gainsharing 1990; Winther 1995), partly on our own research (Logue and Rogers 1989), and partly on our direct experience. Consequently, we were specifically interested in the impact of change or stasis in these organizational characteristics on the firm's financial indicators: productivity, employment levels, profits, and stock values. Could we identifY "best practices" among financially successful ESOPs? We saw the answer as being of interest both to researchers and to practitioners, whether they are professionals advising ESOPs or the managers and union and employee leaders in ESOP companies. Participatory Employee Ownership, an earlier effort at sketching those "best practices," grew out of the research for this book and our field experience (Logue, et al. 1998). Before reporting the results of the study, let us sketch the history of employee ownership and employee participation in America; the origins, structures, and limits of Employee Stock Ownership Plans; and the layout of the remainder of the book.

Employee Ownership in American History

In the nineteenth century the idea of workers' ownership of the means of production through cooperatives was part of the ideology of organized labor. The Knights of Labor, the precursor of the American Federation of Labor (AFL) energetically promoted the organization of production cooperatives; between 1878 and 1886 at least 135 were established. Although most did not survive as businesses, the idea survived in the craft unions. The preamble of the Machinists Union constitution of 1891, for instance, cites the organization of cooperatives as one appropriate means, alongside economic and political organization, to achieve

From Frontier Egalitarianism to Employee Ownership

7

the goal of "restoring the commonwealth to all those performing useful service to society." For the better part of a century the growth of co-ops was stymied by a structural problem. Those co-ops that failed in the market disappeared, for the obvious reasons, but those that succeeded disappeared too. The problem lay in the design of ownership. Each founding member bought one share, and if the co-op did well, all shares appreciated equally in value. Thus, when founding members wanted to retire, new workers could not afford to buy the retiring members' shares, so success was as fatal as failure; retiring members sold to outside buyers, and the cooperatives were converted into conventional corporations. Despite this difficulty, the concept of co-ops was revived regularly to provide employment for blacklisted craft unionists and in crises as a means to put the unemployed back to work or to avoid plant shutdowns. Occasionally their size and numbers made them significant in individual industries locally and, in the single notable case of the plywood industry of the Pacific Northwest (Gunn 1984, 99-131), nationally. The structural problem that had stymied the transfer of ownership from founding members to new workers was finally solved by the internal account system popularized in America in the 1980s by the Industrial Cooperative Association and patterned on the Mondragon cooperatives in Spain (see Adams and Hansen 1987, 94-96, 224-233). Cooperatives gradually disappeared from labor's agenda as industrialization advanced. They were realistic in the traditional crafts, where a business was little more than a pool of hand tools and expertise, but it was hard to see how they could work in mass production. How do you start up a cooperative steel mill or auto plant? So while cooperatives became the mainstay of family farms, supported by federal agencies and providing the economies of scale in purchasing, processing, and marketing for millions of family farmers, they led an increasingly peripheral existence in industry. Mter the turn of the century, labor radicals such as the Industrial Workers of the World (IWW) or the Congress of Industrial Organizations (CIO) unions focused on fighting the bosses rather than taking ownership of the means of production. The real economic gains achieved by collective bargaining so far outweighed the hypothetical benefits from production cooperatives that by the 1950s the concept had virtually disappeared as a subject of union interest. Indeed,

8

INTRODUCTION

workers acquired sufficient influence over wages, hours, and the conditions of employment through collective bargaining that some theorists of American industrial relations (e.g., Milton Derber 1970 and 1977) have argued that collective bargaining itself is industrial democracy U.S.-style. Some corporations, however, promoted worker ownership of company stock as a matter of managerial philosophy. The first such stock ownership plan documented in this country was initiated by Rand McNally, the Chicago publishing firm, in 1879. During the boom of the 1920s enough companies instituted stock purchase plans through payroll deductions to put corporate stock in the hands of more than 300,000 employees by 1926 (Employee Benefit Research Institute 1988, 4). The crash of 1929 put an abrupt end to this development, and although a few individual firms, such as the Milwaukee Journal in 1937 and the Bureau of National Mfairs (BNA) in 1947, adopted employee ownership for idiosyncratic reasons, they were the exceptions. With neither union nor corporate support, employee ownership pretty much disappeared from view in America until the early 1970s. Whereas in Western European countries the push for industrial and economic democracy in the late 1960s and early 1970s came from the labor movement, it was not labor and the left that put worker ownership back on the U.S. political agenda. Instead, the prime legislative proponent of the concept was Louisiana senator Russell Long, a moderate southern Democrat and son of Huey Long; the principal theoretician of the movement was investment banker Louis Kelso. Both sought to stabilize the capitalist system, not to overthrow it. 4 They saw the increasing concentration of capital in ever fewer hands as a threat to capitalism; to survive, the capitalist system needed more capitalists, and where were they to come from if not from the ranks of workers? And in fact, better pay and benefits while working, improved pensions and other post-retirement benefits, some increase in family savings, and the explosive growth of home ownership did put more workers into an economic position where ownership of productive assets was a reasonable option. The demand for economic equality in America has been couched not so much in collective terms, as was generally the case in Europe, as in individualistic ones. From Thomas Jefferson's ideal nation of independent farmers and artisans through the populist revolt of the 1890s up to Huey Long's "share the wealth" campaign of the 1930s, even U.S. radicals idealized the economically independent producer. Thus

From Frontier Egalitarianism to Employee Ownership

9

employee ownership strikes a chord in the overarching Jeffersonian ideology that America is-or should be-a land of independent producers in town and country. That is obviously not possible in a pure form in an advanced industrial economy, but employee ownership approximates a contemporary equivalent of the Jeffersonian view. It is fitting that Robert Dahl, the principal theorist of pluralist democracy in the postwar United States, concluded in the Dilemmas of Pluralist Democracy (1982) that the size and power of major corporations threatened to undermine the workings of pluralism-the modern form of the founding fathers' checks and balances. His remedy in A Preface to Economic Democracy (1985) was to democratize the ownership of the large corporations. That, in a nutshell, is why the concept of employee ownership has enjoyed broad political support from such public figures as Ronald Reagan on the right to Jesse Jackson on the left. It is a part of the American consensus (Kruse and Blasi 1999, 4-5). Belonging to no political party or taction, employee ownership belongs to all.

Employee Participation in American History

American industrialization at the end of the nineteenth and beginning of the twentieth century was shaped by the combination of the economies of scale permitted by our vast continental market and a workforce drawn overwhelmingly from immigrants and the countryside. The consequences were the twin triumphs of the "scientific management" of Frederick Winslow Taylor and the assembly line of Henry Ford. Taylor offered a convincing argument for the effectiveness of subdividing work into smaller and smaller components and for separating the planning and supervising of production from the performance of the job itself. Ford married this theory to a mechanically driven assembly line that made the worker stationary while the product moved past. Together they created modern mass production. There was no place in the Taylorist system for employee participation in decisions about the job; the point of "scientific management" was the supremacy of the expert in determining the one right way to accomplish the job and laying down standard procedures for doing it. In this framework, employee participation could only be a hindrance to efficiency. The twentieth century, however, has experienced three major waves

10

INTRODUCTION

of employee involvement. The first was the corporation-sponsored push in the 1920s which sought increased productivity through employee involvement. It was epitomized by the experiments in Western Electric's Hawthorne works in Illinois between 1927 and 1932, which established that all forms of employee involvement, with or without a material content, had beneficial impacts on productivity, at least in the short run. This wave vanished with the Depression and left few traces outside of the academic literature. The second was the government-sponsored labor-management committee program that was a core feature of the World War II production effort. Immensely successful at the time, the program was dismantled quickly in the postwar outbreak of hostilities between unions and management in 1946--47. Unions attempted to make up for the wage restraint of the war years and to exercise the organizing muscle built during the war, while management tried to roll back the union organizing gains of the 1930s and the wartime solidification of unionization in the industrial sector. Neither side sought a continuation of governmentally sanctioned cooperation. By 1964 only 44 of the 5,000 labormanagement committees established during the war were still in existence (Gold 1986, 5-7). The third wave began modestly in the 1970s, grew rapidly in the 1980s, and continues today. Initially, the new interest in employee participation represented a response to economic globalization by involving employees to do more with any given level of capital investment. In the 1970s and 1980s we were shocked to find that our European and Japanese competitors had gained a competitive edge by using widespread employee involvement strategies to improve product quality and productivity. In Europe, employee involvement was largely a result of legislated codetermination; in Japan, it was a consequence of the teachings of W. Edwards Deming, an American quality expert and the prototype of the prophet without honor in his own country before Japanese auto producers started inundating the American market with highquality cars. In the 1990s the move toward a knowledge-based economy intensified interest in employee involvement. For corporate America, employee involvement has become a competitiveness strategy; for unions, it has been a job-retention and job-enrichment strategy; for government, it has become part of an enlightened economic development policy. This convergence of corporate, union, and governmental interests has given employee involvement much deeper roots and more

From Frontier Egalitarianism to Employee Ownership

11

staying power than did the efforts of the 1920s and the World War II years. Increasingly, it is the way a major segment of the American economy conducts its business.

Kelso, Long, and the Employee Stock Ownership Plan Employee ownership, as we know it in the United States today, originated at a dinner between Senator Russell Long and San Francisco attorney Louis Kelso on November 27, 1973, in the Montpelier Room of Washington's Madison Hotel (see Kurland 1997-98). Long, son of Louisiana populist Huey Long, chaired the powerful Senate Finance Committee, which oversees federal tax policy. Kelso, the latest in the American tradition of self-taught economic iconoclasts, had long argued that capitalism's tendency to concentrate wealth was exacerbated by the shift from labor to capital as a factor of production. Government efforts to redistribute income through welfare state policies led away from the free market and toward socialism. The answer, Kelso argued, was to allow working people access to capital accumulation as part of their income: that is, to disperse capital ownership more broadly. 5 He had pioneered the development of employee stock ownership through what he called "Second Income Plan Trusts"-popularly called Kelso plans-to spread equity among employees, establishing the first at Peninsula Newspapers in the San Francisco Bay area in 1956. Kelso's theories were flatly rejected by the mainstream of the U.S. economics community. Nobel laureate Paul Samuelson told Congress in 1972 that "Kelsoism is not accepted by modern scientific economics as a valid and fruitful analysis of the distribution of income, but rather it is regarded as an amateurish and cranky fad." Similarly, Nobel laureate Milton Friedman dismissed Kelso's "crackpot theory."6 Yet Kelso persuaded a number of companies to set up Kelso plans, which in effect gave employees equity in their companies as part of their labor income, creating capital ownership for employees alongside the previous owners. In a few cases, including that of Peninsula Newspapers, the plan used borrowed money to buy stock from retiring owners, putting equity into employee hands as the loan was repaid out of corporate earnings. What Kelso developed was a means to change the distribution of the ownership of productive assets over time without

INTRODUCTION

12

expropriating the property of existing owners. Generally, the broadened distribution of ownership was derived from the growth in corporate retained earnings. This sort of proposition appealed immensely to Russell Long, who responded to Kelso's dinner-table presentation by relating it to his father's "share the wealth" proposal. "Long compared Kelso's ideas with those of his father," writes Norm Kurland, who had arranged the meeting and attended as Kelso's Washington collaborator, "and made it clear that he himself was not a Robin Hood populist-implying that his father was. But Russell Long liked the idea that every man should become a capital owner, what he called a 'capitalist.'" The very next day Long took Kelso's proposition before the Senate Commerce Committee, which was considering what to do with the bankrupt northeastern railroads. "I've got the answer to this railroad problem. None of us want the railroads to be owned by government, where taxpayers have to keep supporting it. And why should we be bailing out the stockholders from the old Penn Central? I've got the answer: Let the workers become the owners. Let's design it so the workers will become the owners of the railroad, own a piece of the action" (Kurland 1997-98, 7-8). From that day until his retirement in 1987, Long sought to introduce employee ownership into what he saw as appropriate legislation. Conrail, the resulting governmentally sponsored consolidation of the northeastern railroads, became 85 percent government and 15 percent worker owned. The key measure was the official sanction of Kelso plans as "Employee Stock Ownership Plans"-legitimate pension plans under the Employee Retirement Income Security Act of 1974 (ERISA), the basic pension legislation for the U.S. private sector.

What Are ESOPs? As "qualified employee benefit plans" under ERISA, ESOPs (and stock bonus plans, which are very similar and which we group with ESOPs throughout this study) are a type of defined contribution pension plan. Like other company pension plans, they are funded by company contributions that are allocated to individual employee accounts within a trust fund. Like other qualified employee benefit plans, they restrict employees' property rights to their ESOP accounts while they are working; the primary financial benefit is realized when the employee

From Frontier Egalitarianism to Employee Ownership

13

retires. ESOPs differ from other qualified employee benefit plans in two notable ways, however: ( 1) they invest primarily or solely in stock of the sponsoring company, and (2) they can borrow money. These characteristics make them an ideal tool for employees to purchase part or all of the business at which they work. Designed by Congress to spread the ownership of productive wealth in America among employees, the ESOP uses the lure of tax breaks to tempt companies to give their employees a share in capital formation. When a firm contributes company stock (or cash to buy company stock) to the ESOP, the contribution is deductible from its taxable income: every corporate dollar contributed saves about forty cents in federal and state taxes. This, in effect, permits tax-free retention of company earnings-but in the hands of employees, not outside shareholders. Employees too receive a tax break: as in other pension plans, ESOP participants are not taxed on the stock when it goes into their accounts but only when it is cashed out at retirement or other departure from the company. (If the stock were given to the employee directly, as part of compensation, instead of going into a qualified benefit plan, it would be taxable at the outset.) Further, in 1984 Congress added a tax break for owners of closely held businesses who sell 30 percent or more of their stock to their employees through either an ESOP or a co-op. If the seller reinvests the proceeds of the sale in other "qualified domestic securities" (i.e., stocks or bonds of domestic production companies), the tax on the seller's capital gain is deferred until the replacement securities are sold. If the replacement securities are never sold but pass into the estate of the seller at his or her death, the capital gains tax liability disappears. Consequently, owners of closely held businesses find the sale of stock to their employees through an ESOP immensely attractive. Typically, the ESOP borrows from a commercial lender to buy the owner's stock, and the company repays that debt out of pre-tax earnings. This combination tends to stabilize the existence of family-owned businesses, especially at the retirement of the primary owner when no heir is interested in continuing to run the business. As a consequence of federal tax incentives, there was an explosive growth in ESOPs in the United States in the 1970s and 1980s. 7 Before the passage of favorable federal legislation in 197 4, there were only a few hundred ESOP companies, employing fewer than 100,000 workers.

INTRODUCTION

14

By 1998, there were estimated to be some 11,400 ESOP firms, whose 8.5 million employee owners held $400 billion in assets (National Center for Employee Ownership [NCEO] 2000a, 1), or about 8 percent of private sector employment; these included such household names as AT&T, Procter and Gamble, Mobil Oil, and United Airlines. Another two million employees are estimated to own company stock through profit sharing and 401 (k) plans (NCEO 1998). ESOP growth leveled off in the 1990s as their number grew in smaller companies but declined somewhat in larger companies. 8 How Does the Individual Employee Benefit?

An ESOP is a form of joint employee equity in the company that employs them. It is formally set up as a trust fund-a legal entity separate from the company-which holds the stock allocated to employees individually and is administered by a trustee who acts on their behalf. Thus it combines joint ownership of part or all of an enterprise by its employees with individual property rights and financial benefits. Each year the company contribution of stock or cash is allocated to individual employees' accounts on the basis of hours worked, pay received, or some other labor-based formula no less equal than pay (companies have several choices for allocation, but once the firm has made the choice, it must use the same rule for everyone-managers and production workers alike). Consequently, ESOPs do not require equal ownership for all employees; rather, they provide approximately equal annual shares for similar service. The effect of annual allocation of shares is to reward seniority: the longer you stay with the company, the more stock you accumulate. To have a vested (guaranteed) right to the stock, the employee has to meet the period of service required by the plan, which under federal law cannot exceed seven years. The stock forfeited by employees who leave the enterprise without being fully vested is reallocated among the remaining plan participants. Individuals cannot sell or mortgage the stock while it is in the ESOP trust, but when vested employees leave the company or retire, they have a right to receive either their stock or cash. If the stock trades on the stock exchange, they can sell it whenever they choose. But if the company does not trade on an exchange (and nearly all small and most medium-sized companies do not), then the company or the ESOP is

From Frontier Egalitarianism to Employee Ownership

15

required to repurchase the stock at the fair market price, which is set annually by the valuation of an independent third party. The company usually contributes the repurchased stock again to the ESOP, so additional stock is available every year for allocation among current employees. Thus, newly hired employees also come to share in ownership and, in their turn, accumulate stock over time. In effect, then, each employee receives both a money wage and a capital wage from his or her labor. The fact that the capital wage remains bound in the firm for the duration of the worker's employment permits the accumulation of a significant and stable capital pool and ensures a permanent ownership stake in the firm for all full-time, permanent employees. Over time, value accumulates in the individual employee's account for two reasons: (I) the annual company contribution to the ESOP allocated to individual accounts; (2) the growth in value of the individual employee's previously allocated shares through reinvestment of earnings in the firm and through the firm's improved performance. To clarify how this works in practice for the individual employee, look at the concrete example of Reuther Mold and Manufacturing in Cuyahoga Falls, Ohio (Table 1.1). Reuther Mold is a family-owned business that manufactures rubber and plastic molds and large industrial fans. Its ESOP, established in the firm's 1988 fiscal year, owns 42 percent of the company's stock; two Reuther family members own the remainder. In effect, the company is a family-employee partnership. Reuther Mold's ESOP is close to the Ohio median: it is at the median in employment and sales, somewhat above the median in percentage of stock owned by employees, and somewhat below the median in its rate of ESOP contribution and growth in share price. Table 1.1 shows the capital accumulation in the average Reuther employee's ESOP account between 1988 and 1999. An employee who has worked all twelve years has accumulated 941 shares worth almost $18,000. Employees who have worked fewer years have fewer shares: for example, an employee who worked only the last three years would have 146 shares worth about $2,800, and a new employee who worked only in the most recent plan year would have 54 shares worth $1,000-assuming that the newer employees were as well paid as the average employee. Given employee turnover, the average Reuther ESOP participant had 650 shares, worth about $12,500, at the end of the 1999 plan year.

INTRODUCTION

16

Table I. 1. Accumulation of Shares and Value for the Average Employee Owner at Reuther Mold and Manufacturing

Date Allocated

2/29/88 2/28/89 2/28/90 2/28/91 2/29/92 2/28/93 2/28/94 2/28/95 2/29/96 2/28/97 2/28/98 2/28/99

New Shares Allocated

Shares lr; Forfeiture"

232 121 70 71

0 6 5 13 70

57 14 33

27 10 7 60

41 38 47

10 3 7

Total for Year

Value Share

Dollar Value

Previous Shares

Total Shares

Total Value

232 127 75 84 70 84 24 40 60 51 41 54

$12.99 $15.60 $17.05 $18.18 $17.15 $17.30 $13.40 $14.30 $15.50 $17.50 $19.10 $19.10

$3,016 $1,974 $1,279 $1,527 $1,200 $1,465 $316 $565 $930 $893 $783 $1,031

0 232 358 433 517 587 671 695 735 795 846 887

232 359 433 517 587 671 695 735 795 846 887 941

$3,016 $5,597 $7,382 $9,399 $10,067 $11,608 $9,313 $10,511 $12,323 $14,805 $16,942 $17,973

per

" When employees leave without being fully vested, their unvested shares are redistributed among the accounts of the remaining employees. Source. Reuther Mold and Manufacturing. Average shares reflect rounding.

How Much Influence Should Employees Have in ESOP Companies?

The assumption that ownership of property implies control of that property is not necessarily true in the case of ESOPs. Federal ESOP legislation was designed to achieve three goals: to broaden the ownership of corporate stock, to encourage capital formation, and to improve corporate performance (GAO 1985, 5). Workplace democracy, although near and dear to the hearts of many proponents of worker ownership was not part of the intent of Congress in 1974. It has been a subject of controversy ever since. Congress refrained from linking employee ownership with employee participation or influence in the company. ESOP legislation specifically permitted closely held companies to place voting rights on stock held in ESOP plans solely in the hands of the plan trustee on most shareholder issues; the trustee can be appointed by management or the board of directors and, in a circular fashion, vote to reelect the same board and, hence, management. The law requires that stock voting rights in closely held companies be passed through to ESOP participants only for

From Frontier Egalitarianism to Employee Ownership

17

supermajority issues such as mergers, major acquisitions, or sale of the company. (There was one exception: from 1989 until its repeal in 1996 the tax break for lenders on interest on ESOP loans was triggered only by an ESOP owning 50 percent of stock and passing through full voting rights to ESOP participants.) In short, employee shareholders can be treated as "beneficial owners" of their companies: they are denied the right to vote for the board of directors or to have any influence over decision-making in the company they own. A substantial body of academic literature argues that, for a variety of theoretical reasons, democracy in economic enterprises is inefficient and welcomes the fact that, as Yale law professor Henry Hansmann puts it, 'Typically adoption of an ESOP not only fails to bring an increase in workers' formal participation in control but also fails to bring an increase in informal participation by workers in firm decision-making" (1990, 1799). To some, firms are simply not appropriate subjects for democratic governance. "Some social relations simply cannot be conducted in a democratic manner, or can be so conducted only with the gravest of dysfunctional consequences," argued Princeton political science professor Harry Eckstein. "We have every reason to think that economic organizations cannot be organized in a truly democratic manner, at any rate not without consequences that no one wants" (1966, 237). For Nobel laureate economist Herbert Simon, the "crude analogy" between political democracy and democracy in companies simply "does not hold up under examination," for a business is not like a country; its "primary responsibility ... is to operate efficiently-that is, to make profits while staying well within the law.... It is in the interest of society and in the interest of a firm's customers that employees work very hard, be very efficient and very productive," but "an employee's view of what is a good day's work is not always the same as his employer's" (1983, 37-38). Simon places his faith in the control of firms by the market and, as needed, by bargaining and government regulation-not by employees. Some economists specifically argue that truly worker-controlled firms will invariably eat up their capital, because workers, unlike absentee shareholders, have a short time horizon. In this view, employee involvement in management, even European-style codetermination, inevitably "is less efficient than the alternatives" (Jensen and Meckling 1979, 473). Workers will pay themselves higher salaries at the cost of deferring

18

INTRODUCTION

maintenance and postponing investments beyond their time horizons; therefore, labor-managed firms can be expected to be successful only when "the optimal production technology involves very little capital relative to labor. In these situations the inefficiencies arising from the horizon problem will be much smaller and so, too, will those from the common property problem" (483, 502)-such as law firms, for example (according to the American Bar Association's Model Rules, which have the force oflaw in most states, these must be employee owned) or other professional partnerships. Others, such as Hansmann (1779-1816) argue against employee participation in decision-making because the costs of collective decisionmaking are too high in terms of efficiency in a heterogeneous workforce. Specifically, Hansmann maintains that "the experience with ESOPs provides little affirmative evidence that direct worker participation in the control of enterprise through ownership can be made both effective and efficient with a heterogeneous workforce, while it provides considerable circumstantial evidence suggesting that such participation may be quite costly" (1800). For him, the advantage of the ESOP form is precisely that it permits the separation of financial ownership from decision-making rights: "Industrial firms that are only beneficially owned by their workers may be more efficient than fully worker-owned firms, but," he notes, "are evidently less efficient than investor-owned firms" (1802). There are at least equally strong theoretical arguments for employee influence and control. These are derived from other principles, including those of distributive justice, market efficiency, strengthening political democracy, parallels between firms and political units, and Catholic social and economic teachings (see Logue 1991, 314-319). Congress, in its wisdom, chose to ignore the theories of both camps. It neither required that ESOP companies democratize their decisionmaking practices nor prevented them from doing so. The law permits, on the one hand, an autocratic CEO to trustee an ESOP that owns 100 percent of his company and to vote the stock to elect a compliant board and to run the company as he sees fit without any employee influence. Even when employees are majority shareholders-as they are in about 2,500 U.S. companies, employing more than 1.5 million workers 9employee ownership does not guarantee employee influence, much less employee control. But on the other hand the law also permits the company to adopt democratic structures from top to bottom, from a

From Frontier Egalitarianism to Employee Ownership

19

board 100 percent elected in a one-person, one-vote employee ballot to self-managed work teams on the shop floor. The choice is left to the company. The consequence in practice is that the employee-owned sector has become a great experimental laboratory for employee participation, from the shop floor to the boardroom. The 11,000 firms that make up the evolving world of employee ownership in America run the gamut from the autocratic to the democratic, and that variance offers insight into the impact of employee participation on company performance. The Ohio study gives an empirical basis for examining the structures, culture, and impact of informed employee participation.

The Road Map for This Book

Because its exploration is empirical, this is not a book about abstractions. We do not demonstrate on the basis of impeccable, deductive reasoning from the rational theory of the firm, supported by mathematical equations, that employee-owned companies are bound to succeed ... or bound to fail. If you want equations, please look elsewhere. Nor do we prescribe ways to overcome the sad plight of alienated labor in postmodern society through employee ownership. If you are looking for a Marxist deconstructionist or postmodern feminist analysis of human alienation from creative activity, you should, again, look elsewhere. This book is a doggedly inductive account of what employee ownership is in practice: successes and failures, the good, the bad, and the indifferent. In short, it is about the real world of employee ownership. Chapter l discusses our methods briefly (for more on methods, read Appendix 1) and describes the characteristics of employee-owned companies-for good and ill-from the administration of ESOPs to their wealth-creation effects. It explores the wide range of plan choices made and ways in which ESOP companies have chosen to structure themselves. It is the real world of employee ownership that is our subject, not an idealized one. The next two chapters examine the impact of the various structures and reward systems within employee-owned firms on various aspects of company performance. Interestingly enough, our data show little impact of financial incentives (though our direct experience with employeeowned firms continues to lead us to recommend coupling short-term

20

INTRODUCTION

incentives-dividends, bonuses, and profit sharing-with the long-term financial incentives of the ESOP). Given these inconclusive findings, we have focused on the incidence and the impact of employee training and open communications (Chapter 2) and employee participation (Chapter 3) on various indicators of company performance. We find a weaker but positive correlation between training and communications and performance, and a stronger and positive correlation between participation and performance. The success of democratic, majority employee-owned firms demonstrates that a democratic employee-owned sector can thrive in the market in competition with conventionally owned and managed firms. Chapter 4 looks at the experience of unionized companies with employee ownership. It compares unionized firms that have excluded union employees from ESOP participation with those that have included them, and both categories with nonunion ESOP firms. The chapter emphasizes the degree to which unionized, m;yority employee-owned firms differ from nonunion ESOP companies with respect to the democratic principles that unions espouse. Their performance record is as good or better than other firms in the study. Chapter 5 asks whether the data support the "maturation hypothesis" that employee-owned firms evolve over time toward what some posit as the ideal: a growing percentage of stock owned by employees; a significant investment in training; open, two-way communications; and increasing employee participation from the shop floor to the boardroom. We do not find a natural maturation process; but we do develop a model that links choices ESOP firms can make with their impact on company performance. Most companies are not using it, but it increases the likelihood of improved performance. The final chapter examines the degree to which public policy (at the state and local as well as the national level) and private initiatives (including cooperative company networks) can improve the performance of the employee-owned sector. We estimate the cost of ESOP tax breaks by category of firm and find that most of the government subsidy to ESOPs goes to firms that do little of what can be achieved with ESOPs. Would we be better off to redesign these tax subsidies to provide "full ownership rights to employees," as the General Accounting Office (1980, 24) suggested in its first ESOP study in 1980?

1

The Real World of Employee Ownership in Ohio

Question: What do you regard as the biggest advantage of having an ESOP? We thought the employees would be excited to have such a plan, but they do not seem to care. We held company meetings, etc., but employees seem to be happier with a profit-sharing plan only. (Company 135) In our organization, none. (Company 144) The funding costs of our leveraged ESOP amount to about 2 percent of sales. Results (cost reduction, more cooperative attitude, reduced waste) have saved more than 2 percent-making our ESOP a profit maker. Of more importance, the ESOP has provided a way for longterm family stockholders to lighten up and diversify without threatening the jobs of long-term employees. (Company 9)

The glossy brochures on Employee Stock Ownership Plans from the big law firms and investment banking houses say a great deal about tax breaks. Tax breaks for owners selling stock to ESOPs, for companies sponsoring ESOPs, and for banks lending to ESOPs (between 1989 and 1996) powered the spread of the plans. Since there was money to be made for the professionals who establish and maintain them (attorneys, valuators, investment bankers, actuaries, trust departments, and accountants), ESOPs quickly acquired their coterie of specialists and promoters in each of these professions. For all of them, ESOPs have been very much a top-down strategy of corporate finance and ownership succession, a world of business and pension law, of trusts, and of esoteric financial transactions. But what is the real world of employee ownership? What difference, if any, does employee ownership make for ordinary working people? Are 21

22

CHAPTER

they better off financially? Do they have more rights? Does employee ownership lead to changes in management or in corporate governance? How do employee-owned companies perform relative to their conventionally owned competition? How do unions act in employee-owned companies? And is there some growth pattern-some natural maturation path-that employee-owned firms follow over time? Comparable empirical questions are raised by company managers and local union leaders who seek to benchmark their companies. What do other companies do under these circumstances? How do they handle repurchase obligations, or ESOP administration? On a daily basis, does employee participation really make a difference? Shouldn't it be confined only to the shop? Isn't it dangerous to have union representatives on the board of directors? Likewise, lenders have a strong interest in making loans to companies committed to whatever employee ownership practices are most likely to lead to improved performance, and consultants have a strong interest in structuring ESOP plans and companies to achieve the same ends. They know the law, but what are the facts?

Study Design and Data Collection

In our search for those facts we undertook a total population study of Ohio companies that had ESOPs and stock bonus plans in 1990. Survey data were collected between June 1992 and May 1993. The methodology of the study is discussed at length in Appendix 1; the questionnaire and frequency distributions of the answers are found in Appendix 2. The first issue was to determine the universe of Ohio companies that had ESOPs or similar plans, and 518 Ohio firms were identified as possibly having-or having recently had-an ESOP, a qualified stock bonus plan, or a TRASOP or PAYSOP. 1 After eliminating duplicate listings and firms that had gone out of business, had terminated their plans, or claimed never to have had an employee ownership plan, we ended up with a list of 280 firms; 270 of these were confirmed to have an ESOP at the time of the survey. In order to produce an accurate picture of the real world of ESOPs, we made every effort to get the highest response rate possible from these 270 firms. Low response rates are the Achilles heel of ESOP surveys: because firms that are enthusiastic about ESOPs respond at a much

The Real World of Employee Ownership in Ohio

23

higher rate than firms that are not, the lower the survey response rate, the worse the data are skewed toward favorable reports. (That's the primary reason why ESOP studies in the 1970s and early 1980s were so far off base in their results, and why the General Accounting Office study of 1985 (GAO 1987) with its 81 percent response rate was such a valuable corrective.) In collecting our data, we found that second- and thirdround solicitations and telephone interviewing produced a higher proportion of negative results but a more realistic picture of Ohio ESOPs. Of the population of 270 companies confirmed to be owned at least in part by their employees through ESOPs and related plans, 167 (62 percent) completed our survey questionnaire. The response rate of 62 percent is eminently respectable among ESOP surveys and, so far as we know, better than any other survey's response rate except that of the 1985 GAO survey. Moreover, an additional 32 (12 percent) provided baseline information over the phone. In our attempt to study the entire population of Ohio ESOP companies-not a random sample-there are some known and some likely biases in the response pattern. We know that responding firms appear to overrepresent middle-sized ESOP companies with larger proportions of employee ownership, leaving both very small and very large firms underrepresented. Our impression is that firms not making regular contributions to their ESOPs are also underrepresented. We do not know but we suspect that the 26 percent of firms that did not respond even by phone were less participatory, communicated less, and did less training of employee owners than those that did respond. The data discussed here should be considered with that fact in mind. We compared the findings of our 1992-93 survey with 1993-94 filings of IRS form 5500 for both Ohio and the United States when these data became available in 1996-97 in clean form from Larkspur Data, a commercial data firm that has specialized in making Federal data available. (The results of this comparison are reported at length in Table A.4 and the accompanying narrative in Appendix 1.) The firms included in our study look pretty much like the Ohio and national ESOP population, as far as the few facts reported in the 5500 filings go, but they do appear to have slightly fewer employees than the Ohio and national averages, and to include more of their employees (50 percent) as plan participants than indicated in Larkspur's Ohio data (44 percent), though fewer than the national filings show (62 percent). Survey respondents are

24

CHAPTER

clearly more likely to be unionized, and their plans are somewhat richer: the mean value per participant is $28,500, versus $22,500 for Larkspur Ohio firms and $24,000 for the national filings. The survey overrepresents manufacturing firms (42 percent) relative to Larkspur's Ohio data (33 percent) and the national filings (24 percent), but it under-represents ESOP companies in finance and insurance. In short, on the few objective criteria for which we have baseline data, survey respondents look much like what can be known of all Ohio ESOP firms. Compared with national figures they have a harder edge, which comes from Ohio's industrial history, unionization, and deindustrialization. These are, however, only baseline data on company employment and industrial sector, number of ESOP participants, and plan value. In no way do these comparisons speak to the crucial questions of how ESOP companies work internally in terms of egalitarian allocation of stock, employee participation in the shop, nonmanagerial representation on the board, open communication about the business, shared financial information, employee training for informed participation, or the other characteristics we examined. Nor can we compare our results with national data on these items, since there has not been a national study with a reliable response rate since the GAO study of 1985, and it largely ignored these issues. 2 One final cautionary note. Because all surveys are based on self~ reporting-in this case by company managers, who were in the best position to provide the information requested-there is clearly an element of subjectivity in the answers. This is particularly true in managers' evaluation of impact of the ESOP, so we have differentiated between "objective" measures (e.g., impact on scrap rates, absenteeism, and production costs) and "subjective" measures (e.g., impact on employee motivation and job satisfaction). We tested for possible distortion from self-reporting but found very little. 3

Profile of Employee Ownership in Ohio The remainder of this chapter presents the basic characteristics of Ohio ESOP firms. (For more complete data on any item, turn to the relevant question in Appendix 2.) We examine what sorts of companies set up ESOPs and why they do; look at whether ESOPs really do create wealth for individual employees; sketch the basic findings on employee partie-

The Real World of Employee Ownership in Ohio

25

ipation, business communication, and employee trammg; investigate ESOPs' impact on employee and management attitudes and on company performance; scrutinize some of the differences between minority and majority employee-owned and between closely held and publicly traded firms; and conclude by tracing change over time. Our goal here is description. Analysis follows in Chapters 2 to 5.

What Sorts of Companies Set Up ESOPs? Companies that sponsor ESOPs in Ohio-like those in the rest of the United States-are most likely to be in the manufacturing, wholesale, and financial service sectors and less likely to be in retail trade and other services when compared with overall employment by sector (Table 1.1). Of Ohio ESOPs surveyed, 42 percent are in manufacturing firms, compared with 23 percent of Ohio employment. ESOPs are also disproportionately found in construction ( 10 percent of ESOPs, 5 percent of employment), wholesale trade and distribution (12 percent of ESOPs, 6 percent of employment), and financial services ( 12 percent of ESOPs; 6 percent of employment). By contrast, industries that depend on part-time and temporary employees or have high turnover-such as retail trade, janitorial services, restaurants-are significantly underrepresented in ESOP ranks. (For complete figures, see Question 1 in Appendix 2.)

Table 1.1. ESOPs and Employment by Industrial Sector, Ohio and the United States (%) Ohio Survey

Agriculture and forestry Mining Construction Manufacturing Transportation and utilities Wholesale Retail Finance, insurance Other services Total

OhioESOPs Larkspur

Ohio Employment

0

USESOPs Larkspur

2

us Employment

4

I

10 42 4 12 R 12

9

11

20 11

5 23 5 6 22 6 32

100

100

101

33 5 13

7

7 24 5

11 7

6 16 6 6 20

26

7

17

35

100

101

Sources: OEOC Ohio survey; Larkspur Data, Datamaster, Ohio Bureau of Employment Services, Labor Market Review, July 1999; and U.S. Department of Labor, Bureau of Labor Statistics, Employment Situation, August 1999. Totals in this and subsequent tables may not equal 100% because of rounding conventions.

CHAPTER

26

The median size of firms sponsoring employee ownership plans is about 110 employees and about $16 million in sales-in short, these are smaller businesses. Sponsoring firms vary in size, however, from tiny, closely held firms to Fortune 500 companies (Questions 2 and 3). Most ESOP firms are minority employee-owned: employees own less than a fifth of the stock in the firm in 35 percent of the companies and one-fifth to one-half in 34 percent (Question 10). Only 30 percent of sponsoring companies are majority employee-owned. The median share owned by the employees is 32 percent-a substantial minority interest. Although the overwhelming proportion of Ohio ESOP firms are closely held-83 percent (Question 4)-the 17 percent that are publicly traded companies account for 90 percent of the sales, 80 percent of the employees, and 75 percent of the participants in Ohio ESOP companies. ESOPs own less than 10 percent of company stock in more than fourfifths of public companies; by contrast, ESOPs own less than 10 percent of the stock in only one-fourth of closely held firms. Why Were ESOPs Established?

ESOPs are covered in the media primarily when employees seek to buy a plant or company to avert its shutdown. Although most such buyouts fail, fully 14 percent of companies responding to the survey cited averting job loss or shutdown as a major (5 percent) or minor (9 percent) reason for setting up their ESOPs (Question 7g) .4 Collectively, these firms employed 2,200 persons. In addition, Ohio employees have purchased several plants being divested by major corporations, to prevent their being bought by firms likely to reduce employment dramatically; such cases, though not directly motivated by averting shutdowns, have probably retained another 1,500 to 2,000 jobs that otherwise would have been lost in the state. The survey indicates, however, that by far the most important single reason for setting up an ESOP is to buy stock from a retiring owner: 70 percent of firms cited this as a reason, and 58 percent cited it as the major reason (Question 7b). An ESOP is a proven mechanism for handling business succession in closely held firms where owners selling to employees receive special tax advantages. Such a sale is not only a good exit strategy for a retiring owner but also a good way to preserve the jobs and the business for the community.

The Real World of Employee Ownership in Ohio

27

Perhaps most interesting with regard to economic development, fully 29 percent of Ohio ESOP companies reported that they established plans to help expand the business (Question 7h), a use of ESOPs that receives little attention in the popular press. In management practices, organizational structure, and firm performance, however, ESOPs established for expansion resembled other firms in the study.

What Role Does Philosophy Play in Establishing the ESOP?

The survey twice asked what role company (i.e., management's or owners') philosophy had played in setting up the ESOP. In response to the first version of the question, 67 percent of the 167 respondents cited a philosophical commitment to employee ownership as a major or minor reason for establishing a plan, and 41 percent cited their desire for participative management (Questions 7e and 7k, respectively; those who skipped the question are treated as not having a commitment to either). Subsequently, we asked respondents to weigh a philosophical commitment to employee ownership against tax incentives as a motivation for setting up the plan (Question 44). This time, 70 percent cited a philosophical commitment. One-quarter of firms established ESOP plans because of the conviction that the employees deserved to be owners and said they would have done so had there been no tax incentives-up from 20 percent in our 1985-86 Ohio study, which asked the identical question. Another 45 percent liked the idea of employee ownership but would not have proceeded without the tax incentivesdown from 56 percent in 1986. Fully 30 percent said their plans were established exclusively because of tax and financial benefits-up from 16 percent in 1986; had these companies been able to achieve the same benefits without employee ownership, they would have preferred to do so.

Do ESOPs Replace Other Plans?

A key question for the labor movement and for the Department of Labor's pension experts has been whether ESOPs are replacing diversified pension plans and putting employees' retirement security at risk. ESOPs typically put the bulk of their assets into employer stock-

28

CHAPTER

four-fifths of Ohio ESOPs are at least 80 percent invested in employer stock, and more than half have invested 100 percent of their assets in the employing company (Question 12)-and are hence more risky than the diversified holdings of most pension plans. 5 Hence ESOPs are poor replacements for diversified pension plans but good supplements to them. This indictment ofESOPs for risk may be particularly telling when an ESOP replaces a diversified pension plan, as happened in 10 percent of the Ohio cases (although some of those changes were necessary to avert the more immediate problems of plant shutdowns or job loss); 23 percent replaced profit sharing or other plans. Most Ohio ESOPs-67 percent-were established as an additional employee benefit (Question 6) (significantly higher than the national average of 42 percent of ESOPs maintaining other pension plans; GAO 1991, 9). These companies maintain at least one other pension plan; 401 (k) plans, defined benefit plans, and profit-sharing plans, in that order, are the most common (Question 23).

Rules That Affect Individual Accounts The financial benefit of ESOPs for employees depends on how stock is allocated within the plan. The most usual method in Ohio is the least equal: 83 percent of companies allocate ESOP stock to employee accounts on the basis of W-2 earnings, which tends to reinforce wage inequalities with inequalities in capital accumulation. Four percent use hours worked or equal allocation. A number use mixed formulas that include W-2 earnings and hours worked (3 percent), or years of service (6 percent), or equal allocation (l percent) (Question 16) Still, there is more tendency toward equality in stock allocation in Ohio ESOPs than nationally: the General Accounting Office found that fully 98 percent of ESOPs allocated stock purely on the basis of W-2 earnings (GAO 1991, 2). Vesting schedules determine how many years of service are required for employees to acquire a guaranteed right to the stock in their ESOP accounts. In Ohio, 28 percent of ESOP companies offer vesting schedules that are more generous than federal minimum requirements (including 11 percent that provide immediate vesting); 24 percent provide five-year "cliff" vesting (i.e., no vesting until the com0

The Real World of Employee Ownership in Ohio

29

pletion of five years in the plan when 100 percent vesting occurs), and 46 percent have a seven-year vesting schedule starting in year 3 (Question 1 7). When employees leave the company, 24 percent of firms distribute their stock but retain a right of first refusal (i.e., the departing ESOP participant has to offer the stock to the company before he or she can sell to anyone else); 5 percent permit employees to take stock without a company right of first refusal; 43 percent permit the employee to choose a distribution in either stock or cash, and 28 percent require that employees take cash (Question 25). Fully 76 percent handle the repurchase of employee stock from company cash flow; 7 percent use at least some insurance (usually combined with cash flow), and 10 percent borrow or combine borrowing and cash flow (Question 26). The failure to plan for repurchase of ESOP stock is a time bomb under company cash flow and must change as participant accounts grow. Building Employee Wealth

The intent of Congress in establishing Employee Stock Ownership Plans was to spread the ownership of productive assets more broadly. Our study confirms the success of ESOPs in that regard. The value of shares held by the Ohio ESOP plans in the study is about $3.75 billion (N = 141 companies), or an average value of $27,000 per participant. That overall number is inflated by the inclusion of a good bit of borrowed money in recently established leveraged plans. The median Ohio ESOP firm's annual contribution to the plan recently has been 8 percent of payroll, and median stock appreciation has been 7 percent. The medians conceal much variation, however. About one company in eight (Question 15c) had made no ESOP contribution in the previous two years, and an additional one company in five had contributed less than 5 percent of payroll, but almost 30 percent were contributing more than 15 percent of payroll. Figure 1.1 graphs the distribution of Ohio ESOP companies by average annual growth in account value (including both company contributions and stock appreciation). Fortunately, of those companies at the bottom of the barrel in terms of average annual dollar growth in participants' accounts, 85 percent

C H A PTE R

30

~ 20

= ~ 15 +-------------------e ~ 10

0 0- 500

501 - 1,000

1,001 - 2000 2,001 - 5,000 5,001 - 10,000 10,001 - 49,111 Growth, in U.S. Dollars

Figure 1.1 Average Annual Growth in ESOP Plan Value per Participant

sponsor at least one additional pension plan. Only 55 percent of those at the top sponsor another plan. The value per participant accumulated at actual wage levels of Ohio ESOP firms has averaged $3,825 annually in nonleveraged plans and an almost ide ntical $3,835 in older leveraged plans (i.e., plans that have borrowed money to buy stock) that have existed for five or more years. This figure tends to understate the value accumulated per participant, since it averages in new employees with those who have been working since the ESOP was put into place. The accumulation of employee wealth is, of course, tempered by the fact that som e plans serve as compensation to employees for giving up current or future wages and benefits. Employees made su ch sacrifices in 9 p ercent of the Ohio ESOPs, giving up wages and benefits (four firms), profit sharing or bonuses (six), or a pension plan (two) (Question 22). In addition, as noted above, one-third of Ohio ESOPs were conversions of existing benefit plans--pension plans (one in ten in the study) and profit-sharing plans (two in te n) ; these essentially continued in a different (and perhaps riskier) form what employees previously were getting. All in all, existing plans were converted or terminated or wages and benefits given up in 39 p ercent of responding companies. Still, the two-thirds of responding companies that maintained at least one other retirement plan in addition to the ESOP (Question 23) certainly bettered the 42 percent nationally that the GAO found, as cited above.

The Real World of Employee Ownership in Ohio

31

One very curious finding in the study is that employees were as likely to sacrifice another plan or wages and benefits for the ESOP when the company was not distressed or threatened by a hostile takeover (38 percent of 73 companies) as they were when the company was distressed or threatened (40 percent of 30 companies). Furthermore, the nondistressed companies were less likely to have another pension plan in addition to the ESOP (61 percent) than the distressed ones (77 percent). Part of the explanation is that the firms in distressed situations included more unionized companies, which had better benefits to start with; another part appears to have been an effort to finance the payments on leveraged ESOP loans to buy out retiring stockholders with funds previously committed for employee benefits. More curious yet, publicly traded companies-which generally put in ESOPs as a takeover defense-were more likely than closely held companies to pay for them by converting other plans (see Table 1.3). The value of financial rewards in some firms was limited by the exclusion of a significant portion of employees from participation in the ESOP. Responding firms reported having 300,000 employees but only 150,000 ESOP participants. 6 This difference reflects the exclusion from plan participation of employees with little long-term commitment to the firm (temporary and part-time employees), employees in plants abroad, and, sometimes, unionized employees. Federal law enables both employers and unions to opt out of an ESOP if they have another collectively bargained pension in place. In 22 of the 42 unionized firms in the study, union members were excluded from the ESOP; in 19 of the 22 cases the union was excluded because the company had another collectively bargained pension. In only one case did the union itself reportedly decide not to participate in the ESOP. (We return to the issue of the unions and ESOPs in Chapter 4.) In addition to the long-term financial reward that ESOP stock may provide, many Ohio ESOP companies also provided short-term incentives. A majority had profit-sharing systems (53 percent; Question 38j) or gain-sharing plans (11 percent; Question 38e). Others paid dividends to employee shareholders (Question 24): 25 percent said they had passed through cash dividends to their employees in at least one of the last three years. Compare 9 percent in the 1985 GAO study (calculated on the basis of Tables 4.3 and 4.4 in GAO 1986, 37-38) shortly after Congress sought to encourage payment of dividends to ESOP participants. The mean Ohio dividend payout was 2 percent of share value.

32

CHAPTER

Employee Participation

Previous studies, most notably the 1985 GAO study, have shown that only those employee-owned companies where there is employee involvement and participation in decision-making outperform their conventional competitors (GAO 1987, 14-31; see also Logue and Rogers 1989, and Keogh and Kardas 1994-95). Our study supports those conclusions, as detailed in Chapters 3 and 5; here we only describe types and levels of participation. Responding managers reported, with few exceptions, that the ESOP's establishment had had a positive effect on nonmanagerial employees' participation and their interest in decision-making. Overall, 74 percent of ESOP managers indicated that the plan had a positive impact on employee participation (Question 3lk). Among majority ESOPs there was a positive effect on employee involvement in 89 percent of companies, and 85 percent reported increased nonmanagerial interest in making decisions. Among minority ESOPs, 70 percent reported a positive effect on employee participation, and 49 percent noted an increased interest in decision-making. One important aspect of employee participation is the right to vote ESOP shares. Federal laws mandate that employee owners in closely held companies be given voting rights only on a handful of issues such as merger, liquidation, or a major sale of the assets; there is no requirement that employee owners be allowed to vote for the board of directors, although past research has found that voting rights have symbolic value in building successful ESOPs (Ivancic and Rosen 1986; Rosen, Shaw, and Snyder 1991). Among Ohio survey respondents, 42 percent of closely held companies passed through full voting rights to ESOP participants, including the right to vote for the board (Question 34) (up from 14 percent in the 1985-86 survey). 7 In majority ESOPs, 53 percent passed through voting rights versus 36 percent in minority ESOPs. A minority of the companies in the study-17 percent-had nonmanagerial employee owners on their board or had had them in the previous five years. These include 37 percent of majority and 10 percent of minority ESOP firms. By contrast, the 1985 GAO study found nonmanagerial directors on the boards of only one in twenty-five ESOP companies (GAO 1986, 40). Perhaps even more striking is the fact that the GAO finding that the most common form of selection for nonmanagerial board members was

The Real World of Employee Ownership in Ohio

33

appointment by management, whereas 22 of the 28 Ohio firms' nonmanagerial directors were elected (Question 36b), including all those in majority ESOP firms and half of those in minority ESOP firms (where the other half were appointed by management). Most of these companies had only one or two nonmanagerial employee board members, but in eight cases nonmanagerial employee members constituted 35 percent or more of the board and in three cases, a majority. Though the GAO study found that employee ownership led to improved company performance only when coupled with employee participation (1987, 14-31), it also found that only one-quarter of ESOP companies provided more involvement for nonmanagerial employees in company decisions than previously, and that three-quarters of this small group provided no formal mechanisms for employee participation (1986, 41). That is no longer true, at least among Ohio ESOP companies: 63 percent of the companies surveyed provided one or more formal mechanisms for employee participation in shop decisions-up from 37 percent before the ESOP was put in place (Questions 38c, d, f, g, h; N = 122). Sixty percent reported that employees expressed an interest in playing a greater role in decision-making after the ESOP was established (Question 33), up from 28 percent in the 1985-86 study. Employee participation also increased. The answers to question 38, "Does your company have any of the following employee involvement programs?" (comparing the company before and after the ESOP was established) showed increases in every form of employee participation. Problemsolving groups (41 percent after the ESOP versus 20 percent before), labor-management participation teams (25 percent after versus 13 percent before), and self~managing work teams (20 percent after versus 11 percent before) virtually doubled in use. 8 Successful employee participation programs require informed employees. The answers to Question 40 suggest increases in managementemployee information flows of 50 to 100 percent. If we treat all the missing cases as companies that do not communicate, the proportion of companies at least holding an annual employee meeting doubled, from 28 percent before the ESOP to 56 percent afterward. The reported increase in employee participation and interest in decision-making varied by the level of employee ownership and type of participation. In general, employee owners had a greater voice in majority ESOP firms than in minority ones. Majority employee-

CHAPTER

34

owned firms were more likely to have shop-floor teams (75 percent versus 59 percent of minority ESOP firms), company steering committees including hourly workers as well as management (27 percent versus 11 percent), and nonmanagerial employees on the board of directors (37 percent versus 10 percent). In many minority firms, employees had a limited voice in decisions about day-to-day working conditions and, not surprisingly, barely a whisper in most major decisions. Overall, more than 80 percent of respondents said that employees had input on working conditions; that is, they were at least asked for their opinion (Question 4la). Input, of course, is different from actual decision-making, but nearly half of majority ESOPs (48 percent) stated that nonmanagerial employees helped to make decisions about working conditions; among minority ESOPs, only 27 percent. Involvement rates dropped dramatically when the decisions were traditional management prerogatives. Overall, for example, 49 percent of respondents said employees "receive information only" about layoffs, and 27 percent not even that. Among majority ESOP firms, 34 percent asked for input on layoffs or otherwise involved nonmanagerial employees, whereas only 12 percent of minority firms did so. The pattern in selection of supervisors was similar: nonmanagerial employees played no role in 75 percent of the firms surveyed; among majority ESOP firms, 36 percent involved nonmanagerial employees in selecting their supervisors; among minority firms, only 20 percent. We analyze employee participation in more detail in Chapter 3. Training and Communications for Ownership

To increase informed nonmanagerial employee participation, companies have to provide workers with the skills and environment to facilitate their involvement and the knowledge and information necessary to make informed decisions. Building new understanding and new skills often involves extensive training (see Chapter 2). Companies reported a substantial increase in every form of communication after the ESOP was put in place (Question 40). For example, the 4 7 percent that published employee newsletters before the ESOP rose to 70 percent; the 38 percent that held an annual employee meeting increased to 71 percent. Further, 47 percent

The Real World

of

Employee Ownership in Ohio

35

were distributing financial information to employees regularly, and more than half the remainder were providing it on request (Question 37). ESOP companies in general made a greater investment in training nonmanagerial employees than they did before they established their ESOPs. The answers to Question 35 suggest that the change was slight in technical training, where the pre-ESOP level was very high anyway, and greatest in training related to participation and ownership. Problem-solving training for nonmanagerial employees went from 31 percent before the ESOP to 54 percent afterward (Question 35d); group-process training from 31 to 45 percent (Question 35e); financial training from 20 to 40 percent (Question 35f); and ownership training from 8 to 38 percent (Question 35c). 9 Here again, though, majority ESOPs made the greater training commitment (although, interestingly, they actually did less nonmanagerial training before establishing their employee ownership plan than minority ESOPs did). In majority employee-owned firms, the proportion doing problem-solving training jumped from 24 percent of the firms to 55 percent; group-process training rose from 21 percent to 53 percent; financial training for nonmanagerial employees exploded from 8 percent to 51 percent; and ownership training rocketed from less than 8 percent before the ESOP was set up to 63 percent afterward. The growth in employee training in minority ESOPs was less dramatic but still substantial; for instance, the percentage of minority firms doing problem-solving training for nonmanagerial employees increased from 35 percent to 54 percent.

Impact on Employment

Ohio ESOPs have had a direct impact on job retention, averting job loss or shutdown or avoiding sale of a plant to a firm that would have moved the work out of state and thus, as reported above, saving about 4,000 jobs that otherwise would have been lost. Moreover, ESOPs appear to have contributed to employment stability and growth in Ohio. During the 1989-92 period-a sluggish time for the state's economy-41 percent of Ohio-based ESOP enterprises increased employment levels, while 21 percent cut employment (Ques-

CHAPTER

36

tion 32a)-yet only 10 percent of respondents said that employment in their industries had increased overall, while 52 percent said that employment had fallen (Question 32b). On an individual basis, 50 percent of Ohio ESOP companies reported that they outperformed their industry in terms of job creation or retention , 48 percent matched the industry, and only 1 percent did worse (see Figure 1.2) . Of the firms establishing ESOPs to avert job losses or shutdowns, all performed as well as or better than their industry. If the rest of Ohio's companies had matched Ohio's ESOP firms during the 1989-92 downturn, the state would have had full employment.

Impact on Employee and Management Attitudes

Most Ohio managers thought that employee ownership had improved their companies in some way-an informative finding for managers of conventionally owned companies. The impact was greatest on managers'

-

0

10

40

20

30 (percent of firms)

•

Wooe thon Industry - I"

D

50

60

Same os lndus1ry - 48"

[1]] Better than lndus1ry -

51"

N= 167 Figure 1.2 How Ohio ESOPs Compared with Their Industries in J ob Creation and Retention

The Real World of Employee Ownership in Ohio

37

appraisal of employee behavior and attitudes. A remarkable 75 percent of those who responded to our impact question said the ESOP had had a positive effect on employee attitudes (Question 31o), creating "a more open working environment; more personnel are interested in the long-term growth of the company," as one manager described it. Respondents felt that the ESOP had also had a positive effect on communication (62 percent positive versus 34 percent no impact and 4 percent negative impact; Question 31 b), improved employee motivations (69 percent positive, 30 percent no impact, 1 percent negative; Question 31h), provided workers with more job satisfaction (59 percent positive, 38 percent no impact, 3 percent negative; Question 3lf), and fostered an improvement in labor-management relations (48 percent positive, 48 percent no impact, 4 percent negative; Question 31m). Overall, 65 percent of the survey's respondents said there had been a positive effect on employees' on-thejob performance; 32 percent said there was no impact; 3 percent said the impact was negative (Question 31c). Moreover, 50 percent of Ohio ESOP firms noted that customer service had improved (49 percent said no impact; 1 percent said service was reduced; Question 31j). Employee participation was up at 74 percent of responding companies, the same in 24 percent, and down in 2 percent (Question 31k). Of course, since these are obviously subjective questions, workers and customers may hold different views from the managers completing the questionnaires. Managers were less positive about ESOP impact on more quantifiable results, but positives still outweighed negatives. ESOPs were held to have had some positive impact on production costs (36 percent positive, 60 percent no impact, 4 percent negative; Question 31n); on product quality (50 percent positive, 49 percent no impact, 1 percent negative; Question 31d); on employee turnover (51 percent positive, 44 percent no impact, 5 percent negative; Question 31e); on absenteeism (27 percent positive versus 72 percent no impact and 1 percent negative; Question 31a); and on profitability (52 percent positive versus 41 percent no impact and 8 percent negative; Question 311) .10 Not all companies praised ESOPs, however. A few respondents were disillusioned by employees' lack of interest despite their being owners: 'The average employee really doesn't want the responsibility to make decisions," complained one manager in response to Question 45: "What is the biggest disadvantage of your ESOP?" Half a dozen respondents

CHAPTER

38

complained of too much employee interest-or interest in the wrong things. "Employees believe that because they're owners, they have the right to manage the daily operations of the company. They don't understand that management people must continue to manage (and that everyone can't be involved in every decision)," commented one. "All employees become micro-managers," noted another. "The sharing of large amounts of information allows for much questioning and slows down the decision-making process," wrote a third. In short, some ESOPs created employee expectations that could not be met. The primary target of managers' complaints about ESOPs, though, was not inappropriate employee expectations but regulation. Thirty-one respondents of the 117 who volunteered an answer to Question 45-26 percent-complained about the plans' administrative, legal, and regulatory burdens and costs. "At current levels and values, administrative complexity and difficulty in explaining [the ESOP] to employees outweighs the human-relations advantages," explained one disgusted manager who had apparently not expected the administrative burden. "An ESOP for a small company (fewer than 50 employees or $25 million in sales) is a pain and tremendous expense to administer and manage," commented another. The disadvantage of future repurchase liability (ten comments) paled by comparison. The heavy burden of federal regulation of ESOPs in smaller firms was also cited repeatedly as a cause for terminating plans among managers who otherwise were sympathetic to the idea of employee ownership.

Comparing Majority and Minority ESOPs Does majority ownership make a difference? On the surface, the answer is yes (see Table 1.2). Majority-owned Ohio-based ESOPs provided greater financial rewards to employees-the median participant account was worth twice as much as in minority ESOPs-and reported more involvement, participation, and improvement in performance. They also reported sharply increased employee interest in decision-making (85 percent versus 49 percent), nonmanagerial employees serving on the board of directors (37 percent versus 10 percent), and, in closely held companies, the pass-through of voting rights (52 percent versus 37 percent). They were also more likely to have been created from the conversion of another benefit plan (40 percent versus 25 percent).

The Real World of Employee Ownership in Ohio

39

Table 1.2. Comparison of Minority and Majority Employee-Owned ESOP Firms

Number of companies Total number of employees Mean number of employees Total ESOP participants Mean ESOP participants Total value of plans Mean value of plans Mean plan value per participant Median plan value per participant Mean contribution per participant Median percentage of stock owned by ESOP Mean year plan was put into place Total annual sales Mean annual sales Percent unionized Thereof: union members excluded Percent converting another benefit plan Greater employee interest in decision-making Nonmanagerial employee elected to board Voting rights passed through (closely held only)

Minarity

Majarity

110 264,267 2,360 124,284 1,120 $3.5 billion $36.3 million $21,843 $13,245 $4,995 16% 1985 $57.9 billion $546.0 million 25% 59% 25% 49% 10% 36%

48 16,941 376 11,292 251 $229.0 million $5.3 million $37,720 $27,500 $6,406 84% 1984 $2.1 billion $46.0 million 27% 38% 40% 85% 37% 51%

The biggest differences, however, were not between majority and minority ESOPs but between very small ESOPs-those with less than 10 percent employee ownership-and more significant minority ESOPs. In companies with less than 10 percent employee ownership, managers report even fewer overall benefits. For example, 30 percent of managers of firms with ESOPs holding less than 10 percent of company stock thought the plan had no impact or a negative impact on an index of fifteen performance and internal cultural characteristics in Question 31, as compared with 11 percent of firms with ESOPs holding between 11 and 49 percent of company stock (and 13 percent of majority ESOPs). Similarly, only 36 percent of managers from firms with less than 10 percent employee ownership believed that their firm's ESOP had had a positive effect on profitability, whereas among firms with 11 to 49 percent employee ownership, 57 percent saw a positive effect on profitability-almost equal to the 58 percent of m~ority employee-owned firms that reported a positive effect. Is it the extent of ownership itself that makes the difference? We should not conclude that from these figures. Firms with a higher percentage of employee ownership are also more likely to have increased

CHAPTER

40

1

employee involvement and increased employee training, a particularly efficacious combination. Moreover, minority ESOPs that encourage employee participation seem to have more in common with majority ESOPs than they do with those minority ESOPs that do not stress participation. (The interrelation of these factors is the subject of further analysis, particularly in Chapter 3.) Note, incidentally, that the size of the majority-owned sector is quite limited. Majority employee-owned firms made up 30 percent ofthe total ESOP companies but achieved only 3 Y2 percent of the ESOP sales and employed only 8 percent of the ESOP participants.

Comparing ESOPs in Closely Held and Publicly Traded Companies It is worth underscoring the fact that in the real world of employee ownership, although closely held companies accounted for more than four-fifths of ESOPs, publicly traded companies accounted for the overwhelming majority of ESOP participants, plan value, and tax expenditures (sec Table 1.3). Despite the greater size and wealth of publicly traded ESOPs, the closely held firms have made slightly larger contributions and report significantly larger values per participant. Only one (4 percent) of the publicly traded companies was majority employeeowned, as opposed to 35 percent of the closely held firms. The average employee stake in the public companies was 6 percent; it was 33 percent in private firms. Publicly traded firms were more likely to be unionized than closely held ones, but there was significant unionization in both categories. As shown in subsequent chapters, the introduction of employee ownership into public companies had less impact on corporate governance (no nonmanagerial employees on their boards versus 16 percent on those of closely held ESOP companies), employee participation (see also NCEO l997a), communications, training, and company performance than in closely held firms. Nevertheless, public companies' ESOPs provided financial benefits to their participants approaching those of the private companies. Their mean annual contribution per participant was about 85 percent of that of private firms; their mean plan value per participant was 74 percent and their median plan value per participant 66 percent of those of closely held companies. But public companies were somewhat more

The Real World of Employee Ownership in Ohio

41

Table 1.3. Comparison of ESOPs in Publicly Traded and Closely Held Companies

Number of companies Total number of employees Mean number of employees Total ESOP participants Mean ESOP participants Total value of plans Mean value of plans Mean plan value per participant Median plan value per participant Mean contribution per participant Percent majority employee-owned Median percentage of stock owned by ESOP Mean year plan was put into place Total annual sales Mean annual sales Percent unionized Thereof: union members excluded Percent converting another benefit plan Greater employee interest in decision-making Nonmanagerial employee elected to board

Closely Held

Publicly Traded

139 48,386 353 30,520 231 $417,618,984 $3,631,470 $28,140 $18,549 $6,884 35% 33% 1984 $5,554,600,000 $41,377,612 23% 55% 31% 66% 16%•

28 252,432 9,015 119,615 4,271 $3,347,874,458 $128,764,402 $20,745 $12,181 $5,930 4% 6% 1986 $54,547,875,591 $2,273,000,000 36% 53% 39% 26% o%·

• An additional 4 percent of firms have one or more appointed nonmanagerial directors.

likely to finance their ESOPS by shutting down other employee benefit plans (39 percent did so) than were closely held companies (31 percent). Changes in Ohio ESOPs Over Time

Significant changes have taken place in the world of the Ohio ESOPs between our first study in 1985-86 (also a total population study with a reasonably high response rate; see Logue and Rogers 1989) and our second. These suggest that the ESOP sector became more important for the community and for individual employee owners and that it was becoming more democratic. The major changes are as follows: • the size of the ESOP sector grew substantially; • company contribution rates doubled, probably largely because of increased ESOP debt repayment occasioned by a fourfold increase in the proportion of leveraged ESOPs; • financial benefits for employee owners nearly doubled;

CHAPTER

42

Table 1.4. Comparison of 1985-86 and 1992-93 Ohio Surveys: Sector, Coverage, and Financial Benefits 1985-86

Proportion of ESOPs in manufacturing Leveraged ESOPs Median annual contribution as percent of payroll (average of last two years) Median annual change in stock value (average of last two years/three years, respectively) Projected median value of account for employee earning $18,000 per year at end of tenth year of plan participation (based on contribution and appreciation rates) ESOP established through conversion of another pension plan Wage or benefit give-backs Average number of participants per plan Total participants

(1\:

= 64)

1992-93 (N = 167)

42% 13% 4.5%"

42% 58% 8%

7.5%

7%

$11,500'

$20,000

27%

33%

!)s

Mean of average value per participant, unleveraged ESOPs

N=5

$32,110

(1 of 13)

8%

0%

42% 33% (2 of 6)

0% 67% ( 4 of 6)

Percent publicly traded

Percent where major or minor reason for ESOP was to avert shutdown or job loss

Percent of group engaged in manufacturing or wholesaling

$156,218

$234 million

N = 26

$22,202

N = 36

$31,769

$27,111

11% (8 of71)

10% (7 of 78)

8% (4 of 49)

14% (7 of 49)

- !0

3"1

$219,334

$129 million

16,963

553

86,000

6,636

Total ESOP participants

16,232

2,038

23,581

42,788

15,187

\1ean number of employees

Total employees

182,248

Nonunion N= 80

908

Union-Excluding N= 22

7,269

N = 12

l'\=8

Unionized Union-minority

Union-majority

Table 4.1. ESOPs in the Unionized Sector, by Union Relationship to ESOP

Union Brothers and Sisters in the Boardroom?

119

included the union were more likely to report that their profits had been below their industry before the ESOP was established (29 percent of union-majority and 33 percent of union-minority versus 10 percent of union-excluding and nonunion firms). To sum up the forest of statistics, the "typical" majority-unionized ESOP was formed by employees making concessions in the face of a shutdown or divestiture, whereas only about one in three minorityunionized ESOPs had faced such threats. The union-minority ESOP category had no "typical" form. The group comprised two very large publicly traded firms in which employees owned a small percentage of the stock, one firm with about 5,000 employees, and nine firms each having less than 600 employees. Firms in the other two categories were also diverse in size though typically smaller than the two largest unionminority firms. Nonunion and union-excluding ESOPs had typically not been in any special financial distress or dangerous institutional transition when they were formed, although many were making a transition from individual or family ownership to employee ownership. Employees made concessions to create the ESOP most often when their firms were threatened with shutdown or takeover.

Expectations about Unions and ESOP Companies

From experience in working with unions in ESOPs, we expected that the unionized firms as a group would do more communication, training, and participation, because they are larger and because these are familiar methods that unions use to "spread the word" and educate their membership. In addition, union leaders in the more sophisticated international unions often have training in organizational development. We also expected that unionized firms in which union members are included in ESOPs would be more likely to have participation in all aspects of the work process, from the shop floor to the boardroom, because of unions' mistrust of executive leadership and a desire to be present and involved when decisions affecting their members are being made. We expected that unionized firms with majority ESOPs would he most likely to provide information, training, and participation to employees, because the union members would have the power of majority stockholders to insist on change. We expected unionized firms with minority ownership to be somewhat less developed in communication,

120

CHAPTER

4

training, and participation but to be more active than nonunion firms or firms that excluded union members from their ESOPs. In addition, we expected that the union-excluding firms would be least likely to have added communication, training, and participation-even less than nonunion firms. We predicted that firms where the union was included would be more egalitarian in the distribution of benefits, because equality and sharing are strong components of the labor movement. We expected that as a result of greater communication, training, and participation, firms with ESOPs that included the union would be better economic performers than nonunion companies. We further hypothesized that any beneficial effects of unions on processes and performance within the firm would be most pronounced where employees had majority ownership. Majority ownership would improve the prospect for beneficial suggestions arising from the employees to receive systematic attention and implementation. We expected firms that exclude the union from the ESOP to have the worst performance of all, because the situation created by excluding the union would deprive the firm of many of the assets the unionized employees can bring to operations and leave the firm Yulnerable to having the organizational strength of the union turned against it. In the next section these expectations are put to the test. Because the groups we distinguish are quite small, however, statistical measures would almost never be significant, even if differences among them were quite dramatic, so we do not report on tests of statistical significance. 1 Unions and Organizational Development

In their general orientation toward the ESOP, majority employeeowned firms were philosophically most receptive to employee ownership. They were least likely to have established the ESOP for tax benefits alone (only 14 percent versus 30 percent of others in the unionized sector) and most likely to report a belief that employees should be owners (43 percent versus 25 percent of other firms). We expected that more favorable attitudes toward employee ownership would cause union-m;~ority firms to lead the field in all aspects of organizational development. Expectation: Unionized companies will have more communication. Active

Union Brothers and Sisters in the Boardroom?

121

union support of the ESOP (especially in majority ESOPs) is a positive factor for the development of communication, because the union can utilize its already-established networks and techniques to create and facilitate communication within the firm. And indeed, it is clear that firms where union employees are in majority ownership have added much more communication than firms where the union is not present. Union-minority firms and union-excluding firms report the least increase in communication. Fifty-one percent of union-majority firms reported adding three or more types of communication, as compared with 10 percent of union-minority, 6 percent of union-excluding, and 14 percent of nonunion firms. Two of the six union-majority firms reported adding four or five new methods. The important role of the union can be seen in responses to the question "Does the company keep employee owners informed about the business through the local union since the ESOP [was] established?" All the union-majority firms responded "yes," but among the union-minority firms, only 56 percent said "yes," and only 13 percent "yes" among the union-excluding firms. As to financial communication, 63 percent of union-majority and 83 percent of union-minority companies reported that they provided employees with financial statements, as compared with 41 percent of the union-excluding and 43 percent of the nonunion companies. Of the union-minority firms, 42 percent were publicly owned (as were 23 percent of the union-excluding firms) and therefore required to provide financial information to stockholders. Another indication of the extent of communication was the circulation of information about the CEO's compensation package, such as salary, benefits, stock, stock options, performance incentives, and severance pay. In union-including firms such information was more widely available than in firms where the union was excluded from the ESOP or where there was no union. Within the unionized sector, among the closely held firms where disclosure is optional, only 29 percent of 7 union-majority firms and 20 percent of 5 union-minority firms restricted information on the CEO package to the board of directors, whereas 77 percent of 73 nonunion firms and 71 percent of 17 union-excluding firms did so. Expectation: Unionized firms do more training. Firms in which the employees have majority ownership added considerably more training after establishing the ESOP than did minority-owned firms, nonunion firms,

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or firms where the union was excluded from the ESOP. Before the ESOP was established, union-majority firms' training practices did not look much different from those of other firms in the unionized sector. Mter the ESOP, 71 percent of union-majority firms reported adding a net increase of at least one type of training since the ESOP was established. 2 Of union-minority firms, 38 percent reported adding at least one more type, as did 37 percent of union-excluding and 43 percent of nonunion firms. Expectation: Unionized jirrns have rnore participation. With a handful of scattered exceptions, the firms in the unionized sector looked much alike in having had a low engagement with shop-floor participation before their ESOPs were created. Mter the ESOP, union-majority firms were the most active in trying participatory shop-floor production techniques: 67 percent tried at least one. This compares with 44 percent of union-minority, 46 percent of nonunion, and 49 percent of union-excluding firms. Union-majority firms were likewise the most adventurous in trying a variety of techniques: 51 percent reported adding 3-5 techniques, as compared with 15 percent of union-minority firms, 6 percent of union-excluding firms, and 13 percent of nonunion firms. It was also the union-majority firms that generally engaged in bringing nonmanagement membership to the board of directors, and 75 percent used election by the employees in the selection process. In contrast, no union-minority firms had nonmanagement board members. The one and only union-excluding firm with a nonmanagement board member reported that that person was appointed by management. And 14 of the 80 nonunion firms ( 17 percent) reported electing their nonmanagement board member; 2 used appointment. Overlapping with majority ownership and board membership is the factor of wage concessions. Many of the union-majority ESOPs were created in difficult financial situations which required their employees to make concessions on wages, benefits, and working conditions. Of the union-including firms where employees were reported to have made concessions, 83 percent had a nonmanagement board member, compared to just 8 percent of those where no concessions were made. To sum up, the union-majority firms stand out for their high levels of participation. Reports of involvement reflect impressions of shopfloor and boardroom participation for firms in the unionized sector. In

123

Union Brothers and Sisters in the Boardroom2

Figure 4.1, subtracting the percentage of firms reporting no involvement from the percentage reporting the highest involvement yields the percentage difference index (PDI) for each type of firm on each of the seven dimensions of involvement. When the PDI is greater than zero, high involvement outweighs no involvement. When the PDI is less than zero, no involvement is the dominant response. The highest level of reported involvement is for union-majority firms; union-minority firms come next; union-excluding and nonunion firms look very much alike in having the lowest levels of involvement: the percentage of firms that neither inform nor consult their employees-outside of social events and working conditions-is notably higher than the percentage in which management and workers decide together. Expectation: Employees are more interested in decision-making in unionized firms. Union-majority firms and nonunion firms were most likely to report an increase in employee interest in decision-making after the ESOP was established (43 and 26 percent); union-minority and unionexcluding firms were least likely to do so (9 and 5 percent). Expectation: Unionized firms are more egalitarian in their style of management and in policies on compensation and stock ownership. We expected

80

Involvement Percentage Difference Index: %most involved- %least involved Greater than 0 shows most involved are more numerous than least involved

60 40

20 C5 0...

0 -20 -40

---

----

...........

______-r----~ ! Working Conditions Personnel Layoffs Social Events Compensation Supervisor Selection Investment % Management &Workers Dedde Together - % Neither Consulted nor Informed - - - Union Majority - - - Union Minority • ·- • • • • Union-Excluding Nonunion

-60-L------~----~------+-----_,

Figure 4.1 Nonmanagerial Employee Involvement and Union Relationship to the ESOP

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vesting (granting employees access to ownership) to be more egalitarian and payout of benefits faster in unionized firms. We expected that there would be more profit sharing in unionized firms and that its basis would be more egalitarian. As for retirement plans, we were fairly confident from field experience that unionized employees would prefer the security of a definedbenefit pension plan over placing all their retirement funds in a stock plan. This is egalitarian in the sense that hourly employees can be reasonably sure of getting something in the way of a retirement income, as opposed to getting nothing if all their pension funds are in an ESOP that falters or fails. Hourly employees, who generally receive less income than management, are more likely to be wholly dependent on their pension and Social Security for retirement income. Confounding our expectations, however, firms that included union members in their ESOPs were only a little more likely to have immediate vesting, which we expected would be offered in compensation for concessions that employees had made to help in the creation of the ESOP. But the evidence for this in the data was less striking than expected: about one-fourth of firms that included the union had immediate vesting, and only 10 percent or less of firms that excluded the union or were not unionized; there a waiting period of five to seven years is more typical. Another modest impact of the more egalitarian values of the union may be seen in the fact that the union-majority firms were more likely to base allocations to ownership accounts on hours worked (25 percent) or to make equal allocation (13 percent), rather than the more usual formula based on W-2 earnings. In contrast, only two nonunion firms (3 percent of those in the sector) used hours worked as a basis for allocations. Union-majority ESOPs, however, were the least likely to allow immediate payout to an employee leaving the firm for reasons other than retirement, death, or disability. Only 17 percent of the majority employee-owned unionized firms provided for immediate distribution, compared with 33-36 percent of other firms in the unionized sectors. This finding, which contradicted our expectations, may reflect the birth conditions of those firms: often born in adversity and still not highly profitable, they simply could not atlord to pay out retirement accounts swiftly. In fact, fully a third of the union-majority firms reported that

Union Brothers and Sisters in the Boardroom?

125

payouts for deceased or departing employees would not begin until the ESOP loan was paid off. (When these firms become more profitable, we may once more test our hypothesis that unionized firms have the fastest payout.) As for other benefits, only union-minority firms stood out as being slightly more likely than others in their sectors to have a 401 (k) plan. As we expected, union-including ESOPs were more likely to have a defined-benefit pension plan (50 percent compared with 30 percent of others in the sector) and a little more likely to have a profit-sharing plan (30 percent compared with 17 percent). A review of the preceding evidence makes quite clear that unionized, majority employee-owned firms stand out as having done the most to change and develop their organizations. Within their capacities, they are also doing the most to protect the employee owners' defined benefit pension funds. Will these efforts translate into high economic performance? We believed that they would, but the data failed to confirm our expectations in the area of economic performance. Unions and Performance

Expectation: The union, where it is constructively engaged in the ESOP, can minimize absenteeism. Unions can help their employee-owned firms by discouraging absenteeism, but there is no evidence in the Ohio data to indicate that they were doing so. Within the unionized sectors, all but one of the union-majority firms reported that the ESOP had had no impact on absenteeism. Just 2 of 10 union-minority firms (20 percent) and 10 percent of the union-excluding firms reported some positive impact on absenteeism. The largest extent of beneficial impact on absenteeism was reported by the nonunion firms, 31 percent of which reported that the ESOP had had a positive effect. Expectation: The union, where it is constructively engaged in the ESOP, can minimize waste. Minimizing waste is part of reducing production costs, which some scholars have suggested can be the earliest benefit of an improved work process. But no striking differences were found in the reported impact of the ESOP on production costs, whether firms were unionized or nonunion, whether their ESOPs included or excluded the union: 43 percent of union-majority, 40 percent of union-minority, 38 percent of union-excluding, and 35 percent of nonunion firms reported that the ESOP had had a favorable impact on production costs. The

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direction of results is as expected, but the differences among the groups are too small to confirm any special beneficial effect of the union. Expectation: The union, whnz constructively engaged in the ESOP, will minimize grievances. Seventy-two percent of union-majority firms did report that grievances had decreased, but only 10 percent of union-minority firms. Expectation: Firms with ESOP~ that includr union mernbrrs will perform better than other firms. The weight of the evidence on improving profits relative to other firms in the industry suggests that the union-majority firms did as well as others in the unionized sectors, but evidence for superior performance is lacking. Table 4.2 summarizes several important indicators of economic success, including employment growth relative to the industry, the overall quantitative and qualitative impact of the ESOP, stock prices, and profits. Although a review of the performance indicators does not show that the switch to an ESOP has vastly improved the unionmajority firms' m·erall financial picture over other firms in their industry, the economic outlook is no worse on four of the seven indicators and on two indicators is better. Within the unionized industries there were no striking differences among groups with regard to the ESOP's impact on profitability; 50 to 60 percent of all the firms reported a positive impact, although the union-majority firms had the highest percentage (33 percent) reporting a strong positive impact. As to change in profits relative to their industries, 43 percent of majority employee-owned union firms stated that they were doing better, as did 30 percent of nonunion and 14 percent of union-excluding firms, and 22 percent of the union-minority firms. On the other hand, union-majority and union-minority firms also reported the highest incidence of decline in profitability relative to their industry (43 and 22 percent respectively). Some union-majority firms seemed to be doing quite well after difficult beginnings, but many of the remainder were definitely doing worse. On the reported quantitative impact of the ESOP, there was no notable difference among the firms in the unionized sectors. On the index measuring qualitative impact of the ESOP, the union-majority firms did less well than nonunion firms but a little better than unionminority or union-excluding firms. Of union-majority ESOPs, 33 percent reported an increase in employment relative to their industry, less than the 36 percent of union-minority, 43 percent of union-excluding, and 55 percent of nonunion firms. There was not much difference among

43% (3 of 7)

57% (3 of 7) 57% (3 of 7) 33% (2 of 6)

75% (3 of 4) 50% (2 of 4)

Quantitative impact of ESOP: some positive or strong positive

Qualitative impact: some positive or strong positive

Increased employment relative to industry, calculated from report of firm employment and industry employment

Change in stock value greater than 10% over three years (1/1/89-12/31/91)

Change in stock value greater than 20% over three years (1/1/89-12/31/91)

50%

ESOP had a positive impact on profitability

Improved relative profit index, calculated from report of firm profitability and industry profitability before and after ESOP

43% (3 of7)

Direct report that firm profit is somewhat or considerably higher relative to industry since ESOP established

Majority-ouned, Union Included

43% (3 of 7)

43% (3 of 7)

36% (4 of 11)

40% (4ofl0)

50% (5ofl0)

22% (2 of 9)

60%

(1 of 9)

11%

Minority-owned, Union Included

47% (8 of 17)

65% (11 of 17)

43% (9 of 21)

48% (10 of 21)

57% (12 of 21)

14% (3of21)

52%

43% (9 of 21)

Union Excluded

Table 4.2. Role of the Union and Performance Indicators in the Unionized Sector

44% (21 of 48)

60% (29 of 48)

55% (39 of 71)

71% (53 of 75)

55% (42of76)

30% (21 of 70)

57%

47% (35 of 74)

1Vonunion

as well as other firms in sector

better than other firms in sector

worse than other firms in sector

as well as other firms in sector

as wc ll as other firms in sector

better than other firms

as well as other firms

as well as other firms in sector

Performance Summary: Majority-Owned, Unionized

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groups with regard to total changes in stock value during the three-year period 1989-91, but it is notable that the union-majority firms did as well as or better than others in the unionized sectors, even though nvothirds of them were created from distressed companies facing sale or closing. Overall, however, the prediction of outstanding economic performance by union-majority firms was not supported. Their reports suggest that they may have done a little better than average, but they did not stand out as especially good performers, even though many of them seemed to be making a lot of the right moves in developing their organizational culture. Nor did the unionized ESOPs that excluded the union, which we expected to be poor performers, seem to be doing significantly worse than others in the sector. Union-majority and nonunion firms stood out as making high contributions to the ESOP: 37 percent of firms in these nvo categories reported making contributions ranging from 14 to 26 percent of payroll, in contrast to union-minority (12 percent) and unionexcluding firms (5 percent). Nevertheless, for a small segment of our sample the union role was more dramatic. We asked firms that included the union in their ESOP whether grievances had changed since the firm became employeeowned. No firms said that grievances had increased, but some answered that they had stayed the same or declined. Only 16 firms provided data, a very small group, but the relationship between declining grievances and improved operations and performance was very strong (more details in Chapter 5).

Toward Economic Democracy?

It appears that the relationship benveen union and ESOP has a substantial effect on the organization and operation of the firm. Unionized companies with majority employee ownership stand out in many ways, from their perilous birth process through their considerable and varied efforts to change the operation of the firm, to their unusually bipolar pattern of success and failure. "\\'hen union members take charge of firms by becoming majority owners, training and participation are likely to be greatly expanded and the information flow substantially improved. The demonstrated willingness of unions to accept change in the work-

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place goes against the conventional wisdom that unions are conservative and defensive about change. Rather, the data suggest that unions can embrace change when their members have power and responsibility in the firm. In contrast, the firms that excluded their unions from the ESOP experimented the least with training, communication, and participation. There is some evidence that the presence of union members as majority owners is also linked to a somewhat more egalitarian culture in the ESOP firm. Information is spread more widely; stock accounts may be built more equally; consultation and participation are more extensive. This spirit of equality does not appear to harm the economic performance of the firm. In the firm's qualitative and quantitative performance, transforming union members into unionized employee owners seems to make some positive difference, especially if the company is majority employeeowned. Overall, firms where union members were owners performed no better than nonunion firms, but-equally important-they did no worse. 3 In thinking about employee ownership and unionization relative to economic performance, however, it is impossible to ignore an important reality: two-thirds of the majority employee-owned unionized firms reported that their ESOPs had been established to avert a shutdown or takeover, and that employees had made economic concessions in order to create the ESOP-and these firms made the most changes in communication, training, and participation. There is good reason to believe that the prospect of imminent demise may have affected both the nature and pace of organizational change and the profitability of the firm. Behind every organizational change is the reality of individual willingness to change (Briskin 1996, pref.), and it may be that most employees, both hourly and salaried, embrace change more willingly when the entire organization is facing collapse-just as most individuals will not consider changing dysfunctional behavior until they are faced with crisis in their daily lives. Given the special "economic birth" circumstances of these firms, their unremarkable performance reports on profits and stock value may conceal what is actually a good economic performance. Anecdotal evidence suggests that a parent corporation, in anticipation of a closing or sale, may strip the company of assets by selling off inventory or equipment, neglecting maintenance, and postponing capital invest-

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ment, all of which results in the firm's falling behind its competitors. When employee owners take over, then, they have to do a lot of catching up to bring their firm back into a competitive market position. "Coming from behind" to catch up with the industry represents a strikingly better than average performance by the employees and their management. Perhaps "coming from behind" explains why some union-majority ESOPs are doing poorly. The incidence of lower profits relative to industry among the union-majority firms suggests that special attention is required to prevent new employee owners from getting stuck in declining, highly competitive business sectors where the prospects of success would be poor for any owner. On the other hand, even a "lemon" business represents an asset. It is an ongoing organization of people with skills, knowledge, and interpersonal connections who can cooperate to take their business in a new direction, if they are not overly burdened with debt and do not face serious internal obstacles to change. In addition, where the overall market for the product is declining, the chief benefit of employee ownership may be simply that the employees can receive wages and benefits. They are therefore willing to accept a lower rate of return on capital than traditional investors. Without a demand for high returns, the firm may be able to cut costs and remain competitive in its market for years. Of course, new product and process development should be a high priority for such firms. That union-majority firms are doing no worse overall than other firms in the unionized sector, after mostly starting at a disadvantage, speaks to their economic viability and the benefits of the changes in structure and decision-making that they have put into place. It appears that unions can work well in ESOPs, and that where they are in the majority they can participate constructively in major restructuring of the firm's organization and culture without any harm to the firm's economic outlook. 4 In general, then, it makes sense to include the bargaining-unit members in the plan except when there are strong, specific reasons for their exclusion. It is worth paying attention to the actual state of relations between companies and unions before making a decision on this issue. Blasi and Kruse come to a similar conclusion (1991 b, 101): where relations are good, or have a good chance of becoming good, including the union in the ESOP can improve performance. 5 Some of the more unexpected developments in our world of union-

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ized ESOPs are worth noting. For example, we know of seven firms where the union president has become a major executive officer in the firm: president of the board, CEO, CFO, or plant manager. Two of these are quite small firms, where leadership has always been in the hands of entrepreneurial craftsmen rather than professional managers. It is an enormous challenge for a union leader to move into top management, but the fact that it is happening shows that the potential roles of unions in ESOPs have only begun to be developed. In another ESOP firm composed of craftsmen, all the employees-including the top leadership-are in the union's pension plan and health plan. Everyone seems quite happy with this arrangement, since the larger risk pool saves the company money and provides security for all employees. National and international unions also have the resources to develop training and education programs for their members who are employee owners, especially for firms that are too small to hire expensive consultants. What is more, union headquarters can be a source of considerable written and tacit information on emerging management talent. This information could be used to develop a pool from which to recruit managers with the skills and temperament suited to the leadership of employee owners. Blasi and Kruse (199lb) write that either unions will stubbornly resist employee ownership and cling to the past, or they will turn their considerable talent, experience, and resources to developing a "shareholder culture" and fostering the potential of unions to prosper in flourishing ESOPs (199lb). On the basis of our data, we lean more toward the promise of employee ownership than toward the scenario of resistance.

5

Do ESOPs Mature? Modeling Performance and Profits

[The ESOP] gives the worker the benefits and feelings that come with ownership. Participation alone would not do it.... [However,] a small number of employee owners feel because they own a minority share of ownership they have the same authority as a majority or sole owner would. (Company 10) Employees have a very important say in how the companv does. There is more accountability. (Company 118) Employee attitudes about the company and their role in it are much more positive than other companies in our industry. (Company 123)

Do ESOPs mature as organizations? As applied to a person, the adjective mature suggests prudence and wisdom derived from a lifetime of experience. It suggests someone who is able to perform his or her life's roles with efficiency, competence, and realisticjudgment. As we all know, aging alone is no guarantee of maturity, but when life experiences engender changes for the better in attitudes, we say that someone is maturing. And we expect that future behavior will reflect the new attitudes. A parallel notion of maturity for organizations would incorporate parallel concepts: wisdom, realism, and prudence arising from experience. This perspective leads to a rough operational definition of organizational maturity for the ESOP firms in this study. Since we cannot measure wisdom, prudence, and realism directly, we define mature firms as those that are experienced in using a variety of techniques for operating their business, producing their product or service, and planning for the future. A more academic phrase for what is being measured is 132

Do ESOPs Mature? Modeling Performance and Profits

133

organizational development, as indicated by the presence of specific activities and structural features in the firm. The U.S. Department of Labor (1993) has found that high levels of organizational development characterize high performance firms. In the case of employee-owned firms, organizational development is likely to be more extensive and richer, qualitatively different from that of traditional firms. The difference can be so great that we are tempted to embellish the label of organizational development and call it participatory organizational development when it is fully realized in employeeowned firms. For example, the most developed employee-owned firms often have nonmanagement employees on the board of directors. Employees often have a considerable financial stake in the company's success. And information may be provided in a much richer context, reaching more employees, than in most traditional firms, as revealed in the vignettes of Chapter 2.

Measuring Maturity: Organizational Development

To measure the maturity or organizational development of employeeowned firms, we combined scores on five variables-financial communication, communication, training, shop-floor participation, and boardroom participation-into a single measure indicating the extent of each firm's experience with a variety of approaches to its own management and operations (it does not show the impact or success of each). Staff experience leads us to believe that each of these aspects is very important in its own right and that all should be present in some degree. The right kind and amount of each type of development varies with the type of firm, its management style, and its business activity. Without specific information for each firm, it seems prudent to assume equal importance for each major dimension of organizational development. So that no one of the five variables would weigh more heavily than another in the index, some were collapsed, allowing each to have a maximum value of 2. A negative score on a variable indicated that the firm reported doing less than it had done before the ESOP was adopted (only training, communication, and work-unit/shop-floor participation could have negative scores). A 0 indicated that there had been no net change in the number of techniques used since the ESOP was adopted. A score of l indicated

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"a little change" in the sense of 1 or 2 additions to training, communication, or shop-floor participation; making available but not actively distributing financial information about the firm; or appointing nonmanagement board members. A score of 2 indicated "much" change in the sense of trying 3 to 5 new techniques of training, communication, or shop-floor participation; the intentional distribution of financial information to employees; or the election of nonmanagement board members. To create the overall index of maturity, scores on the five variables were simply added together. The possible range of scores was -3 to +10; the actual range was -1 to +10. The resulting "maturity" variable roughly indicates the breadth and depth of a firm's experience with the various techniques of organization and management which are currently available to ESOP firms. Since the measurement does not reveal the care, thoroughness, or commitment the firm has made to any of these, scoring high on the maturity variable doesn't guarantee that a firm will always act wisely or prudently. But it does indicate that the employee owners have worked with many different approaches to managing the firm and in doing so have had the opportunity to develop a repertoire of responses to business challenges. The more varied experience the firm has in working on problems, the better its ability to resolve favorably any business issues that may arise. Our hypothesis in this chapter is that the more developed the firm as an organization, the better its business performance. The distribution of the maturity variable in Figure 5.1 shows that most firms have had only a little experience in developing their organizations, that some firms have had a modest amount of experience, and that about one-fifth have had considerable experience with a variety of approaches and techniques of organizational development. 1 For the sake of conceptual simplicity in the analysis to follow, we collapsed the distribution in Figure 5.1 into four categories: (1) firms that did nothing on balance, or even reduced overall their commitment to development, amounting to 8 percent of the firms studied; (2) firms that did "a little" (scoring 1 or 2 on the maturity variable), amounting to 35 percent of the group; (3) firms that tried "some" changes-more than "a little" but not a lot (scoring 3 or 4), amounting to 30 percent of the group; and (4) firms that experimented considerably (scoring 5 or more), amounting to 27 percent of the entire group of 119 firms for

Do ESOPs Mature? Modeling Performance and Profits

135

N= 119; meon =3.4 30

25

------

20

--

-

§

= ~

~ -"'

-

15

E

.5 10

-

--

0

---1

-

-

t--

-

-

-

t--

~

0

2.

I

4

3 •

-

lLL_

7

10

Maturity

Figure 5.1 Distribution of Maturity Scores

which complete data were available. The collapsed variable was useful in comparing the "most mature" firms with all the rest and in relating maturity to firm performance. The "Most Mature" Firms

The firms scoring highest on the maturity index tended to be smaller ones. But the medians of the two groups were comparable: 132 employees for the most mature firms; 120 for all others. The most mature reported a little lower sales per employee ($176,057 versus $191,034) and about the same age of the ESOP (mean = 6.9 years versus 6.6 years) as lower-scoring firms. The most mature were more likely to be in manufacturing or wholesaling (72 percent versus 53 percent). They were much more likely to be majority employee-owned (56 percent versus 24 percent

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of the less mature firms) or to have a larger share of ownership: in 69 percent of the most mature, employees owned 30 percent or more of their firms, as compared with 40 percent of the less mature. They were much more likely to have been created to avoid shutdown (41 percent versus 5 percent) or in the face of corporate divestiture (24 percent versus 7 percent), and they were a little more likely to be leveraged (78 percent versus 60 percent). 2 They were not more likely to be unionized (78 percent were nonunion, versus 73 percent of the others), but they were more likely to have majority ownership with a union ( 16 percent versus 1 percent); furthermore, no firms in the most mature category excluded union members from ownership. The most mature firms were more likely to have an ESOP administration committee (88 percent versus 64 percent), more likely to pass through voting rights to employee owners beyond those strictly required by law (63 percent versus 38 percent), and more likely to report high nonmanagement involvement in decisionmaking (33 percent versus 10 percent). And 44 percent of the most mature reported interest in decision-making "much increased" compared with 12 percent of other firms. Getting Older or Getting Better?

As it does among people, chronological age had little to do with maturity among the Ohio firms. Even ESOPs of fairly long existence did not necessarily report much experience with techniques that could develop the versatility and organizational strength of their firms. The gamma correlation between age of ESOP in years and maturity was .06, suggesting no relationship at all, and a similar pattern existed between age in years and every measure of firm performance or organizational innovation. Our conclusion is that firms do not naturally get better as they get older.

Maturity and Performance

Between organizational maturity and organizational performance there was a consistent pattern of positive relationships. The most mature firms were more likely to report that they were doing better than their industry in profitability (41 percent versus 18 percent) and to report higher performance on other measures, as shown in Table 5.1. On every single indicator in the table, the most mature firms outperformed the

Do ESOPs Mature? Modeling Performance and Profits

137

Table 5.1. Maturity and Firm Performance, Measures of Association

Maturity and Performance Variables

Quantitative impact of ESOP: percent reporting "some or strong positive impact" Customer service: percent reporting strong positive impact Productivity: percent reporting strong positive impact Product quality: percent reporting strong positive impact Profitability: percent reporting strong positive impact Production costs: percent reporting strong positive impact Qualitative impact of ESOP: percent reporting some or strong positive impact Profits relative to industry: percent reporting profits better than industry Value of stock change in 3 years >20 percent

Percent of Least Mature (Negative, Nothing or Little) Reporting Positive Impact

Percent of Most Mature Reporting Positive Impact

33% of 49

72% of32

.29**

4% of49

22% of 32

.41 ***

4% of 49

19% of 32

.36**

4% of49

22% of 32

.36**

10% of 49

16% of 32

.26*

4% of 49

6% of 32

.26#

39% of 48

78% of32

.39***

18% of 45

41% of 32

.23#

44% of 34

52% of21

.11

Value of Gamma

Statistical significance:# p,; .10 level;* p,; .05; ** p,; .01; *** p,; .001.

two least-mature categories, often by a factor of two or more. That was true even of variables beyond employees' direct control, such as profit relative to industry and increase in stock value. Many of these relationships were statistically significant, and all were in the positive direction, suggesting that working with a variety of management techniques and organizational approaches is likely to benefit ESOP companies.

Organizational Development: The Process of Gaining Maturity

If performance is enhanced by organizational development in the form of training, communication, and participation, it makes sense to ask

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which initiatives ought to come first. With many options to choose from and limited resources of time and money, firms need to plan what to do and in what order. The previous chapters described many ways in which ESOPs can develop themselves as organizations, selecting from a variety of management techniques and organizational structures and tailoring them to the specific needs of the firm. Ohio ESOP firms did not show any typical pattern in their order of trying techniques of organizational development or in the combinations of techniques that they use. This lack of pattern suggests that there was no general consensus about what techniques should be used first and which ones would be better saved until later in the process. Instead, firms seemed to be testing the techniques at random or, more probably, according to some internal dynamic of their own, which might include a casual call from a business consultant, a serendipitous conversation of CEOs at an ESOP conference, or an article in a business publication. 3 What is the Right Amount of Organizational Development? It is logical that information and training would enhance the effectiveness of participation by enabling employees to make decisions based on a wider perspective than their own personal experience in the work unit. But even without formal participation, information and training can help with performance, because some employees will act on their own. Likewise, participation opportunities even without information and training can benefit a firm because participation allows employees to contribute to the work process the knowledge they have gained on their own in the workplace. Even so, if only some of the elements for organizational development are present, their effect is likely to be diminished. When a company is doing it all-sharing information, training employees to use the information and participate effectively, and providing opportunities to participate in the work unit and the boardroom-a firm can develop a synergy that OEOC training staff often remark upon. How well do the data of the study reflect that observation? We created a measure combining the five major components of organizational development identified in this study. It is related to the maturity index but is simplified so that high development in one area cannot make up for a lack of development in another, and a reduction of activity in one area cannot obliterate the impact of activity in another. A

Do ESOPs Mature? Modeling Performance and Profits

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company scored one additional point for each component it added since establishing an ESOP, even if it added only one technique. Nothing was added to the indicator if the firm had done nothing or reduced its activity. Even if some of the major indicators were missing, firms were not excluded from analysis on this variable but scored according to what they did report doing. We wanted the largest possible group of respondents to test whether "doing it all" produced much higher performance scores than just doing part. Figures 5.2-5.5 summarize the results. In general, the more components were added, the better the firm's performance. But how do the various elements of organizational development link with performance?

100

-.--------------------------------------------~

N= 163

40%

80 ~--------------------------------------

52%

~

60

=