By Joseph E. Godfrey III, CLU, AEP, managing director, Americana Financial Services, Inc.
The September CPA Journal featured a panel discussion on the benefits of using ESOPs in succession and exit strategy planning in closely held businesses. As discussed in the article, the two major benefits of using an ESOP are 1) the seller gets out tax-free and 2) the principal payments on debt created in the transaction are tax-deductible. Many financial or strategic buyers might still ask, "Does the cost of equity dilution justify sharing the future economic returns on the equity with employee-owners?"
The answer can be found in a study done at Northwestern University's J.L. Kellogg Graduate School of Management by Professor Hamid Mehran, now at the Federal Reserve Bank of New York. This study, done under the auspices of Hewitt Associates LLC, looked at both the quantitative and qualitative aspects of the "ownership dynamic." The CEO of a Fortune 500 spin-off summarized it best when he said, "Employee-owners see things differently, they take appropriate risks, they do what it takes to make the business grow, they are not satisfied with being average."
The quantitative study looked at the financial performance of 382 companies for a period of two years before and four years after adoption of an ESOP. Three hundred three of the companies survived the full six-year period of the study.
The study found the following:
* Return on assets (ROA) was 2.7% higher for the 382 companies than their industry peers without ESOPs for each year in the four-year period. For the 303 "survivors," the return was 14% greater than the industry average each year over the four years.
* Total shareholder return (TSR) in ESOP companies was cumulatively 6.9% higher over the four years than their industry counterparts. For the 303 surviving companies, cumulative four-year TSR was 12% greater.
* Stock market reaction was positive for more than 60% of the ESOP companies over the two days following the announcement.
The financial results were obviously very positive about the operating benefits for those companies with ESOPs. Still, is the "cause and effect" relationship here? A separate qualitative study was also made under which a separate written survey was sent to the senior management of the ESOP study companies plus another 230 companies with broad-based employee-ownership programs.
Eighty-two percent of respondents believed the ESOP had a positive to significantly positive impact on business results. A major strength of companies with broad-based ownership is wide access to information such as financial results and business unit strategies. There was also a correlation between employee training and use of information. Building greater connectivity among people, information, and action can enhance the "ownership attitude" of employees in the ESOP. The employee-owner dynamic doesn't just happen; companies have to work at and nurture it.
In the final analysis, the performance of these companies goes to prove that Louis A. Kelso--lawyer, economist, and father of the ESOP movement--was correct in his dream and vision to motivate owners to spread company ownership among employees. It also seems to indicate that the tax subsidies are not only deserved, but also worthy of expansion. *
The CPA Journal is broadly recognized as an outstanding, technical-refereed publication aimed at public practitioners, management, educators, and other accounting professionals. It is edited by CPAs for CPAs. Our goal is to provide CPAs and other accounting professionals with the information and news to enable them to be successful accountants, managers, and executives in today's practice environments.
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