Profit-Sharing Employment Model Undersold as Economic Booster

Presidential candidates grasping for remedies to correct economic inequality have largely focused on reforming the tax code. GOP frontrunner Donald Trump has had a field day beating up on the “hedge fund guys” and reviving an old and well-honed debate about “carried interest.” Fellow Republican candidate Sen. Rand Paul (Ky.) wants a flat tax.

Sitting quietly in the midst of this rhetorical swirl are Employee Stock Ownership Plan companies, or ESOPs. They received a hat tip from Democratic frontrunner Hillary Clinton this summer, but no other White House candidate has included them in a platform. ESOPs have long enjoyed broad support in Washington, and their proponents now are saying they could help bridge the income gap.

“Every day they come to work, our employees know they own the company,” Greg Klein said at a briefing last Friday. “It keeps employees at our company and allows them to grow that nest egg.”

Klein is president of Inland Truck Parts and Service Co., an ESOP company based in Overland Park, Kans.

The ESOP model drew national attention when Clinton endorsed a 15 percent tax credit for companies that adopt such profit-sharing models for the first two years that they use them. “Profit-sharing that gives everyone a stake in the company’s success can boost productivity and put money directly into employees’ pockets,” she said when unveiling her economic plan in July.

Republicans have long supported the ESOP model. The party’s 2012 platform called them the “employer-employee relationship of the future” and lauded their emphasis on private property and ownership.

There are some downsides. ESOPs can make a company less capable of attracting investment from private equity investors, who could be turned off by an ESOPs’ inability to rapidly expand. A public company can also struggle with the ESOP model because of the market’s emphasis on growth and returns to investors.

“A public company invests all its capital, and if there’s anything left over it pays to the shareholders,” said Stephen Smith, general counsel for Amsted Industries, an ESOP and industrial manufacturer. “We have to pay the shareholders—the retirees—every year, and that has to come first by law. We have found that we can do the capital investment that we need to do. What we don’t do is the $2 billion acquisition. That probably is not feasible.”

ESOP enthusiasts say that’s a good thing. Their lack of appeal to private equity and judicious investment strategy is part of what makes their business model work. “Many sellers want to keep their companies intact, they don’t want private equity sweeping in and owning their businesses,” said Stephanie Silverman, executive director of the ESCA, the exclusive industry association for ESOPs. “They don’t want foreign owners coming in and owning their companies and busting them up.”

The lack of appeal to private equity may resonate with voters in an election season dominated by critiques of Wall Street and anti-establishment candidates on the left and right. Candidates from Clinton to Trump to former New York Gov. George Pataki (R) have called for higher taxes on hedge fund managers or “Wall Street fat cats.”

Currently, there are more than 2,000 ESOPs in the United States employing more than 470,000 workers, a minuscule percentage of the 157 million member U.S. labor force. Proponents like Clinton and ESOP executives say the model is highly underutilized. One thing that would help, they say, is if Congress would provide some tax incentives. But that’s a ways down the road. It’s not part of any tax package on this year’s agenda.

Here’s how ESOPs work. The company puts its own shares into a trust, which is then sold as shares to employees. As shareholders, employees receive profit-sharing benefits in addition to their salaries. The legal framework for ESOPs specifies that companies can give as much as 25 percent of compensation to their employees for any combination of qualified savings and retirement plans.

Heavy reliance on employee stock options for retirement savings raises red flags for employee protection advocates, who worry about the risk of tying retirement funds to the performance of one company.

The most prominent example is United Airlines, whose experiment with an ESOP model ended with its 2002 bankruptcy filing. Because of limits on retirement contributions, many higher paid employees were unable to open 401(k) accounts without sacrificing their ESOP shares. When the company went bankrupt, those employee owners lost most of their retirement savings. Profit-sharing advocates blamed the company’s lackluster commitment to the ESOP model for its failure.

“The efforts to create an ownership culture were terminated after one very successful year,” Corey Rosen, director of the National Center for Employee Ownership, which supports ESOPs, wrote at the time.

ESOP executives say the United Airlines example represents a misconception of their business model. “About 85 percent of our companies have multiple retirement plans,” Silverman said. “For example, most will have a 401(k). Some will have a cash-balance plan in addition to their ESOP.”

In addition, an Ernst & Young study found that ESOP retirement funds outperformed the Standard & Poor’s 500 Index by 62 percent between 2002 and 2012.

Morning Consult