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October 1, 2001 Issue

How Can I Create Employee Ownership Without Using Stock Options?

For compensation professionals in the for-profit world, the concept of employee ownership via Employee Stock Ownership Programs (ESOP) is nothing new. For those not well versed in compensation or working for non-profit organizations, this is not a familiar concept. Today we will explore basic design concepts and implications on employee decision making and involvement in the organization from using ESOPs. The next issue of Astronology will explore creative alternatives to ESOP programs.

An ESOP is an employee benefit plan that makes the employees of a company owners of stock in that company. Several features make ESOPs unique as compared to other employee benefit plans.

First, only an ESOP is required by law to invest primarily in the securities of the sponsoring organization.

Second, an ESOP is unique among qualified employee benefit plans in its ability to borrow money. As a result, leveraged ESOPs may be used as a technique of corporate finance. A company that wants to set up an ESOP creates a trust to which it makes annual contributions. These contributions are allocated to individual employee accounts within the trust. The most common allocation is in proportion to compensation.

The shares of company stock and other plan assets allocated must vest before the employees are entitled to receive them. The least liberal vesting schedule allowed by law is 20% per year until the employees are fully vested after seven years of service. Many companies vest an employee's entire account immediately. The key is that employees now have an interest in the value of the company's stock. The assumption is that, as owners, employees will be more interested in how they personally impact the success or failure of the company. It also assumes more employee involvement in decision making and participation in policy establishment.

Regardless of the type of industry we are in, we are all familiar with the concept of goal sharing. Taken from the WorldatWork Building Blocks series, goal sharing is a business process that focuses on business unit performance while rewarding participants for achieving continuous improvement. It typically involves a balanced scorecard approach in setting and measuring goals for individual business units. These goals may include improvements in financial performance, quality and customer satisfaction, or growth and process improvements. Often, each goal stands alone and pays out on its own. Payouts are incremental based on the amount of improvement.

Key to the success of a goal sharing program is setting fair goals that require each business unit to stretch its performance beyond what is achieved during the prior measurement period, typically a year. Like an ESOP program, goal sharing assumes direct employee participation in decision making on issues that impact the outcomes and thus the level of "reward" available.

There are many organizations that are experimenting with programs that offer advantages of both ESOP and goal sharing programs. One common aspect of both programs lies in the initial design process. There are several key strategic questions that need to be addressed at the start of the design process:

What long and short term results are the organization attempting to achieve?
What employee efforts and behaviors are required to achieve these results?
Who will be eligible to participate?
How will the program compliment and support current compensation philosophy and strategy?

Stay tuned. In the next issue of Astronology, we will explore design fundamentals of an Employee Ownership Goal Share (EOGS) program.

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ISSN Number 1549-0467