Yes, ESOPs Really Are Good Retirement Policy



Yes, ESOPs Really Are Good Retirement Policy

Corey Rosen

Executive Director

National Center for Employee Ownership

In their recent article in Tax Notes “Repeal Tax Incentives for ESOPs,” Andrew Stumpff and Norman Stein argue that ESOPs do not improve employee wealth or corporate performance, encourage excessively undiversified retirement assets, and should be eliminated. They base this on an incomplete and highly selective look at the data. In fact, researchers “outside the ESOP community” (to use their words) have concluded quite the opposite.

For instance, the most comprehensive study of the effect of ESOPs on wealth was done in 1998 by Peter Kardas and Jim Keogh of the Washington Department of Community, Trade, and Economic Development, and Adria Scharf of the University of Washington. In Wealth and Income Consequences of Ownership, they used 1995 state data and a survey to match 102 ESOP companies with 499 comparison companies. The study found the average value of all retirement benefits in ESOP companies was equal to $32,213, of which $7,952 was outside the ESOP. The average value of retirement assets in the comparison companies was $12,735.[1]

Douglas Kruse and Joseph Blasi at Rutgers have shown that that ESOP companies are much more likely to have secondary retirement plans than non-ESOP companies were to have any kind of retirement plan.[2] So ESOPs are primarily an add-on benefit. In the mythical world the Mssrs. Stumpf and Stein posit, absent tax incentives for ESOPs, companies presumably would put the same amounts into 401(k) plans. A quick look at the current 401(k) landscape dispels this notion.

We are now completing an analysis of Department of Labor Form 5500 filings that reconfirms the Blasi and Kruse findings, showing that companies with ESOPs are more likely to have secondary retirement plan than other companies are to have any plan at all. The data also confirm the Washington State data that overall retirement assets for ESOP participants are about three times those of employees in non-ESOP companies.

According to the Employee Benefits Research Institute (EBRI), just less than half the work force is even eligible for any kind of retirement plan.[3] Companies that do have retirement plans generally contribute only about 3% to 4% of pay per year to the plans, and that money disproportionately goes to more highly paid workers because it is in the form of a match based on employee deferrals. Moreover, many lower paid employees do not defer anything and thus are left out altogether. In ESOPs, by contrast, all employees meeting the basic eligibility requirements (the same as those for 401(k) plans) get contributions of the same percentage of pay or, in some companies, contributions even more tilted to lower-paid employees. Typical ESOP contribution rates are about 6% of pay per year, based on Form 5500 data, and companies usually make contributions to their other retirement plans as well. So yes, the employees are less diversified in their ESOP accounts, but 56% of the work force is not actively in any kind of retirement plan. Even in the uncommon case that the ESOP is the only retirement plan and never becomes at all diversified (most do over time, at least somewhat) that beats being 100% diversified in nothing.

Dallas Salisbury, head of the Employee Benefit Research Institute, the most credible source of retirement plan data in the U.S., had this to say about this issue on an NCEO blog in 2008:

“[Companies] that use an ESOP alone might choose to do nothing if the ESOP was not available as a voluntary option, and those workers would be worse off as a result.

"Labor economics argues that all that ESOP money would be paid as added wages if it did not go for the ESOP, but most employers say that is seldom true. And, even if true over the very long term in the aggregate, it is not true on an individual by individual basis. Thus, many workers are getting ESOP savings that would get nothing above the current wage level were the ESOP not to exist.

"The investment diversification issue misses this added value in place of nothing added (in) reality. Being a voluntary system, even a worthy objective like investment diversification should not be allowed to result in no savings for the worker. The rules must be balanced with the facts of voluntarism and added value."

The reasons ESOP companies are more generous is threefold. First, ESOPs are typically used to buy out an owner of a profitable closely held company. Companies need to make substantial contributions to the ESOP to make this possible. Most already had existing retirement plans in place, and are reluctant to get rid of them. Second, ESOP companies are often led by people who take a more pro-employee view of work. Finally, ESOP companies are in fact more successful.

Corporate Performance

After evaluating all the studies on employee ownership and performance, Douglas Kruse at Rutgers testified before Congress in 2002 that companies adopting ESOPs saw a 4% to 5% increased in productivity, had faster employment growth, and had higher rates of long-term survival.[4] Steven Freeman at Wharton, in a 2007 paper, came to the same conclusion about ESOPs after looking at all the existing studies on the issue.[5] In a major project on ESOPs and other forms of broad-based ownership completed in a series of papers in the middle part of this decade, the National Bureau of Economic Research came to the same conclusion as well.[6]

For ESOPs, Blasi and Kruse found in a comprehensive 2000 study that these companies grew about 2.3% per year faster in sales, employment, and productivity than would have otherwise been expected.[7] That remains the largest and most careful analysis of ESOPs in closely held companies. The evidence is more mixed in public companies, but the largest and most recent study, "The ESOP Performance Puzzle in Public Companies," published in the fall 2006 issue of the Journal of Employee Ownership Law and Finance, by (outside academics) Robert Stretcher, Steve Henry, and Joseph Kavanaugh found that ESOP companies had a 5.5% higher return on net assets and 10.3% higher net profit margin than comparable companies.

In short, before attacking ESOPs as a failed retirement policy, it would be wise to become a good deal more deducted about the topic than the professors did. There is a vast body of research on this topic; they looked at a very small sample and came to some very wrong conclusions.

The National Center for Employee Ownership is a private, nonprofit membership and research organization on broad-based employee ownership. It does not lobby and is not support by grants or contributions. Corey Rosen is its founder and director, and prior to that worked on ESOP legislation on Capitol Hill and taught political science at Ripon College.

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[1] by Peter Kardas and Jim Keogh of the Washington Department of Community, Trade, and Economic Development, and Adria Scharf of the University of Washington. In Wealth and Income Consequences of Ownership, (National Center for Employee Ownership, 1998).

[2] An academic paper on these results is in submission; details can be found at

[3] EBRI has put out several studies n this topic in recent years. For a complete list, go to . The most recent is “Individual Account Retirement Plans: An Analysis of the 2007 Survey of Consumer Finances, With Market Adjustments to June 2009.”

[4] Douglas Kruse, “Research Evidence on Prevalence and Effects of Employee Ownership,” testimony before Subcommittee on Employment Relations, Committee on Education and the Workforce, U.S. House of Representatives, Feb. 13, 2002.

[5] Steven Freeman, “Effects of ESOP Adoption and Employee Ownership: Thirty Years of Research and Experience,” University of Pennsylvania Working Papers, 2007, available at .

[6] See, for instance, Joseph R. Blasi, Richard B. Freeman, Chris Mackin, Douglas L. Kruse, “Creating a Bigger Pie? The Effects of Employee Ownership, Profit Sharing, and Stock Options on Workplace Performance,” NBER Working Paper No. 14230, August 2008/

[7] Joseph Blasi and Douglas Kruse, “ESOPs and Corporate Performance,” paper in submission and summarized at .

8. Robert Stretcher, Steve Henry, and Joseph Kavanaugh

The ESOP Performance Puzzle in Public Companies, Journal of Employee Ownership Law and Finance, Fall 2006.

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