Originally published on Knowledge@Wharton by Angie Basiouny.
When many people think of employee-owned companies, an artisanal cheese shop or organic cafe springs to mind. But, the 6,000 U.S. companies that are partly or wholly owned by their employees come in all sizes — from small firms to large, publicly traded companies. In this episode of the Dollars and Change podcast, Wharton management professor Katherine Klein speaks with Corey Rosen to demystify what it means to be employee owned (and no, it’s neither requiring nor simply allowing employees to buy stock). Rosen is founder of the National Center for Employee Ownership and has long advocated for this corporate structure because it offers better performance, greater stability, and higher wealth for workers and the community. He is co-author of the new book, Ownership: Reinventing Companies, Capitalism, and Who Owns What.
Read an edited transcript of the conversation below.
Katherine Klein: Before we dig into the details of the book, I’d like you to give us the elevator pitch for employee ownership. What’s employee ownership, and why do we need more of it in this country?
Corey Rosen: We’re often looking for that idea that’s at the intersection of “it works” and “it’s politically possible.” There aren’t very many ideas that are at that intersection anymore. We know employee ownership works because there are extensive data and studies that show that the employees in these companies have substantially greater wealth than employees in comparable companies. We know that these companies perform a lot better. We know that they lay people off at dramatically lower rates — one-third to one-fifth of other companies.
You have employees with retirement accounts that are about three times that of comparable employees in companies that have retirement accounts. And 50% of the private sector workforce is in no retirement plan at all, so the median account balance for an employee in a private sector company is zero.
We know that employee ownership works for wealth accumulation. We know it works in reducing layoffs. We know that the companies perform consistently better after setting up a plan. That means their communities prosper as more money is reinvested.
But this is not just some kind of idea for the occasional company or the altruistic owner. This is an idea that has been supported by Republicans and Democrats since 1973. Congress has provided significant tax benefits for these plans, and every bill at the state and federal level that has been introduced to encourage employee ownership has passed unanimously.
So, it’s an idea that works politically. It’s an idea that works economically, but it’s not an idea that people are paying enough attention to.
Klein: You make a compelling case that employee ownership is something that we ought to take more seriously. We’re talking about employees owning part of all of the company they work for, and not just executives, but the rank and file. Typically, 100% of the employees, after a year or so of employment, are owners of the company.
You hinted that one of the thoughts people might have when they hear about employee ownership is, “That’s for weird companies. That’s for lefty companies, socialist companies, idealistic companies. That’s not for any company I’ve ever heard of.” Counter that argument. What are the examples of companies we might have heard of?
Rosen: Yes, a lot of people think employee ownership is the local worker cooperative coffee shop. There are certainly those examples. But seven of the largest 15 engineering companies in the U.S. are 100% employee owned. It’s also Publix, one of the largest supermarket chains in the United States, as well as several other very large supermarket chains, like the rapidly growing WinCo in the Northwest. So, it’s not some peculiar idea that’s limited just to, as you say, some left-wing social activists. In fact, many of the companies that are employee owned are among the leaders in their industries — W.L. Gore & Associates, the makers of Gore-Tex, for instance.
There are a variety of ways for employees to become owners. The one that we really highlight the most in the book is the employee stock ownership plan or ESOP. There are about 14 million participants in these plans. They are particularly attractive to owners of closely held companies looking at moving on. Of course, with the “silver tsunami,” that’s a lot of people. They could sell to private equity. They could sell to a competitor, or they could just liquidate. None of these options may be very appealing to people who want to preserve the legacy and culture of their company.
An employee ownership plan, because of these tax benefits, offers a very appealing way for these owners to transfer ownership to their employees. In these plans, the employees are not buying the stock. What happens is that the company can borrow money to buy the shares of the owner, and the company repays that loan out of the future tax-deductible profits that the employees help to create. It’s no different than what a private equity firm does when they go buy a company and borrow money and pay it back with the future profits of the company they just bought. It’s just that private equity means a handful of people get the benefit, and employee ownership means everybody does.
Klein: In my understanding of ESOPs, the company is setting up a trust. If I’m an employee and you’re an employee of this company, we are getting ownership shares in the company that vest over time, and we get that amount of the stock that we’re holding proportional to our salary. So, if I make twice as much as you, I’m getting twice as much stock. How much money are we talking about?
Rosen: One thing to note is there’s a cap on the maximum amount of salary that counts when you make these allocations. It’s currently $305,000 a year. But you’re right. If I make twice as much as you do, then I get twice as much of the allocation, typically. Some companies are flatter. But the typical ESOP company contributes about 6% to 10% of pay per year into the employee’s account each year. It can be as high as 25%, and there are certainly companies that do that. And for various technical reasons, there are additional allocations that may go to the employees on top of the contributions the company makes.
These contributions are made every year and allocate more and more shares to employees as they go forward. It’s important to note that people worry, “Well, that’s in lieu of what the company might put into another retirement plan.” Typical companies put a match of up to 50% of what employees put into a 401(k) with a cap of no more than 3% of their pay going into the 401(k). But first, it’s pay to play. You don’t get anything if you don’t put something in. It’s skewed towards higher-paid people because they put more in, and a lot of employees just can’t participate in them at all.
ESOP companies, by contrast, are not pay-to-play. It’s not based on what you put in. It’s much more fair to lower-income employees than other plans are. These companies are somewhat more likely to have a secondary retirement plan that’s diversified than comparable companies are to have any plan at all. So, it’s not accurate to say the ESOPs are replacing other plans, because they aren’t.
ESOPs by law can’t exclude people because they don’t put something in. But 401(k)s are an almost accidental program. They weren’t ever specifically legislated. They were created by a pension advisor and became the norm. I’m not against 401(k) plans, but in terms of creating a truly equitable retirement system, they’re a failure.
Klein: A company that sets up an ESOP is giving stock to all of its employees. That benefit is vested over time. When do I, as an employee, get my hands on that money? Is it just a retirement plan? How should we think about employee ownership in this way as a wealth-builder? When do I get to use that wealth?
Rosen: It is legally a retirement plan. It’s governed by the same law, the Employee Retirement Income Security Act, as pension funds and 401(k) plans, and so on. The way the law works for ESOPs is after you leave the company, if you leave prior to death, retirement, or disability, the company has to start distributing your account to you no later than five years after that event. If it’s for one of those other reasons, like you retire, then it starts one year after you leave. You get a notice from the company saying, “It’s time to get your distribution,” and the company will typically write you a check for the value of your shares. In theory, in some companies, employees could hold onto the shares, but in private companies, there’s not much reason to do that because your market is the company.
There are a lot of participants in ESOPs in public companies. Public companies typically have about 3% to 5% of their shares owned by employees through ESOPs. And in those companies, once you leave, you typically get a distribution right away. And you can do what you want with the shares. It’s a public market, so you can go ahead and sell them or keep them.
Klein: You make a point in the book to contrast the forms of employee ownership in the U.S. today. I was fascinated by the comparison and what you highlight about publicly traded companies and companies owned by private equity. You have concerns about those forms of ownership, not that you’re arguing in any way that those forms can or should go away. But talk to us a little bit about what gives you pause and what makes you think the ownership system in this country is broken and needs more employee ownership?
Rosen: There are two ways that it’s broken. The most compelling way it’s broken is that there aren’t enough owners. It used to be people didn’t worry so much about that. “Well, you’ll make enough money from your salary, and you’ll have a pension plan that will pay you out some fixed amount over the course of your life that can go up in value with some sort of cost adjustment.” Fifty percent of the workforce used to be in manufacturing as far back as the early 1970s, and when companies invested more, wages would go up. When they bought more capital, then people with more efficient wages would go up.
Well, that relationship broke around the early 1970s, and real wages have been stagnant over that period, while returns to capital investment have gone up about 8% per year in real terms. The Dow had three digits in 1973, and now it has five. At the same time, wealth is increasingly concentrated. Three families in the U.S. own more wealth than 90% of the rest of the population. It’s an astonishing number. And 50% of the population is saying they can’t lay their hands on $1,000 in an emergency. The large majority of employees say they’re not confident they have enough money to retire on. And they’re right about that. There doesn’t seem to be much hope that wages are going to start rising faster in any meaningful way than the cost of living. That only gets fixed if people can be owners, too.
It’s not realistic, given what’s happened to wages, to think they’re going to buy their way into ownership. There are only a couple of ways that you can become a wealthy person. You can start your own business — not many people are successful at that. You can save lots of money — that’s harder and harder to do. Or the best choice of all, of course, is to choose your parents wisely! That’s a choice a lot of people don’t make.
The second way it’s broken is that the main systems of ownership have an inborn bias against sustainability. Your ownership in a public company is more like your bet on a horse at a racetrack. You’re not really investing. In fact, they’re not using your money to buy capital. They’re buying more shares back than they are raising money through selling them. That’s not real ownership.
Mutual funds and pension funds that own public companies have a lot of institutional reasons not to be active investors. In fact, most of their trades are made by algorithms so that they literally are owning shares for fractions of a second. CEOs of public companies have very short tenures, so their focus and the market’s interest is on, “What are you doing for me in the next quarter or less?” That system really puts a premium on short-term thinking.
Private equity has a somewhat longer time horizon — three to seven years. But they, too, are looking to maximize short-term profits so they can sell the company for more than they bought it. The biggest research project on private equity acquisitions indicates that overall they cost jobs, rather than create them. ESOPs create jobs, rather than cost them.
Those two systems, which account for almost half the workforce, have some really innate problems in terms of ownership. And closely held companies can be family ownership that lasts for generations, but eventually, all these companies get sold. And when they get sold, they often get sold to one of the first two groups. Or sometimes even profitable businesses are just shut down.
All these systems of ownership have a role, but employee ownership needs to be at least an equal player at this table for the economy to realize what it really should.
Klein: Corey, you’ve been at this for a long time. You’ve been interested in employee ownership for decades and advocated for this. What’s holding employee ownership back? I would argue that impact investing seems to get more attention. ESG seems to get more attention. Public benefit corporations and B certification get more attention. Is this just the nature of fads?
Rosen: In some ways, employee ownership is kind of a stealth phenomenon. If we look at ESOPs, it’s 14 million employees with $1.4 trillion in assets. A hundred companies that are majority employee owned have collectively almost 700,000 employees. The smallest on that list has 1,500 employees. In some ways, this is a much bigger phenomenon than people realize. It’s certainly bigger than the growth in unions right now, not that these are competing ideas. That’s another example of something that’s getting a lot of attention, but unionization of the private sector has actually declined.
So why doesn’t employee ownership get more attention? I think part of that is what you mentioned earlier. In the minds of a lot of people, employee ownership is still that little worker-owned cooperative. It’s not these big companies that are doing this. It also is maybe just a little harder to understand. “We’re a benefit corporation,” or “We’re an impact investor, and we’re going to invest in a company that produces green energy.” Those are easy concepts to get your hands around. But the concept of employee ownership, particularly through ESOPs, involves a bunch of rules and moving parts, and it’s kind of counterintuitive.
I can’t tell you how many times I’ve talked to a business owner, and the first thing I say is, “The first thing you need to know is the employees aren’t buying the shares.” We go through the whole explanation. Twenty minutes later, the business owner says to me, “I got everything that you just explained. It was great. Tell me when the employees buy the shares.” That’s how we think of it. It’s a tricky thing for a lot of people to get their hands around. And I think some people think it’s almost too good to be true, that, “You’re keeping something from us. There must be a lot of failures. There must be a lot of problems.”
It’s not right for every company, but it’s a lot more practical than people realize. Also, in the business advisory community, there are a lot of people who just really don’t want their clients to sell to an ESOP because, frankly, they can make a lot more money if they can get them to sell to somebody else. Their advisory fees are higher.
Klein: Give us a sense of what you’re hoping to achieve with this book and what kinds of changes you’d like to see that would accelerate the growth of employee ownership.
Rosen: We think that three things are really important: One is greater awareness. For instance, California unanimously passed the California Employee Ownership Act to create a program to increase awareness of this. There is an act in Congress that has a very good chance of passing, called the Work Act, and it would create funding for 50 state programs to do that. These would be tremendously impactful changes.
Second, the financing arrangements for ESOPs could use some work at least for some deals. Many business owners are very happy with the way ESOPs are typically financed, often with a partial or total seller note, but for some owners, some kind of loan guarantee or other support would help get the deal past the finish line. There are proposals on this as well. This would be very inexpensive, just a tweak to the existing system. It’s making ESOPs eligible for a lot of the same kind of loan support that states and the federal government provide to all kinds of businesses now.
And the last thing is simply for people to start talking about it. In the U.K. in 2014, all three parties at the time, the Liberals, Conservatives, and Labor, said they wanted to create a “John Lewis economy.” John Lewis is the iconic British supermarket and department store chain that’s employee owned. They all just gave it that name and made it a big part of their pitch. It was front page of the Financial Times over and over again. They passed their own employee ownership law, and it’s growing much faster there than it is here. Part of that is just because their financial press and their politicians talk about it a lot. It’s not a big change. It’s not costing anybody anything to do that. It’s certainly not costing them politically.
Klein: I want to thank you for drawing attention to employee ownership and sharing all you know about this. As you know, I’ve long been interested in this topic, and it’s great to have reinforced what a powerful mechanism this is.
Rosen: I can’t help but say that Katherine was our first employee way back when. As a graduate student she came, looking to do a project, and we were looking for somebody with her kinds of skills. Boy, did we hit the jackpot in getting Katherine.
It was a three-year project, and it’s fair to say that the research that came out of that project that Katherine led changed the way people understand what makes employee ownership work better or worse. It has become the touchstone of now the common wisdom in this field, and it has really affected the way companies are run in a dramatic way. So, I’m very grateful that we had that opportunity.
Klein: It’s wonderful to hear that, and I will say I remember early on, as I was looking around for a dissertation topic, and I kind of stumbled onto employee ownership. I thought, “Wow, this is something that would really change people’s lives and would really make them feel differently about their work and their companies.” And it’s true. So, it’s really fabulous to revisit the topic. Thank you.