| Leading Companies Online Magazine
Equity Plays a Variety of Roles
By Anthony I. Mathews, Beyster Institute Staff
 
Often, when we talk about employee ownership, we seem to be implying that it is one coherent movement; that the phrase employee ownership means the same thing to all the people who use it. In fact, that is not the case at all. Employee ownership as a concept encompasses a broad range of vehicles and approaches, from selective stock options to synthetic equity programs to non-qualified stock plans (both broad-based and restricted) all the way to ESOPs. More important, this range of vehicles reflects an equally broad range of intentions for the people and entities that employ them. The range in general terms spreads from equity as a compensation currency all the way to broad equity ownership as a corporate and personal value.
If this range of intentions is viewed as a spectrum, it provides a very useful way of thinking about which vehicle (or vehicle designs) might best approach meeting the planner’s real objectives.
On the left end of the spectrum, if you will, is equity purely as a compensation substitute. In its most basic application, this sort of vehicle is intended to attract and/or retain employees by making a portion of their salaries dependent on the successful growth of the company. Often characterizing this category are stock plans that are given in lieu of wages as an attempt to either save a failing company or assist in the risky startup of a new company.
Ownership itself may be a significant notion in the minds of some in these situations, but more likely, the intentions of the original shareholders and management are directed at sharing an amount of equity that will generate a desired behavior. Lots of discussions and analyses of “dilution” are had in these situations. Sometimes, of course, especially where the business circumstances are particularly dire, this may result in a substantial percentage of employee ownership, and when it does, this sort of plan may move farther right on our spectrum. But the usual initial intention is to use equity as a temporary replacement for compensation and, as a consequence, both sides generally are motivated to liquidate the currency at the earliest possible opportunity.
Next to that, and moving right, is equity as an incentive currency. This application overlays equity interests in the company on an otherwise complete compensation package to provide an extraordinary potential advantage in the event that the company’s value grows. In this category are the many incentive compensation programs that are usually reserved for small numbers of “key employees.” I’ve always thought it rather dear that these plans are referred to legally as “top hat” plans… reminiscent of the Monopoly icon.
The very name indicates the selectiveness with which this technique is usually applied, and it can be a very effective way to link the performance of corporate executives to the value that is being created for the body of shareholders. This sort of incentive is being recognized widely to have application to a much broader selection of employees, and there are increasing numbers of cases in which these sorts of programs are finding broader application. One need only scan the employee ownership programs of the 100 Best Places to Work to see that significant employee ownership is at work in those “best places” and it comes in a very wide variety of forms. In these cases, the “top hat” plan may become a more “baseball cap” plan with sometimes remarkable results.
As we continue to move right on this spectrum, we come to programs that use equity as a method of developing long-term commitments to the company and its growth. These programs (including many very broad-based stock and pseudo-stock plans) are generally intended to share the value that is created in order to inspire a long-term mutuality of purpose among employees and shareholders. Many very well-known names in corporate America practice this sort of employee ownership very successfully.
This approach moves smoothly to the next level, which builds on this attitude to see equity sharing as a method of profit sharing and value distribution, often just because it is the right thing to do. Not only do we want to share ownership so that the employees will do a better job of creating wealth for the other shareholders, but it is a clear matter of justice that employees share in the real success that they are helping to create. Louis Kelso, the father of modern employee ownership, saw this as the fundamental economic justice, that over the course of a career, every employee ought to be allowed to earn ownership of capital assets so that they could look to the productive result of that ownership to create a secure future. As he said many times, “The only problem with capitalism is that it doesn’t create enough capitalists.” Fixing that fixes a lot.
As we now approach the right end of the spectrum, we come to broad sharing of equity as a statement of the fundamental values of the business. This is the ultimate application of equity and the basis for the much discussed (although not universally understood) notion of an ownership culture.
While the level of ownership that these spots on the spectrum represent tend to rise as you move from left to right, that is not universally true. Many companies practice employee ownership in a way that creates a central value – an ownership culture – even though the employees as a group may only own a small percentage of the company. Starbucks is a good example of this type of company. And in the same way, we have witnessed “bail-out” employee ownership programs that resulted in high percentages of ownership with very little that one would recognize as an “ownership culture." And, predictably, the long-term outcome of most of those has not been all that positive.
Likewise, the vehicles used to create employee ownership vary significantly at every point on the spectrum. It would seem that the most direct way to create an “ownership culture” is to aim a company at 100 percent employee ownership through an ESOP, but it is entirely possible to get to the same place through a myriad of other approaches, and there are many good examples to demonstrate this. Just look back at those “100 Best” to confirm this.
Finally, the motivations of those who initiate these programs vary almost as widely. Often the employee ownership programs are initiated at one point on the spectrum (say as an incentive program or a startup compensation substitute) and develop into ownership culture expressions because of the powerful results that employee ownership and empowerment can generate. In most closely held companies, employee ownership begins as a reaction to succession planning on the part of the current ownership. ESOPs carry a basket of advantages such as a business succession tool, that, for many who begin down that path, the fact of employee ownership (on whatever point of the spectrum) is only tangentially related to the decision.
But one thing is clear. Whatever the initial motivation, whatever the initial approach, employee ownership is a powerful factor in creating successful enterprises – a kind of collective entrepreneurship that can meet all these objectives and make for a better society while doing so.
In line with this topic, we have some really exciting news. This fall, we are presenting the first-ever course in the Rady School’s MBA program on equity compensation techniques. We will be covering the full spectrum of intentions (from compensation substitutes to employee ownership as a value) and the full toolbox of vehicles (from synthetic equity to ESOPs)…a small but, we believe, significant step in our quest to get employee ownership into the minds of business professionals at all levels.
©2007 The Beyster Institute and its authors and their entities. All rights reserved.
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