Democracy in the workplace II: employee ownership

Part two of our analysis of employee-owned firms, this

topic shows that the spectrum of employee ownership is

broad and there are key distinctions between various

models within that spectrum.

Democratic Enterprise

Learning Goals

• explain the rights of workers in an employee-

owned firm;

• understand the nature and characteristics of the

main forms of employee ownership;

• assess the current state of employee ownership

in the UK and internationally.

Key Arguments

• Employee ownership encompasses a wide variety of

organisational forms.

• In an employee-owned firm, workers have the right to

participate in ownership, governance and profit, as well as

access to information and participation in management.

• Employee-owned firms have developed a multitude of

governance structures to facilitate employee participation

in decision-making.

Introduction

• ‘Companies where employees own a significant stake in the company

they work for – sometimes termed ‘co-owned’ businesses – now

account for combined annual turnover in excess of £25 billion, more

than 2% of (UK) GDP and growing.’

• ‘Employee owned companies outperformed the FTSE All-Share in

2010 ... Employee owned companies' share prices were up 16.3%,

performing better than the FTSE All Share companies' share prices

which went up by 11.3% over the year.’

• 13.6m workers in US participate in employee ownership plans worth

around $901bn.

What is employee ownership?

The term employee ownership can refer to the entire spectrum

of worker ownership/participation in firms.

Can be a minority shareholding by a minority of employees to

100% ownership and control of a company by all employees.

Employee Ownership Association (EOA) definition:

Employee-owned businesses are companies where employees own a

controlling stake in the business, i.e. more than 50%. An employee

owned company may involve employees owning shares, but may

instead or as well involve ownership via one or more trusts.

Employee ownership

For the purposes of our study, the ideal form of

employee ownership is any company that is

majority owned by its non-managerial employees,

has some form of participation and democracy,

and where employees exercise some form of

control over the business.

Features of employee ownership

• Rationale – why choose employee

ownership?

• Ownership – different options and levels.

• Governance – democratic or share-based?

• Beneficiary – how much should employee-

owners get?

Rationale

The rationale for transferring the ownership of a business to its

employees will have a crucial impact on the success of such an

initiative. There are a variety of motivations and circumstances

that lead to a company becoming employee-owned:

• aligning employee interests with those of the firm;

• co-operation and mutuality;

• creating and sustaining meaningful jobs;

• preventing the closure of a firm; and

• ideological reasons on behalf of the current owner.

Ownership (1)

1. How much of the company is owned by the employees?

2. How many employees participate in the ownership of the company?

A company that is 100% owned by employees but only 10% of employees own shares.

A company that is 60% employee-owned but 100% of employees participate in share ownership.

Governance (1)

Pendleton and others argue that in firms which are majority

employee-owned, employees will expect a significant role in

governance and management.

Kaarsemaker, Pendleton, and Poutsma, ‘Employee Share

Ownership Plans: A Review’, p.37.

Governance can be based on shares (one share/one vote) or

democratic principles (one employee/one vote).

Governance (2)

Employee participation in governance is not guaranteed in a firm that is

employee-owned. Many companies design systems to exclude employees

from governance and management or else only offer cursory opportunities

to participate.

Rousseau and Shperling, ‘Pieces of the Action: Ownership and the Changing Employment

Relationship’, p. 558.

Once an employee ownership structure is chosen, it is then at the discretion of

the company to select an appropriate governance structure. There is an

abundance of options available, including worker representation on the

board, quality circles, participation in monthly management meetings,

partnership councils, and outright decision-making and management control.

Beneficiary

The level of participation in the surplus generated by a firm

differs depending on the form of employee ownership. In a

worker co-operative, employees are entitled to the entire

surplus generated by the business, while in other firms

employees receive a share of the profit based on salary,

while in others, the employees do not participate at all.

Employee-owners are also entitled to benefit from the net

assets of the business.

Forms of employee ownership

• Direct shares

• Employee Benefit Trusts (EBT)

• Hybrid

• Employee Stock Ownership Plans (ESOP)

Direct shares (1)

Simple concept: the majority of employees own the majority of shares.

Employees can either purchase the shares or the company can

finance it out of profits.

Registered as a company limited by shares (CLS).

Issues to consider:

• How do employees (and how many) participate in share ownership?

• What restrictions (if any) are placed on the transfer/sale of shares?

• What system of governance should be adopted?

Direct shares (2)

Benefits

• Direct participation in the growth

of the value of the company;

• Attractive model for outside

investors (raising capital);

• Flexible model that can

incorporate a variety of

ownership options (can be used

with a trust, ability to grant stock

options).

Disadvantages

• Employees mightn’t control the

company (they would need to

vote en bloc);

• If the company is successful,

difficult for new employees to

purchase shares;

• Employee ownership can be

quickly eroded as shares can be

freely traded.

Employee Benefit Trust (EBT)

A trust is ‘a legal arrangement by which one person owns assets on

behalf of somebody else.’ Similarly, EBT own shares in a company

for the benefit of current, and sometimes former, employees.

G. Nuttall and S. Anderson, Employee Benefit Trusts booklet (London:

Equity Incentives, 2001), p. 2.

The EBT that contains the shares is controlled by one or a number of

trustees, usually appointed by the company. The trustees perform

a number of important functions, such as:

• deciding how to distribute the shares in the trust;

• how many each employee should receive; and

• when the distribution is to occur.

EBT(2)

Employees do not hold shares in the company and

have no claim to the shares in the trust.

The ‘trust deed’ documents how the trust is to be

managed; it usually stipulates that the majority, if

not all, of the shares remain in the trust for the

duration of the trust (eighty years in the UK).

EBT (3)

An EBT has a number of uses in a company:

Market maker in an internal market –An EBT can facilitate the purchasing

and selling of shares amongst employees, ensuring the shares remain in

the company, thus preserving the ownership stake of the employees and

providing them with an outlet to realise the value of their shares.

Warehouse for shares – An EBT is often used to hold all or a majority of the

shares in a company for the purpose of ensuring the company remains

employee-owned.

Providing an exit – An EBT provides an opportunity for the founders or

owners of the company to exit the business, ensuring the company is not

bought by a competitor or floated on a stock market.

Nuttall and Anderson, Employee Benefit Trusts booklet, p. 2.

EBT (4)

Issues to consider:

1. Is the trust going to hold all of the shares or just

some?

2. How much control will the employees have in the

company?

3. How will the profit of the company be

distributed?

Hybrid

Involves using an EBT in conjunction with direct shares.

Combines the strengths of both models:

• EBT – stability of employee ownership

• Direct shares – liquidity and access to finance

Stability of employee ownership is ensured by placing the

majority of shares (or fifty per cent) in an EBT, while

allowing employees to participate in the growth of the value

of the company by owning shares directly.

The hybrid model does require a robust governance structure

to ensure that the employees and other stakeholders are

fairly represented in the decision-making process.

ESOP (1)

An Employee Stock Ownership Plan or ESOP is a type of

employee benefit plan that uses a trust to accumulate and

then distribute shares to employees.

Originating in the US, but used in the UK as well, it bears

many similarities to a profit sharing plan.

There are over 10,500 plans in the US covering more than 13

million employees.

ESOP(2)

How do ESOPs work?

1. Establish a trust to hold the shares.

2. The trust accumulates the shares in one of three ways:

– the company makes a contribution out of pre-tax profits to the trust,

which then uses the funds to purchase the owner’s shares;

– the company issues new shares into the trust;

– the trust secures a loan from a bank or financial service provider and

uses it to purchase the shares from the owner. The company then

repays the loan using pre-tax profits (known as a leveraged ESOP).

3. The trust transfers shares to the employees (after a suitable

‘vesting’ period).

ESOP(3)

It is at the discretion of the company how the shares are

divided amongst the employees:

• Equally

• Based on hours worked, salary etc

Employees usually only receive the full amount of their shares

in the ESOP after a vesting period of a number of years i.e.

you are entitled to 20% of your shares after one year, 40%

after two and so on.

ESOP (4)

Despite their effectiveness in spreading wealth and capital

more broadly in US companies, ESOPs are not automatically

a successful mechanism for transferring control to

employees.

That is not to say that companies do not offer some

opportunities for employees to participate in decision-

making, but the extent of input is at the discretion of the

directors of the business.

ESOP(5)

Uses

• to buy shares from a departing

owner;

• to borrow money more tax

efficiently;

• to create additional employee

benefit.

Rationale

• contributions of shares to the

ESOP are tax-deductable;

• cash contributions to the ESOP

are tax-deductable;

• contributions used to pay the

loan are tax-deductable.

• in the US, legislation allows

companies that are 100%

owned by an ESOP to avoid

paying federal income taxes.

Case studies

Science Applications International Corporation (SAIC) – direct

shares

John Lewis Partnership - EBT

Loch Fyne Oysters - hybrid

Allied Plywood – ESOP

Available on Democratic Enterprise VLE

Summary of employee ownership forms (1)

We have only covered some of the main forms of employee

ownership; similar to the co-operative model of enterprise,

employee-owned firms can take a variety of forms and can

differ in terms of their ownership, governance and

beneficiary structures.

What we have covered so far, and the content in the next

slide, represents a stylised view of employee ownership.

Summary of employee ownership forms (2)

Andrew Pendleton, The three forms of worker ownership: summary, Introduction

to employee ownership.

Minority share plans

Worker’ co-operatives

Majority employee ownership (direct, trusts and ESOPs)

Amount of equity held by employees

1–5% 100% 51–100%

Ownership Minority + unequal Majority + equal Majority + equal/unequal

Governance One share/one vote One member/one vote

Varies

Rationale Align employee interests with the firm

Co-operation and mutuality

Business succession

Protect jobs

To turn around a failing business

Industrial democracy reasons (shared capitalism)

Summary

• Employee ownership takes a variety of forms. There are differences,

for example, between the EBT model in the UK and the ESOP model in

the US, and between minority and majority ESOPs.

• In an employee-owned firm, workers have the right to participate in

ownership, governance and profit, as well as access to information

and participation in management.

• The selection of an appropriate governance structure is a crucial

aspect of employee ownership.

• The extent to which employees participate in the rights of ownership

differs for each form of employee ownership.

Resources and Support

Employee Ownership Association

http://www.employeeownership.co.uk/home/.

The Ohio Employee Ownership Center http://www.oeockent.org/.

John Lewis Partnership

http://www.johnlewispartnership.co.uk/media/webcasts-and-videos.html.

The ESOP Association http://www.esopassociation.org/.

National Centre for Employee Ownership http://www.nceo.org/.

European Federation of Employee Share Ownership http://www.efesonline.org/.

Ownership Associates

http://www.ownershipassociates.com/abt_principals.shtm.

Venture Capitalist http://www.avc.com/a_vc/stocks/.

References and Reading (1)

Employee Ownership Association (EOA). ‘About Employee

Ownership’. http://www.employeeownership.co.uk/employee-

ownership/about-employee-ownership/.

Erdal, D. Beyond the Corporation: Humanity Working. London: The

Bodley Head, 2011.

Field Fisher Waterhouse. ‘2010 saw employee owned company shares

outperform the FTSE All-Share according to Employee Ownership

Index’. http://www.ffw.com/press-releases/2011/mar/employee-

owned-company-shares.aspx.

Kaarsemaker, E., A. Pendleton, and E. Poutsma. ‘Employee Share

Ownership Plans: A Review’ Working Paper 44. The York

Management School, 2009.

References and Reading (2)

National Center for Employee Ownership (NCEO). ‘A Statistical Profile

of Employee Ownership’ updated April 2011.

http://www.nceo.org/main/article.php/id/2/, accessed 16 May 2011.

National Center for Employee Ownership (NCEO). ‘How an Employee

Stock Ownership Plan (ESOP) Works’.

http://www.nceo.org/main/article.php/id/8/.

Oakeshott, R. Jobs & Fairness: The Logic and Experience of Employee

Ownership. Norwich: Michael Russell, 2000.

Rousseau, D. and Z. Shperling. ‘Pieces of the Action: Ownership and

the Changing Employment Relationship’ Academy of Management

Review 28 (2003): 553–70.