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Renewing Enthusiasm for Employee Ownership

States have been promoting employee ownership since 1974, and most policies have failed. But there is a proven route. Here's the map.
 
 
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Pundits wring their hands about growing wealth inequality, and the loss of local control of corporations due to takeovers. What most fail to realize is that a proven solution is already at hand. It's employee ownership. And by that we mean real, long-term ownership -- not the speculative stock-option kind. Largely beneath the public radar, a major experiment in employee ownership has been underway for the last 25 years. It's succeeded in putting an estimated $650 billion in company assets into the hands of some 10 million white-collar and blue-collar workers.

It's an experiment that is working. Research and experience has shown that employee ownership can not only broaden the ownership of assets, but also avert plant shutdowns, increase productivity, reduce absenteeism, decrease the risk of capital flight, and defer (or eliminate) taxes for founders who sell to employees. But despite all it offers, employee ownership remains an under-appreciated policy option. It's time for that to change.

Employee ownership deserves to be more widely supported -- for the benefit not only of employees, but of the entire economy. One study reached the dramatic result that, in companies where employees own a majority of the stock, three times as many jobs are created per year as in conventional firms. Another analysis for the New York Stock Exchange estimated that productivity in the U.S. would increase by 20 percent, if American companies made a serious effort to involve employees in decision-making at all levels and reward them with the gains from this effort.

Employee ownership entered the scene in a major way in the 1970s -- after the federal 1974 Employee Retirement and Income Security Act (ERISA), establishing the tax-deductibility of employer contributions to Employee Stock Ownership Plans (ESOPs).

In the following two decades, the number of ESOPs and stock bonus plans increased sixfold, from 1,600 in 1975, to an impressive 10,170 in 1995, according to the National Center for Employee Ownership in Oakland, Calif. Growth more recently has leveled off, with 1998 ESOPs and stock bonus plans totaling 11,400 -- only slightly higher than three years before. The number of employees covered declined slightly after 1996, from a high that year of 8.7 million covered, down to 8.5 million in 1998.

One reason, according to an analysis by the Urban Institute in Washington, D.C., is that employers are choosing other forms of stock compensation -- such as 401(k)s, broad-based stock purchase plans, or stock options. The NCEO estimates 15 to 20 percent of public companies offer options to most employees -- including PepsiCo, Starbucks, Walgreens, Whole Foods, and Whirlpool.

But options do not represent ongoing ownership, because 90 percent of employees sell immediately after exercise. Growing in significance are 401(k) plans, which controlled $300 billion in the stock of sponsoring employers in 1998, compared to $500 billion for ESOPs. But since 401(k)s convey no employee voting rights, they too fail to represent real employee ownership. ESOPs still remain the primary vehicle for employee ownership.

A key reason is that they offer a significant advantage, in the opportunity for employee participation in management. While not all employee-owned firms use participation, those that do find it is key to success. Studies consistently show that when broad employee ownership is combined with informed participation, companies perform substantially better than otherwise expected.

The neglected policy option of employee ownership deserves to be picked up again. In doing so, it behooves us to learn from past mistakes. For if employee ownership itself has been a success, state efforts to promote it have been less so. Since 1974, 28 states have taken steps to encourage employee ownership. The initiatives include declarations of support, state centers with extensive programs, tax benefits, exemptions from state securities laws, loan guarantees, or interest-rate subsidies and special financing.

One objective of many policies has been the broadening of ownership -- as in Maryland's declaration, passed in 1980, saying it was state policy "to encourage the broadened ownership of capital and that ESOPs were an important means of reaching that goal."

Another objective has been avoidance of plant closure -- as with New York's policy, which states: "the general welfare is directly dependent on the economy and plant closures are a problem. The purpose of this act is to encourage employees of these plants to continue them as employee-owned enterprises thereby retaining jobs. "Legislative enactment of declarations and other forms of support peaked in the 1980s. Between 1974 and 1986, twelve states passed employee ownership policies. Between 1986 and 1994, only two did so.

Some policies have since lapsed, been repealed, or been drastically cut. Montana's program was never implemented, and was repealed in 1999. California planned to offer services, but found no demand. Oregon and Washington had operating programs in the 1990s, but discontinued them because of budget cuts. Massachusetts' program was likewise de-funded. Funding for programs in New Jersey and Hawaii was never authorized. A handful of states in the 1980s did fund programs, and today four are still in operation: in Maine, Massachusetts, New York, and Ohio. Two others -- Michigan and Washington -- have limited programs still in operation. The Washington program closed in 1997, but since then sporadic, ad hoc employee-ownership deals have been done.

The most recent action was taken by Maine, which passed "An Act to Broaden Ownership in Businesses in Maine" in the most current legislative session. While the bill originally had three components -- a fund for grants, an outreach program, and a study commission -- only the commission component ultimately passed. The commission is charged with examining current patterns of ownership, the local impact of ownership changes, and policy options for broadening ownership.

Possibly the beginning of a new trend is the investigation of employee ownership as an instrument to privatize government functions, which appears to have replaced the earlier objectives of broadening ownership and avoiding plant shutdown. The Virginia Competition Act of 1995 was the first policy declaration about privatization, and it created the Commonwealth Competition Council to investigate the feasibility of privatizing state functions. North Carolina passed similar legislation in 1998. These states are, in essence, laboratories. If successful, their programs may become a model for a broad movement of privatizing government services through employee ownership.

What can we learn from these two decades of history? One study showed there were three elements consistently found among statutes successfully implemented: laws were clearly written and required specific action; an early effort was made to educate personnel charged with implementing the statute; and the agencies in question had a structure that facilitated activity.

The best example of a program that works is the Ohio Employee Ownership Center in Kent, Ohio, established in 1988. In an NCEO evaluation of state programs, it was deemed the "most efficient and most effective." The center offers a regular newsletter, an annual conference, and technical assistance. It also runs Ohio's Employee-Owned Network, a training network supported by modest annual dues from 60 member companies. It provides 23 full days of training for employee-owners, on topics like understanding financial reports or team-building.

Since the Ohio program was established, formation rates for employee-ownership companies in Ohio have grown faster than the national rate. For private companies, the relative rate of employee ownership plans increased by 45 percent.

The Ohio Employee Ownership Assistance Program has assisted more than 10,500 employees in buying all or part of 47 companies. Many of those employees would otherwise have been unemployed due to plant closings or downsizing. The cost per job retained was just $129. State promotion of employee ownership can work. The key to success is not the phrasing of the law, but implementation. The key to failure is lack of resources.

Another problem has been lack of demand -- due in large part to low awareness by business, potential employee owner groups, and government agencies. Experience shows that state programs can be most effective in five areas:

1) Facilitating ownership transition in small business -- which is the single largest preventable source of job loss. 2) Encouraging employee participation to improve performance -- which is the key to employee ownership success. 3) Adding employee ownership to regional economic development efforts -- as Maine did with Coastal Enterprises, a community development corporation which recently helped workers buy an electric-blanket plant Sunbeam planned to shut down. 4) Using federal money to help avert plant shutdown -- which is the best kept secret in the world of employee ownership. (Only a quarter of the states used these funds; employee buyout groups can raise the issue with the state displaced worker unit). 5) Developing equity funds -- which have worked exceptionally well in the Canadian province of Manitoba. This last item points to one of the most interesting region-level initiatives.

The Manitoba Federation of Labor and the provincial government sponsored the Crocus Fund, a regional venture capital fund, which pools Canadian-style IRA accounts to invest in equity stakes in local firms. Crocus uses social screens, including a preference for employee-owned firms. More than 27,000 working Manitobans have invested in Crocus since it was set up 1993, and its assets have grown to $165 million (Canadian). Crocus now provides about-two thirds of Manitoba's venture capital. It has invested $100 million in 47 companies, creating 3,500 new jobs, and maintaining 5,200 -- in a province with only 1.1 million inhabitants. Notably, Crocus is the top performer in its class of funds in Canada.

If past avenues to promoting employee ownership haven't always proved fruitful, Manitoba's and Ohio's successes show there are programs that work -- and work impressively. The routes to promoting employee ownership are mapped. What we need is a renewed public will to embark on them.