What is employee ownership (EO)?

The term “employee ownership” defines any situation where workers are owners, in some form, of the firm for which they work.  Employee ownership defies the traditional division between owners and laborers and comes in many forms.

What are the most common forms of employee ownership?

cooperatives: the firm is fully owned by the people that benefit from its services and the management is fully democratic; co-ops are called worker, consumer, or producer co-ops depending on who they serve. 

Employee Stock Ownership Plans (ESOPs): a qualified, defined contribution employee benefit plan whereby employees are allocated shares of the firm and receive the full cash value of those shares at the time they leave the firm; can have fully democratic or traditional hierarchical mangement structure, and employees can own between one and one-hundred percent of the firm (see below for more details). 

pension plans: most commonly referred to by their designation in the IRS tax code, 401(k) or 301(b) depending if the firm is for-profit or non-profit; a firm contributes a monthly amount, usually a  proportion of an employee’s wage, to an investment allocated to the employee; in retirement, the employee receives a monthly payment from the accumulated investment; employees can make pre-tax payroll contributions to supplement the firm’s contributions. 

profit sharing: employees of a firm receive on an annual basis a portion of the profits of that firm, usually according to compensation level. 

stock options: employees have the right to purchase a certain amount of the firm’s stock at a certain price within a certain time frame. 

gainsharing: employees work with management on improving firm performance and then share in the financial benefits of those improvements.  Often financial reward is directly tied to a specific goal, i.e. the fewer mistakes an individual makes that are identified by quality control leads to a higher bonus.

 How do ESOPs work?

A company setting up an ESOP creates a trust fund for employees and funds it either by: 
 
• contributing company shares, 
• contributing cash to buy company shares, or 
• having the plan borrow money to buy company shares.
 
Shares of the stock are allocated to employees, usually according to salary; at the time of departure from the firm, employees receive the cash value of their stock.  The value of the stock, of course, may be greater or less than it was at the time of ESOP formation. In ESOPs that borrow money, referred to as "leveraged ESOPs," stock is “vested” to employees over a maximum of seven years, significantly delaying full ownership. 

ESOPs are “qualified, defined contribution plans.”  They are "qualified" because they receive the following tax benefits: 
 

• firm contributions to the trust are tax deductible, including both principal and interest for leveraged ESOPs; 
• reduced capital gains taxes for an owner who sells to an ESOP, provided certain conditions are met.
 
ESOPs are "defined contribution plans" because the employer makes a one-time or multi-year contribution to employees (depending if the ESOP is leveraged or not) that accumulates to produce a benefit of unknown value at the time of retirement.  This is in contrast to many pension plans in which employees receive a guaranteed specified benefit amount in retirement. 

ESOPs can vary tremendously: they can buy large or small percentages of the firm’s stock; all or only a portion of employees may participate; and employees can have extensive or minimal voting rights and extensive or minimal involvement in the management of the firm.  All of these variables make it extremely difficult to treat ESOPs as one homogeneous ownership "structure."