The Economics of ESOPs

Summary

I share Becker’s concerns with the favorable tax treatment of employee stock ownership plans. Such treatment would be justifiable only if such plans conferred benefits on society that could not be generated more cheaply by other means. Proponents of the law that authorized ESOPs and conferred favorable tax treatment on them argued that ESOPs would unlock a new source of capital‚Äînamely workers, who contribute capital to the corporations that employ them when they take part of their compensation in the form of participation in an ESOP. But there is no shortage of capital, so no justification for subsidizing investment in corporate stock. If anything, ESOPs can be criticized from an overall social-welfare standpoint as an antitakeover device that we do not need: workers are unlikely to vote for a takeover, as it might jeopardize their jobs. As Becker points out, abolishing the favorable tax treatment of ESOPs would permit a market test of this form of corporate governance. (In confining my discussion to cases of governance, I focus on situations in which, as in United Air Lines before its bankruptcy, or the proposed reorganization of the Tribune Company, the ESOP owns all or a controlling amount of the common stock of the corporation.)

I believe that it would usually flunk the market test. Granted, the ESOP has an advantage over the conventional worker-owned firm: the value of a firm’s capital stock is the discounted present value of its expected future earnings, so that a worker who owns ESOP shares has, at least in his role as part owner, the same horizon as the corporation itself, rather than the truncated horizon of the worker in a conventional worker-controlled firm (a cooperative), who cannot benefit from anything the corporation does after he retires and who consequently has no financial stake in maximizing the corporation’s present value.