A large component of the dramatic growth of employee stock ownership plans (ESOPs) that occurred in the United States in the 1980s is attributable to their role in mergers, acquisitions, and leveraged buyouts (LBOs). Employee stock ownership plans are involved in mergers and LBOs in two main ways: as a financing vehicle for the acquisition of companies, including through LBOs, and as an antitakeover defense. Bidders and employees discovered that they could make a bid for a firm through an ESOP and realize significant tax benefits that would help lower the cost of the buyout. For their part, targets learned that ESOPs could provide them with an effective antitakeover defense.
Employee stock ownership plans are allowable under the Employee Retirement Income Security Act of 1974 (ERISA), a law that governs the administration and structure of corporate pension plans. The Employee Retirement Income Security Act specified how corporations could utilize ESOPs to provide employee benefits. An ESOP provides a vehicle whereby the employer corporation may make tax deductible contributions of cash or stock into a trust. These trust assets are then allocated in some predetermined manner to the employee participants in the trust. The corporation's contributions to the ESOP are taxdeductible. Moreover, the employees are not taxed on the contributions they are entitled to receive until they withdraw them from the ESOP. The contributions are made in direct proportion to each plan participant's compensation. The proportion is based on the ratio of the employee's compensation divided by total compensation. Thus all employees are paid the same percentage but different absolute amounts.
Participants in an ESOP are required to invest in the employer's stock. They may buy stock in subsidiaries of the employer's corporation if the employer corporation owns more than 50% of the subsidiary's stock. Unlike pension plans, ESOPs do not try to lower the risk level of their assets by diversifying. Although pension plans seek to invest in a variety of assets to lower risk, ESOPs are designed to hold only cash, cash equivalents, or the stock of the employer corporation.
Employee stock ownership plans were very popular in the United States during the 1920s, when the stock market was rising and Americans widely owned stock. The stock market
*The author would like to express special thanks to Robert E. Massengill, vice president and prin-
cipal of Menke & Associates, Inc., for his helpful comments and advice on employee stock ownership