The Advantages and Disadvantages of ESOP's: A Long-Range Analysis

By Block, Stanley B. | Journal of Small Business Management, January 1991 | Go to article overview

The Advantages and Disadvantages of ESOP's: A Long-Range Analysis


Block, Stanley B., Journal of Small Business Management


THE ADVANTAGES AND DISADVANTAGES OF ESOP'S: A LONG-RANGE ANALYSIS

An ESOP, or Employee Stock Ownership Plan, is a qualified retirement plan which can be used to provide employee stock ownership and, at the same time, advance a number of other objectives. While this article gives a thorough review of the financial advantages of ESOP's, it also explores their disadvantages. Because the advantages of ESOP's are so immediately obvious, it is important that management also be conversant with their hidden problems. It is reasonable to think that virtually every business in the U.S. is a potential candidate for an ESOP structuring. ESOP's currently cover over 10 million workers, and the participants range from small, privately held companies to Fortune 500 firms such as Polaroid and J. C. Penny.

The basic idea behind any ESOP is that common stock (or convertible preferred stock) is distributed to the accounts of employees and eventually passed on to them at retirement or departure from the firm (assuming vesting has taken place). ESOP's represent the ultimate approach to corporate democracy. Lewis Kelso, the founder of the modern ESOP, was quoted in the August 1987 issue of the Institutional Investor as saying, "the ESOP is treated as simply an employee benefit, but is really a device to save the human race" (Rosenberg 1987). While these words are somewhat strong, they represent the sentiments of some of the truly fervent devotees to this movement (Mathews 1989).

STRUCTURE OF ESOP'S

ESOP's may be either unleveraged or leveraged in nature. With an unleveraged ESOP, the firm merely makes periodic contributions of employer stock to the ESOP or contributes cash which, in turn, is used to purchase stock. The contributions are tax deductible, and the stock eventually passes on to the employees.

The real tax benefits flow to the second form, the leveraged ESOP. The initial step is once again to set up an ESOP (appropriately administered by a qualified trustee). However, with a leveraged ESOP, stock is not directly contributed to the ESOP. The shares are acquired by the ESOP's borrowing the necessary funds from a financial institution to purchase the stock from the sponsoring company or from key stockholders of the company. To ensure the availability of lendable funds to the ESOP, the sponsoring company normally guarantees the loan from the financial institution and, furthermore, makes tax deductible contributions to the ESOP to ensure that funds are available for the orderly amortization of principal and the payment of interest. The ESOP, upon receiving these funds, uses them to repay the financial institution. The shares acquired by the ESOP are, in turn, assigned to employee accounts and distributed to employees at an appropriate future time.

Most of the comments on ESOP's in this article will be directed to leveraged ESOP's because that is where the primary tax and other financial advantages lie. Leveraged ESOP's allow the sponsoring company to acquire cash for its shares, which can be used for capital investment or other corporate purposes. However, the leveraged ESOP may also acquire the shares from retiring owners of the business in order to facilitate estate planning and to ensure the continuity of the business. In either case, borrowed funds are utilized and repaid with pretax dollars. Further, as pointed out in the popular press, ESOP's also have been used as defensive measures against unwanted corporate takeovers, to facilitate the financing of LBOs and divestitures, and as part of corporate rescue operations (Burr 1989).

In the next section, the tax advantages of ESOP's are highlighted. Since most of these advantages are on the front-end, we will then take a hard look at the caveats and potential drawbacks that can come later.

TAX RELATED BENEFITS

The tax benefits associated with ESOP's may be broken down into three separate categories: those accruing to the corporate sponsor, those provided to original selling stockholders, and finally those available to employee participants. …

The rest of this article is only available to active members of Questia

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
One moment ...
Default project is now your active project.
Project items
Notes
Cite this article

Cited article

Style
Citations are available only to our active members.
Buy instant access to cite pages or passages in MLA 8, MLA 7, APA and Chicago citation styles.

(Einhorn, 1992, p. 25)

(Einhorn 25)

(Einhorn 25)

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Note: primary sources have slightly different requirements for citation. Please see these guidelines for more information.

Cited article

The Advantages and Disadvantages of ESOP's: A Long-Range Analysis
Settings

Settings

Typeface
Text size Smaller Larger Reset View mode
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

Help
Full screen
Items saved from this article
  • Highlights & Notes
  • Citations
Some of your highlights are legacy items.

Highlights saved before July 30, 2012 will not be displayed on their respective source pages.

You can easily re-create the highlights by opening the book page or article, selecting the text, and clicking “Highlight.”

matching results for page

    Questia reader help

    How to highlight and cite specific passages

    1. Click or tap the first word you want to select.
    2. Click or tap the last word you want to select, and you’ll see everything in between get selected.
    3. You’ll then get a menu of options like creating a highlight or a citation from that passage of text.

    OK, got it!

    Cited passage

    Style
    Citations are available only to our active members.
    Buy instant access to cite pages or passages in MLA 8, MLA 7, APA and Chicago citation styles.

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn, 1992, p. 25).

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences."1

    1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

    Cited passage

    Thanks for trying Questia!

    Please continue trying out our research tools, but please note, full functionality is available only to our active members.

    Your work will be lost once you leave this Web page.

    Buy instant access to save your work.

    Already a member? Log in now.

    Search by... Author
    Show... All Results Primary Sources Peer-reviewed

    Oops!

    An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.