Stock Market Reactions to First-Time Employee Stock Ownership Plan Adoptions
Cresson, John E., Academy of Accounting and Financial Studies Journal
This study analyzes the stockholders' wealth effects of firms that are associated with the establishment of first-time ESOPs. Changes in motivation, tax liabilities, and the probability of a takeover may explain these wealth effects. Previous studies that address the effects to stockholders of firms that establish ESOPs have led researchers to contradictory conclusions. This study differs from previous papers in a number of ways. The sample of firms is collected from the Dow Jones News Retrieval Service database. Since the date and the time of each announcement are known, a one-day event window is analyzed. This leads to more powerful tests. Also, firms that announce the expansion of an existing ESOP or the establishment of an additional ESOP are not included in my sample. Only first-time ESOP announcements are analyzed. I find that stockholders earn positive and significant abnormal returns on the event day. However, there are significant, negative abnormal returns several days following the event day. Most of the negative returns are explained by other significant announcements. I find a positive, significant relationship between abnormal returns and ESOP ownership. Also, firms with takeover pressures within a year prior to the ESOP announcement earn negative abnormal returns.
In the early 1970s, the United States Congress passed legislation to alleviate the economic distress of slow productivity growth and eliminate the existing dense concentration of corporate stock ownership. With the passage of the Employee Retirement Income Security Act (ERISA) of 1974, a plan was created that allows employees to become owners of their firms through Employee Stock Ownership Plans (ESOPs). Since then, the number of firms adopting ESOPs has grown rapidly. Pugh, Jahera, and Oswald (2005) note that ESOPs have been popular in the United States since the late 1980s. Possible reasons for this influx of ESOPs include income tax shields, incentive alignment, hostile takeover deterrence, capital acquisition, and pension plan replacement. In this paper, I study the shareholder wealth effects associated with the announcement of first-time ESOP adoptions.
Previous studies of firms adopting ESOPs document conflicting evidence. (Pugh, Jahera-Oswald (2005), Park-Song (1995), and Chaplinsky-Niehaus (1994) also note that prior research on ESOPs has produced inconsistent results.) The United States General Accounting Office analyzes firms that establish ESOPs and concludes that ESOPs broaden stock ownership and provide an alternative means to finance capital growth. However, their evidence is not consistent with improved productivity by the sponsoring firms or high degrees of employee control over or participation in corporate management. Ducy, Iqbal, and Akhigbe (1997) do not find that a firm experiences improved performance after the establishment of an ESOP. Park and Song, however, find that a firm's performance significantly increases after establishing or expanding an ESOP. Iqbal and Hamid (2001) note that employee ownership by itself may not lead to an improvement in firm performance. They argue that ownership has value when there are significant stock price changes. Chang (1990), Muhtaseb and Philippatos (1990), and Gordon and Pound (1990) analyze the wealth effects on firms that establish or expand ESOPs. Chang, and Muhtaseb and Philippatos find significant increases in stockholder wealth, while Gordon and Pound find no significant change in stockholder wealth. For firms subject to takeover pressures, Gordon and Pound (1990) and Chang (1990) find significant negative effects on share prices while Muhtaseb and Philippatos (1990) and Chaplinsky and Niehaus (1994) find insignificant effects.
This study differs from previous papers in a couple of ways. First, I collect my sample from the Dow Jones News Retrieval Service database. Since the date and the time of each announcement are known, a one-day event window is analyzed. …