Employee stock ownership plans, or ESOPs, are tax-favored retirement plans that are required by statute to invest primarily in the stock of the company that sponsors the plan. Over 10,000 companies now sponsor ESOPs, resulting in nearly 13 million ESOP participants and over $900 billion in ESOP-held assets.
The most frequent argument against ESOPs is that they leave employees excessively dependent on the performance of a single company. This argument is intuitive and compelling. A rational independent investor who owned the same assets as those held in the account of an average ESOP participant would almost certainly diversify that investment.
Critics add that ESOP participants have an even more compelling reason to seek diversification because it is not only the value of their retirement assets that depend on the success of the employer, but their paychecks and other benefits as well. ESOPs are detrimental, they argue, because ESOP participants are even more dependent on a single company than our hypothetical concerned investor.
A simple mental experiment, however, shows that diversification cannot be the only factor in making a rational choice between two portfolios. Let’s assume that portfolio A is 50% diversified and portfolio B is 100% diversified. If their current worth is the same then portfolio B is the obvious choice. But what if portfolio A is worth twice as much? Since the diversified portion of portfolio A is worth the same as the entire value of portfolio B, the only rational choice for the investor is portfolio A.
Even more important, however, the analogy of the rational investor is fundamentally misleading in deciding about the merits of ESOPs from the perspective of plan participants. Unlike the investor, an employee’s choice is not how to allocate a fixed dollar value of assets. The employee needs to decide where to work, so a more accurate question from the employee’s perspective is whether working for an ESOP company is better or worse than working for a comparable company, presumably without an ESOP.
Answering this question is far more complex and fact-based than the simple answer suggested by the guideline to seek maximum diversification. It requires us to look at the entire package of benefits offered by different companies. Specifically, we will rely on the data presented here to determine answers to the following questions that define whether an ESOP company is a better or worse choice for a prospective employee:
- How many retirement plans does the company have?
- What is the value of the assets held by employees?
- Where do those assets come from?
- How concentrated in employer stock are those assets?
- What happens when plans terminate?
- How do plans affect different groups of employees?
This paper summarizes research by the National Center for Employee Ownership (NCEO) that attempts to answer these questions. Although the data has some inherent limitations, the results suggest that employees in ESOP companies are significantly better off than employees at comparable non-ESOP companies. Before exploring the six questions, we discuss the methods used in this analysis.
About the Study
This paper reviews data the NCEO collected on defined contribution retirement plans from the Department of Labor Form 5500. Unlike prior research, the study carefully compiled data from multiple plans within a single company and used multiple years of data for each plan.
NCEO collected data from all companies with ESOPs for the most recent filing year available at the start of this project (2007 or 2006, depending on the company) and two prior years, where available. The 3,976 ESOP companies in this study, which represent all companies for which Form 5500 data is available and that meet our screening criteria, represent 38% of all ESOPs, based on the NCEO’s most recent estimate for total ESOPs. The comparison data comes from all non-ESOP companies with defined contribution plans (DC plans) that filed a Form 5500. A total of 64,165 companies are in the comparison group.
The Employee Ownership Foundation commissioned the project and the NCEO carried it out. The source data is information collected by the Department of Labor and distributed by Judy Diamond Associates. The NCEO consulted with two trustees of the Employee Ownership Foundation: Hugh Reynolds (Crowe Horwath) and Rob Edwards (Steiker, Fischer, Edwards & Greenapple, P. C.). NCEO developed a procedure to select the data, screen out inappropriate information, match data from separate plans for companies with more than one plan, and match data from comparable non-ESOP companies to the ESOP data.
The value of retirement plans per participant depends heavily on industry, the age of the plan, and the number of participants in the plan. This analysis examines differences between ESOP and non-ESOP DC plans controlling for differences on these three dimensions.
The design of the study imposes several limits on the data, which are discussed in more detail in the final section of this report. Two limitations bear highlighting:
- Data are not available from companies without retirement plans. Companies that do not offer any DC plans are not part of this project because they do not have to file DOL Form 5500. Currently in the United States, a majority of companies do not offer any retirement plans, so this is a major limitation. In this study, we can compare ESOPs only with companies that have non-ESOP DC plans.
- Combining data from multiple plans is approximate and underestimates assets and contributions in ESOP companies. One goal of this project is to estimate contributions and accumulated assets combined from multiple plans within a single company. The NCEO decided to use an extremely conservative approach. When the number of participants in the two plans differs by more than 5%, the NCEO ignored the second plan and use contribution and asset numbers from the first plan only. Where the number of participants in a second plan is within 5% of the number in the first plan, the NCEO made the simplifying assumption that the set of participants in each plan is the same. While this is true in the great majority of cases, there are exceptions, and all tables in this article that refer to data combining multiple plans should be seen as estimates.
Combining plans by this method substantially underestimates assets and contributions in companies with more than one plan, since contributions and assets in a second plan are excluded in all companies where the participant count is different by more than 5% in the two plans. Fewer than 5% of companies with non-ESOP DC plans have a second plan, so this limitation is not significant for them. More than half of ESOP companies, however, do have second DC plans, so this limitation is quite material in their case. In fact, only 31% of ESOP companies with multiple plans passed the 5% criteria. Where this report refers to combined-plan contributions or combined-plan assets, the conservative design means that the majority of second plans in ESOP companies are excluded.
How Many Plans Do ESOP Participants Have?
ESOP participants have, by definition, at least one DC plan: the ESOP. More than half of them (56%) have a second DC plan, likely a 401(k) plan. In comparison, the Bureau of Labor statistics reports that 47% of companies overall have a DC plan.
Table 1: Plan Prevalence
ESOP companies generally had established vehicles for retirement benefits and later added their ESOPs. The arguments against ESOPs are most compelling in companies where the ESOP is the only retirement plan, so we examined plan ages and plan establishment dates.
ESOPs tend to be more recently established than DC plans in the average non-ESOP company. The median age of an ESOP is 11 years, versus 13 years for non-ESOP DC plans. Table 2 shows the distribution of ESOP and non-ESOP DC plans by age.
Table 2: Age of ESOP and DC Plans in Non-ESOP Companies
Similarly, within a company with multiple DC plans, the ESOP is more likely to be the newer plan. As table 3 shows, for 65% of ESOP companies with two DC plans, the ESOP plan was adopted later than the other DC plan.
Table 3: Timing of Plan Adoption
What is the Value of Accumulated Assets?
Bearing in mind that our conservative method underestimates the combined value of multiple DC plans inside a single company, we estimate that the average ESOP participant in the average ESOP company has $55,836 in combined DC plans, compared with $50,525 for participants in non-ESOP companies with at least one DC plan. In other words, the average ESOP participant has somewhat more DC plan assets than the average DC plan participant, wrapping together both company and employee contributions and combining, whenever possible, multiple DC plans at each company. This relatively small difference grows when we control for company size, industry and age of plan, suggesting that net plan assets per participant are approximately 20% higher in ESOP companies than in similar companies with non-ESOP DC plans.
While the structure of this data only allows comparisons between ESOPs and companies with non-ESOP DC plans, the relevant comparison is between ESOP companies and all non-ESOP companies, including those without any DC plan at all. This data cannot make that comparison, but it is consistent with findings from other studies. Peter Kardas, Jim Keough and Adria Scharf, for example, found that ESOP participants had approximately 2.5 times the assets of employees in non-ESOP companies (excluding personal assets such as houses, cars, and IRAs).
Where Do Plan Assets Come From?
The average ESOP company contributed $4,443 per active participant to its ESOP in the most recently available year. In comparison, the average non-ESOP company with a DC plan contributed $2,533 per active participant to their primary plan that year. In other words, on average ESOP companies contributed 75% more per participant to their ESOPs than other companies contributed to their primary DC plan.
Controlling for plan age, number of employees, and type of business increases the ESOP advantage to 90% to 110% above the non-ESOP companies in our sample. Not surprisingly, ESOP companies have much lower average contributions by employees than non-ESOP companies ($384 versus $2,848), and only 13% of ESOP companies report any employee contributions at all. See table 4.
Table 4: Contributions to Plans
While not included in this report, data for prior years are similar.
The value of the assets contributed by the company to all DC plans in ESOP companies is substantially higher than the value in non-ESOP companies. We estimate that the average ESOP participant has company-sourced DC-plan assets that are more than twice as much as participants in companies with non-ESOP DC plans. Even with the conservative assumptions in this study, we find that the average ESOP participant in the average ESOP company has company-sourced DC assets worth 2.22 to 2.29 times as much as the assets held by the average participant in the average company with a non-ESOP DC plan.
This ESOP difference is necessarily an estimate that depends on two assumptions. First, as noted, the data do not allow us to calculate the actual value of the assets per participant in combined DC plans. Second is our estimate for the portion of accumulated plan assets originally contributed by the company. The data do show how much of each year’s contributions are from the company and how much are from employees and this number is stable. We believe it provides a reasonable basis to extrapolate how much of the accumulated assets in the average employee’s account was originally a company contribution.
These data do not show participant assets held outside the company. Because ESOP participants contribute far fewer dollars to their ESOP than 401(k) plan participants, they have more take-home pay available, and some portion of that additional pay is used for asset-building activities (such as mortgages) or to avoid debts (such as college loans).
How Concentrated in Company Stock Are ESOP Participants?
ESOPs are required by law to be primarily invested in company stock. In practice this means 50% of more of its assets should be stock, although the amount can be less for a limited time. Still, ESOPs do hold assets other than company stock. They often hold cash for various purposes, and federal law requires that participants meeting certain eligibility requirements be allowed to diversify a portion of their accounts into other assets.
Table 5 indicates that the percentage of company stock relative to total ESOP assets is stable at 84%. Not surprisingly, very little of the assets in the first DC plan in the non-ESOP companies is in the form of company stock. Typically the only non-ESOP DC plan that hold company stock in a publicly traded company, and few of them are included in this sample.
Table 5: Company Stock as a Percent of Total First-Plan Assets
What Happens When Plans Terminate?
What happens when companies terminate their ESOPs? This would seem to be the area where the critics of ESOPs are on their strongest ground, with ESOP participants facing risk to their retirement assets and their jobs simultaneously. Clearly in some circumstances the critics are correct: employees at United Airlines, for example, negotiated for shares and ended up making approximately $90 of wage and benefit concessions per share they received. When the ESOP trustee eventually sold those shares, they were worth less than $1.00, followed soon after by a loss of compensation during United Airlines’ bankruptcy restructuring. United’s defined benefit plan, of course, also provided lower benefits than promised. Financial troubles do not affect ESOPs alone among retirement plans.
As often seems to be the case with ESOPs, the typical case is far different from the headline story. United’s example is atypical, not only because most ESOP participants did not give up wages or benefits in exchange for their ESOP, but also because the termination of an ESOP is usually a good thing for employees in financial terms.
Other research the NCEO has performed suggests that the most common reason companies terminate ESOPs is that they receive an offer to buy the company at a substantial premium over their current stock price.
To explore which pattern better fits ESOP companies that terminate their plans, we looked at the 90 companies whose Form 5500 indicated that they had filed a notice to terminate their ESOPs. We compared the total plan assets for the year they filed notice to the prior year to see how those assets changed. On average, the value of plan assets was slightly higher (2.5%) in the year of termination than the prior year. Compared with two years prior to termination, the total value of plan assets was 19% higher. These averages incorporate companies where the stock was worth less in the year of termination as well as companies where it was worth quite a bit more. Over two years, 36% of companies terminating their plans showed a decline in total assets of 10% or more, while 44% saw an increase of 10% or more.
How Do ESOPs and Other DC Plans Affect Different Employee Groups?
The data from the Department of Labor has no information about the impact of DC plans of different types of employees. All we know is the number of participants, the size of total contributions, and accumulated assets.
However, ESOPs by design allocate a greater portion of their benefit to lower-paid employees than do other DC plans. Since no employee contribution is required, a higher percentage of the work force benefits. Among active participants, benefits are less skewed as well, since in 401(k) plans the higher paid participants tend to contribute most.
ESOPs are required by law to allow diversification to all plan participants after they reach age 55 and have 10 years of plan participation. As table 5 shows, company stock is 84% of the assets in an average ESOP, but the percentage is certainly lower among participants over age 55. Ongoing research by the NCEO shows that use of the diversification provision varies widely from company to company. Fifteen percent of companies responding to a survey report that none of those eligible for diversification actually diversified their accounts, and 20% say that over 75% did.
In sum, a person making a decision about which of two jobs to take is, on average, better off choosing to work for a company with an ESOP. Even using extremely conservative estimates, ESOP participants have more plans, more assets in company-sponsored plans, and use less of their own assets.
Methodology
The NCEO purchased access to the Judy Diamond King of Pension Funds data, which is an electronically accessible version of the data collected on Form 5500 for the Department of Labor. On lines 8a and 8b of form 5500 companies indicate which of several codes from a list applies to them. We included companies that use at least one of the following codes:
2O (ESOP other than a leveraged ESOP)
2P (Leveraged ESOP – An ESOP that acquires employer securities with borrowed money or other debt-financing techniques)
2Q (The employer maintaining this ESOP is an S corporation)
We excluded companies with zero active participants and companies with zero employer securities in their plans. The NCEO reviewed the data exhaustively, both by summary statistics and on a record-by-record basis. We combined multiple years for the same plan at the same company into a single record.
We queried the Judy Diamond data to find additional non-ESOP DC plans at the companies in the ESOP database. We quality-tested those records and corrected obvious mistakes or eliminated records with obviously flawed data that we could not correct. We eliminated multiple DC plans and matched the non-ESOP DC plans with the ESOP companies in the database.
We again queried the Judy Diamond data to find the comparison companies that have non-ESOP DC plans. The query used the following criteria:
- Not a company with an EIN (employer identification number) matching one of the EINs in the ESOP database
- Plans with at least one active participant
- A plan-type code that matches a non-ESOP DC plan
- No plan-type codes that match DB plans
- Only companies that have NAICS codes that are on the list of ESOP company NAICS codes.
We quality-checked the data and repaired as needed, ending up with 659,000 records. We re-arranged the data to put multiple years for a single plan into a single record, and then re-arranged to put a second plan for a single company into the company’s main record.
We compared ESOP and non-ESOP companies globally and within categories. We defined three types of categories. Industry categories were based on two-digit NAICS codes. We divided companies into seven categories based on size of work force. Finally, we broke companies into 23 categories based on the number of years since their plan was established.
Based on numbers of companies and irregularities in the data, we screened out companies with 20 or fewer employees and companies with over 1000 employees. In the end, we had 3,976 ESOP companies and 64,165 companies with other DC plans.
This study does not attempt to value or even track the incidence of defined benefit (DB) plans among ESOP and non-ESOP companies. EBRI reports that 24.5% of households have a participant in a DB plan, although these are much more prevalent in public sector than private sector companies.
The quality of this data from form 5500 has improved markedly over the last years. The NCEO screened the data in multiple ways, often redundant, to further improve the quality of the data. However, it is likely that some data entry errors remain, both on the part of the people originally completing the forms and in the transfer of the data from a physical form to a database.
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