Employee stock ownership plans and corporate structure

Employee Stock Ownership Plans (ESOPs) have been around for many decades. They have enjoyed an increase in popularity with the 1974 Tax Act. Financial economists have questioned the rationale behind ESOPs, due to their effect on risk sharing among employees and owners. An employee always has an employment risk, or risk of losing his or her position with the company. With an ESOP the question arises as to why employees, with their very employment at risk in their company, would seek to further increase this risk by purchasing stock in the same company. This research attempts to answer this question by testing three hypotheses. The first is that under informational asymmetry the company is using employees to signal the market of a positive change in its future prospects and gain equity capital. The second is that ESOPs are being used as an instrument, or "devil's pact" between management and labor, to gain access to excess perquisite consumption for management and employees. The third is that under the concept of employee-management incentive alignment the company may be using the ESOP to help increase productivity. Under all three scenarios the terms of the ESOP may be structured to adequately compensate employees for the adverse risk effects entailed in ESOPs.

This study finds that ESOPs that were established to help stop a hostile takeover of the company lent support to the devil's pact hypothesis. ESOPs that were formed in which the employees conceded certain benefits or wages lent support to both the market signaling and the devil's pact hypothesis. "Pure" type ESOPs in which no wage concessions were given and which were not founded for anti-takeover purposes lent support to the market signaling and the employee-management incentive alignment hypothesis.