Employee Stock Ownership Plans (ESOPs)
An ESOP is a type of retirement plan that invests primarily in company stock and holds its assets in a trust, in accounts earmarked for employees. Plan participants do not directly own the stock and are, for the most part, paid out after they leave the company. Most ESOPs are in privately held companies, not companies that trade on the stock markets.
Ownership and Control
The main benefit of employee ownership is that it gives employees the ability to benefit from the value of company stock and to benefit from increases in value.
The ESOP is governed by a trustee who must act for the exclusive benefit of participants. The company operates under the direction of management and oversight by a board of directors. Therefore, the same expectations of management and employee responsibility continue.
Creating an Ownership Culture
The assets in an ESOP, which are primarily stock of the company, are held in a trust. As the company increases in value, the stock in the ESOP, including the employees’ shares, increases in value. On the other hand, if the value of the company decreases, then the stock in the ESOP also falls in value. Therefore, the ESOP gives the employee owner an extra incentive to make the company prosper.
An employee owner has a greater stake in the company and a greater opportunity to reap the rewards of capital ownership. Being a beneficial owner of the company will give an employee greater input into their own financial benefits because the efforts of everyone working together to make the company a success will go a long way towards determining each one’s personal rewards.
With an ESOP, an employee can share in the pride of ownership. An owner employee can gain an increased sense of satisfaction in knowing that their efforts can bring them benefits beyond what they receive from their regular wages. The pride of ownership can be reflected in a number of ways. Company performance can be improved by good work habits, efficiency and conservation. As employee owners, everyone benefits from the efforts of each individual employee.
How Does It Work?
The ESOP trust receives contributions, usually annually, from the company. The amount of the contribution depends on many factors, not the least of which is the company’s profit. Employees pay no taxes on the contribution to the ESOP until the ESOP distributes to an employee his or her “vested” account balance.
The rules for participation in an ESOP are the same as for other qualified employee benefit plans. The rules provide several tests to assure plans meet minimum anti-discrimination requirements. Most ESOP companies cover employees with 1000 hours of service or more in a year who are 21 years of age or older and have at least one year of service.
For each year of eligible employment the company can make a contribution to an employee’s ESOP account. The amount contributed each year may vary. The non-forfeitable right to all or a portion of an ESOP account is subject to a process called vesting.
The value of a particular company’s stock is generally determined by its trading value, defined as the price at which the stock is sold on the stock exchange. ESOP shares in publicly traded companies are thus determined by the market price. Most ESOP companies, however, are privately owned, which means that the stock is not traded on a stock exchange. In that case, the per share value of the company stock is determined by an appraisal performed by an independent valuation firm. The stock valuation is updated annually and each ESOP participant will be informed of the stock value in his or her account.
When an ESOP participant retires or otherwise leaves the company, the value of the total ESOP benefits will be determined by the most recent valuation.
As a qualified employee benefit plan, ESOPs are regulated by the Department of Labor and the IRS according to the guidelines of the Federal Employee Retirement Income Security Act (ERISA). Reports are regularly submitted to the government to insure that the ESOP is meeting all of the regulatory requirements.