THE ESOP EFFECT

WHAT CAN HAPPEN WHEN EMPLOYEES ARE ALSO SHAREHOLDERS

Ask any business leader about the strength of his or her company, and you will hear about sales, costs and investments. Ask Paul Purcell (BBA '69), and you will also hear about mailroom workers. During a talk at Notre Dame, Purcell described how one mailroom worker in his Milwaukee office stopped him in the hall to say, "Paul, I checked my financial statement last night — I see we had a great month! Thank you!"

Purcell has many stories like this one. They feature employees at every level at Baird, the financial services firm where he serves as chairman. He speaks about drivers and administrative assistants, investment managers and executives who are all thoroughly engaged and committed to the company's success. Baird's employees have even caught the attention of Fortune magazine. It ranks Baird No. 16 on its list of the "Best Companies to Work For," and it has included the company for 16 years running.

What makes Purcell's people so special? He says the answer is simple: They're shareholders. "People behave differently when they're owners," he explains. "It empowers people — and life is about empowering people."

Baird is just one of many companies that have used employee ownership as a way to buck troublesome trends such as lackluster employee engagement, low wage growth and ballooning income inequality. For these firms, employee ownership is not just a way to sustain a competitive edge; it is a way to contribute more to employees, communities and society at the same time.

Baird's journey toward employee ownership was not easy or obvious. When Paul Purcell joined the company in the mid-1990s, it had been owned for many years by Northwestern Mutual. Having seen his previous firm, Kidder, Peabody & Co., fail after it was sold to General Electric, Purcell was adamant about "being in control of our own destiny."

He began to take steps as soon as he could to buy back the company's stock. He led an initial stock purchase in 1998 to make the company 36% employee-owned. That number rose to 44% in 2001. Finally, in 2004, after what Purcell describes as an "intense" negotiation, Baird entered into an agreement to buy back an additional 50% of its stock. "This will be an enormous advantage in attracting and retaining the very best people," Purcell announced to his employees, "and it is an important aspect of providing a great place to work — the best place to work."

In just four short years, the financial crisis of 2008 hit, and Purcell's claims faced the ultimate test. Baird's competitors around the globe began to fire employees — sometimes thousands in a single week. "I've never seen anything like it," Purcell says. But Baird, thanks in part to its ability to control its own destiny, could make a different decision. "My mantra in the downturn was, ‘Don't break the trust,'" Purcell says. Baird committed not to fire employees during the crisis, and it managed to remain profitable as a whole. It even began to hire talented individuals who had been let go from competitors. The financial crisis became a recruitment opportunity.

Baird's success story is inspiring. But can it be replicated?

Recent research suggests that, in general, employee-owned firms do have a competitive advantage. A recent meta-analysis combined 102 separate studies of employee ownership, which enabled researchers to examine the performance of 56,984 different firms. The researchers found a statistically significant relationship between employee ownership and overall firm performance.

Another study looked at the ownership advantage differently. It created pairs, matching companies that have widely utilized employee stock ownership plans (ESOPs) with companies of the same size in the same industry that do not have ESOPs. The study found that on average ESOP firms outperform non-ESOP firms in areas such as sales growth and sales per worker. Perhaps most striking: A greater number of ESOP firms completed the study because more non-ESOP firms had gone out of business.

Emerging from recent research is a clearer picture of the effect that employee ownership has on the employees themselves. Researchers at the Institute for the Study of Employee Ownership and Profit Sharing at Rutgers University recently surveyed 40,000 employees at 14 different firms. The firms all had profit-sharing or employee ownership programs, but they had little else in common. Some were large multinationals while others were small factories; some were in the service industry while others were in technology or financial services.

To get the most fine-grained picture possible, the researchers assigned each employee what they called a "shared capitalism" score based on each individual's level of participation in his or her company's available employee ownership or profit-sharing programs. The researchers found that employees with higher shared capitalism scores tended to be more loyal. They were also more likely to take pride in working for their firm and were more willing to work hard and make suggestions to improve the firm's performance. In other words, Paul Purcell is right: People really do behave differently when they are owners.

Employee ownership may have its most profound impact on those who are most in need. In April of 2019, a study appeared that examines the effect employee ownership has on low- and moderate-income employees — the first-ever national study of its kind. It revealed that low- and moderate-income workers at ESOP companies have a median ESOP retirement account value of $165,000 whereas the typical American household has just $17,000 in savings. The study also found that ESOPs can improve overall pay equality. Pay gaps — between women and men and between white and non-white workers — still exist in employee-owned firms, but they are significantly narrower than in firms without employee ownership programs.

CAPITALISM IN CRISIS?

"Capitalism, as we know it, is dead," wrote Salesforce co-CEO Marc Benioff in a recent New York Times oped. Benioff is not alone in his opinion. Many Americans no longer see capitalism as a source of promise and prosperity. Instead, many experience chronic worry over losing their job or being laid off, and most have seen little to no wage growth in the past decade. This loss of faith is especially pronounced among younger generations: A recent Axios poll showed that Gen Z Americans, those ages 18-21, have a more positive reaction to the word "socialism" than to "capitalism."

In response to these anxieties, Benioff's co-CEO along with nearly 200 other American CEOs on the Business Roundtable recently rewrote their statement on the purpose of a corporation. Whereas their previous statement had emphasized that corporations exist to create profits for shareholders, the new statement says corporations exist to benefit "all our stakeholders," including not just shareholders but also employees, suppliers and communities.

Some have dismissed the new statement as mere "values washing." They point out that it lacks a specific commitment, structure or system of accountability. For this reason, employee ownership could be an attractive option for companies that want to realize the Business Roundtable's vision. Instead of simply stating that corporations should benefit employees, employee ownership provides a linchpin that connects more equitable outcomes for employees to the very structure, strategy and culture of the firm.

As we enter an election year, proposals to address America's economic ills have taken center stage. Candidates and pundits have discussed a sweeping array of reforms to increase wages, place worker representatives on corporate boards, institute taxes on robots and automation, and implement a universal basic income (UBI) for all Americans.

Most of these solutions to income inequality are threatened by political gridlock. But employee ownership is not. It enjoys bipartisan support and has been championed by Republicans and Democrats alike. Ronald Reagan called it "the people's capitalism" and hailed it as the "next logical step" in economic progress. Sen. Kristen Gillibrand (D-NY) has pointed out that "Employee-owned businesses have a strong track record of better pay and retirement benefits for workers and a commitment to creating local jobs." Her 2018 Main Street Employee Ownership Act, the most significant legislation on employee ownership in recent years, would make it easier for small businesses to transition to employee ownership.

OWNERS BY NATURE

"No one in the history of the world ever washed a rented car." This maxim is sometimes attributed to the economist Lawrence Summers. But the basic idea that there is something in human nature that responds to ownership is an old one. In fact, it appeared in Catholic Social Teaching at a time when horses and buggies rather than rental cars roamed the streets.

In his 1891 encyclical letter "Rerum Novarum," Pope Leo XIII wrote that "Men always work harder and more readily when they work on that which is their own." His point was that private property is "in conformity with human nature." This means that in the effort to raise ourselves or others up, ownership can serve as a foothold. But without it, we have no way to build a future, to support our loved ones or to rear the next generation.

In making this point, Leo XIII was not engaging in abstract philosophical speculation. He was responding to the threat of communism. He warned that by abolishing private property, Communism would ultimately make the poor worse off, not better.

Nevertheless, Leo XIII also rejected the winner-take-all economy he saw forming all around him. He expressed concern that "a small number of very rich men have been able to lay upon the masses of the poor a yoke little better than slavery itself." But ownership itself was not to blame. In fact, it was the solution: "The law," he wrote, "should favor ownership, and its policy should be to induce as many as possible of the people to become owners."

Later documents in Catholic Social Teaching reiterated Leo XIII's call to make more owners. Forty years after "Rerum Novarum," Pope Pius XI praised work arrangements that allow employees to "become sharers in ownership or management or participate in some fashion in the profits received." Still later, the Second Vatican Council recommended "the active sharing of all in the administration and profits of. . . enterprises" so long as it can be achieved "without doing harm to the necessary unity of management."

More recently, the U.S. Conference of Catholic Bishops (USCCB) released a statement called Economic Justice for All that endorsed profit-sharing and employee ownership, saying that these mechanisms "can enhance productivity, increase the profitability of firms, provide greater job security and work satisfaction for employees and reduce adversarial relations." Through its anti-poverty program, the USCCB even provides grants that help workers to found 100% employee-owned companies, or worker cooperatives.

When it comes to employee ownership, Catholic Social Teaching provides principles, ideals and recommendations. Most encyclical letters and other documents stop short of mandating one particular structure or model of employee ownership, and with good reason. As Pope Paul VI once put it, the church is an "expert in humanity." The strategic and tactical requirements needed to put this vision into practice are where the business community comes in.

OVERLOOKING OWNERSHIP

"If employee ownership is so great, why aren't there more employee-owned businesses?" Jessica Rose (MBA '14) says this question is often on her mind. Rose, who won Mendoza's Alumni Award in 2018, serves as CFO and director of employee ownership programs at a nonprofit called the Democracy Collaborative. It is her job to help people who are interested in employee ownership to start businesses or make the switch from traditional forms of ownership.

Rose takes employee ownership personally. Her path to her current work began with her own experience living on the economic margins. After dropping out of high school at age 16, Rose spent several years in low-income housing. This experience showed her that "far worse than any of the physical manifestations of poverty are the psychological manifestations — what you begin to believe about yourself when you are poor, what you begin to believe about your value as a human being." This loss of dignity, Rose says, is "the biggest threat to our democratic institutions, to our communities, and to our society."

While working in the service industry, Rose obtained her GED and eventually a degree from a liberal arts college. "I can remember sitting at graduation and looking around at my peers," she recalls. "I thought, ‘I don't think there are a lot of people who have had the experience that I had and now have the chance for a better life and to do something impactful.'" It was at this moment that she felt the call to use her education to promote economic equality, a decision that set her on a path first toward teaching, then political organizing, and eventually to Notre Dame for her MBA.

Rose says she has discovered that a simple lack of awareness is the main obstacle that keeps business owners from considering employee ownership. Lately, she spends much of her time working with business owners who are looking to sell their businesses. "Often the sale to employees is an attractive option for business owners," she says. "It is an opportunity not only to get fair market value for your business but also to reward the people who helped you succeed and cement your legacy."

With millions of baby boomer business owners planning to sell or liquidate their businesses in the next two decades as part of the "silver tsunami," Rose sees an unprecedented opportunity to create millions of new employee-owners.

Another reason there are not more employee-owned businesses, Rose says, is a misperception about what employee-owned businesses are like. "When people hear a term like ‘cooperative,'" Rose says, "they picture something small with hippies and the smell of patchouli — cute, maybe, but not anything they, as serious business people, would want to consider."

But Rose has seen first-hand that there is nothing inherently quaint about cooperatives or other employee-owned businesses. She speaks about her recent visit to Mondragon Corporation, a federation of worker cooperatives in the Basque region of Spain. The first Mondragon cooperative was founded in 1956 by a priest, José María Arizmendiarrieta, based on the principles of Catholic Social Teaching. Rose found Mondragon workers using high tech tools to build European railway systems and advanced industrial equipment for factories. Today, Mondragon operates 257 companies on five continents, employing 74,000 people and earning revenues in excess of 12 billion euros (more than $13 billion) per year.

Some large, successful employee-owned businesses are even closer to home for many. "Every day, people shop at employee-owned businesses and don't even realize what they're doing," Rose points out. For example, Publix Super Markets, the largest majority employee-owned company in the U.S., employs 200,000 people and ranks No. 12 on Fortune's list of the "Best Companies to Work For." For some of us, employee-owned businesses appear in our lives when we stop for gas (Wawa), bake (King Arthur Flour) or turn on the lights (GrayBar Electric), whether we know it or not.

OWNING THE FUTURE

It may be an old idea that taps into something deep in human nature, but employee ownership is not about turning back the clock. In fact, as employee ownership encounters the new challenges of the 21st century, it is being forced to adapt and reinvent itself in surprising ways. A major challenge for employee ownership today is that millions of working Americans are no longer technically employees. Instead, many work as freelancers or contractors for "platforms" such as Uber, Lyft, Postmates, Instacart, DoorDash and Grubhub in what's being called the "gig economy." In these organizations, workers tend to be even less involved and committed than in traditional organizations. A few startups are attempting to build an employee-owned alternative to the gig economy business model. Denver-based Green Taxi Cooperative, for example, is a fledgling company built around a digital ride-hailing platform like that used by Lyft and Uber, but its employees own and control the platform they use.

Another issue for employee-owned companies is the challenge of scale. In our era, the biggest businesses are bigger than ever and still growing rapidly. Apple recently became the world's first trillion-dollar company and was quickly followed by Amazon and Microsoft. Many of America's largest businesses face constant pressure from shareholders to grow, acquire and merge. But employee-owned businesses do not encounter the same pressures. They tend to stay more rooted and grow more slowly. While this can be a good thing for employees, families and communities, it can also put some employee-owned companies at a competitive disadvantage.

Will employee-owned companies find new ways to grow in the 21st century? Some experiments are underway that spread employee ownership through a franchise model while others look to impact investing as a way to scale employee ownership.

Employee ownership has always come in a variety of packages, and it may have the best effect on the economy if it continues to diversify. As Oxford
University professor and employee ownership expert Jonathan Michie points out, a diversity of ownership models works like biodiversity in a healthy ecosystem, making the overall economy more robust and resilient and less vulnerable to recessions.

As powerful as employee ownership can be, it is not a shortcut or a silver bullet. For traditional businesses, implementing employee ownership can be expensive and time-intensive and should not be attempted if the business is not in good financial health. And, of course, in order for them to have any positive effect at all, employee-owned firms still have to be successful in the marketplace like any other business. Employee ownership alone cannot substitute for the hard work of building a culture, having great leadership and providing great products and services.

That is one reason why Jessica Rose believes the fate of employee ownership may rest on the shoulders of today's business students. In order for employee-owned businesses to thrive, they need to attract people with business training and acumen. Business people, Rose says, are "trained to be entrepreneurial, to be innovative, to solve organizational problems, to meet market problems with creativity." It will take this kind of thinking to grow employee-owned businesses, manage them and make them competitive in the rapidly changing global marketplace.

While there is much we do not know about the future of the economy, we do know, as Herman Miller President Max de Pree famously said, "We cannot become what we need to be by remaining what we are." What few people realize is that de Pree was talking about the "merging of employees and owners" when he made this statement. As he explained, "The capitalist system cannot avoid being better off by having more employees who act as if they own the place."

Illustrations by Mark Smith

EMPLOYEE OWNERSHIP COMES IN MANY PACKAGES

Employee Stock Ownership Plans (ESOPs) allow employees to accrue shares over time, usually as part of a retirement plan. This is the most common type of employee ownership in the United States, with approximately 14 million participants.

Equity Compensation Plans include ownership in an employee's pay. Common forms include stock options, restricted stock, and performance shares. As of 2014, 7.2% of private sector employees held stock options.

Worker Cooperatives (Co-ops) are 100% owned by employees. Employees also usually participate in governance, either by voting or electing representatives. As of 2017, there were 394 worker cooperatives in the United States.

Platform Cooperatives utilize an online digital platform that is owned and controlled by workers.

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BRETT BEASLEY

Brett Beasley is the associate director of the Notre Dame Deloitte Center for Ethical Leadership.