Employee Stock Ownership Plan

Employee Stock Ownership Plan is an unfamiliar concept here in Pakistan in comparison to rest of the world. It is difficult to describe this concept because in Pakistan's market this concept is almost unknown. Even in U.S, the concept of ESOP was almost unknown until 1974. But now in U.S about 11,000 companies have these plans, covering over 13 million employees (www.nceo.org).

If we have to define employee stock ownership plan or an ESOP in one line so it would be "making your employees the owner of your company". Now the question arouses that or ESOP is an employee benefit plan. It is beneficial to both, the organization and the employee. For that we have to describe how an ESOP does work? An ESOP is more or less like a profit sharing plan. First the company creates a trust, and then it makes contributions into that trust. Those contributions can be in the form of money of stocks of the company. Then those contributions are allocated to individual employees accounts within the trust. The contributions, including shares of company and other assets, allocated to employees' accounts vest over time (Rodrick, 2005).

As employees gain seniority in the company, their right to the shares in their account increases, a process known as vesting. Vesting is a process of giving employees right to possess those contributions. Vesting means to give a secured right to someone of something, present or future enjoyment. If a person has a vested right to an asset, it means that specific asset cannot be taken away by anyone, even though that person may not yet have the possession of that asset (en.wikipedia.org).

By the time of retirement or termination the employees receive vested portions of their accounts. Employees can buy stock directly or stocks can be given as a bonus. When employees leave the company, they receive their vested stock. A company must buy back those stocks from them at its fair market price. If it is a public limited company, traded in the stock market, the employee can sell the stock in the market. Private companies must hire someone from outside the company to evaluate their stocks; this process must be done at least on the annual basis. Employee ownership occurs when a company is owned by its employees, partially or in whole. Employees usually gain a share of the company after a certain length of employment (seniority) or they can buy shares at any time. A corporation owned entirely by its employees will not have its shares sold on public stock markets. Employee-owned corporations often adopt profit sharing plans where the profits of the corporation are shared with the employees. An ESOP can be used for various purposes. It can be used for to buy the shares of the owners who are leaving the firm. Owners of private companies can use ESOP to create a market for their shares (www.nceo.org).

Under this approach, the company can make contributions, which is tax-deductible, to the ESOP to buy out shares from an existing owner, or it can have the leveraged ESOP, in which it borrows money to ESOP to buy the shares. It can also be used to borrow money at a lower after-tax cost. Because of its ability to borrow money, ESOP is unique among benefit plans. The ESOP borrows money, which it uses to buy company shares. The company then makes contributions to the ESOP, which are tax-deductible, to repay the loan, covering both principal and interest is payment. An ESOP can also be used to create an additional employee benefit. A company can simply issue new shares to an ESOP and deduct their value from taxable income, Or a company can contribute in cash. Then ESOP can buy shares from existing public or private owners. Employee ownership appears to increase improve employees' dedication, sense of ownership, and productivity of employees; hence improving the production and profitability. However, there are some drawbacks of implementing ESOP. Involving more people in decision making process can lead to slow decision-making process. ESOP can also increase the employees' financial risk if the company does poorly. The most renowned and studied case of a multi-national corporation regarding ESOP is the Mondragon Cooperative Corporation. Altogether, in U.S there are almost 11,500 ESOP companies, covering over 11 million employees. Most of them are in closely held companies. The other forms of ownership generally occur in public companies, and another estimated 15 million employees participate in one or more of these plans (NCEO).

Advantages to Setting up an ESOP

There are various tax advantages of