The Labour Divide
V. Employee Benefits and Ownership
Also published by United Press International (UPI)
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Aligning the interests of management and shareholders in the West by issuing stock options to the former - has failed miserably. Options are frequently re-priced in line with the decline in share prices, thus denuding them of their main incentive. In other cases, fast eroding stock options motivated managers to manipulate the price of the underlying stock through various illegal and borderline practices. Stock options now constitute c. 60 percent of the pay of Fortune 500 executives.
Whitney Tilson of Tilson Capital Partners notes in "The Motley Fool" that the hidden dilution of corporate equity caused by stock options inflates the stated profit per share. In the USA, stock options are not treated as a business expense. Payment of the strike price by employees exercising their options augments cash flow from financing activities. Companies also get to deduct from their taxable income the difference between the strike price of the options and the market price of the stocks. As a result, overall earnings figures are exaggerated, sometimes grossly.
"The Economist" quotes studies by Bear Stearns, the Federal Reserve, and independent economists, such as the British anti-stock-options crusader, Andrew Smith.
These show that earnings per share may have been inflated by as much as 9 percent in 2000, that options amounted to c. 20 percent of the profits of big American firms (and three quarters of the profits of dot.coms), and that the distorted tax treatment of options overstated earnings growth by 2.5 percent annually between 1995 and 2000.
The Federal Reserve concludes:
"... There is presently no theoretical or empirical consensus on how stock options affect ... firm performance."
Towers Perrin, a leading global management consultancy, spot a trend.
"(There is) a move by employees towards placing greater emphasis on long-term incentive plans ... (This is) creating new international currencies in remuneration ... (There is) a rapid, worldwide growth in stock option plans ... Regardless of the type of company, stock options are much more widely used than performance plans, restricted stock plans, and other long-term incentive (LTI) programs in most countries."
Stock options are now used not only to reward employees - but also as retention tools, building up long term loyalty of employees to their workplace. Multinationals the world over, in an effort to counter competitive pressures exerted by their US adversaries in the global labour market, have resorted to employee stock options plans (ESOP).
Vesting periods and grant terms as well as the events which affect the conditions of ESOPs - in short, the exact structure and design of each plan - are usually determined by local laws and regulations as well as by the prevailing tax regime. As opposed to popular mythology, in almost all countries, options are granted at market price (i.e., fair market value) and subject to certain performance criteria ("hurdles").
Eligibility is mostly automatic and determined either by the employee's position or by his reporting level within the organization. Management in most countries was recently stripped of its discretionary powers to allocate options to employees - the inevitable outcome of widespread abuses.
Ed Burmeister of Baker McKenzie delineates two interlocking trends in the bulletin "Global Labour, Employment, and Employee Benefits":
"Two common trends are the broad-based, worldwide option grant, such as recently implemented at such companies as PepsiCo, Bristol-Myers, Squibb, Merck, and Eli Lilly & Company, and the extension of more traditional executive stock plans or rank-and-file, payroll-based stock purchase plans to employees of overseas subsidiaries. Employers are also beginning to implement stock-based incentive plans through use of offshore trusts.
These trends have led to increased scrutiny of equity-based compensation by overseas taxing and regulatory bodies. Certain trends, such as the relaxation of exchange and currency controls in Europe and South America, have favored the extension of U.S.-based equity compensation plans to overseas employees."
Granting stock options is only one of the ways to motivate an employee. Some companies award their workers with stocks, rather than options, a practice known as "non-restrictive stock bonus". Others dispense "phantom stocks" or "simulated equity plans" - using units of measurement and accounting whose value corresponds to the price fluctuations of a given number of shares. Yet others allow their employees to purchase company shares at a discount (section 423 stock purchase plans).
David Binns, Associate Director of the Foundation for Enterprise Development describes novel solutions to the intricate problem of customizing a global stock options and equity plan:
"Often the companies provide international staff with a 24-hour loan facility whereby they can direct a designated stock broker in the U.S. to give them a loan sufficient to exercise their options. The broker then immediately sells enough shares to pay off the loan and transaction fees and deposits the remaining shares in the employee's account."
"Another approach to international equity plans is to create an 'International ESOP' in a tax-free haven. Each of the company's international subsidiaries are given an account within the trust and each participating employee has an individual account with the appropriate subsidiary. The subsidiary corporations then either purchase shares of the parent corporation based on profitability or receive grants of stock from the parent and those shares are allocated to the accounts of the participating employees. The shares are held in a trust for the employees; at termination of service, the ESOP trustee sells the employee's shares and makes a distribution of the proceeds to the employee. This has the advantage of alleviating securities registration concerns in most countries as well as avoiding certain country regulations associated with the ownership of shares in foreign corporations."
As far back as 1997, virtually all American, Canadian, and British companies offered one kind of LTI plan, or another. According to the Foundation for Enterprise Development, employees own significant blocks of shares - aggregately valued at more than $300-400 billion - in more than 15,000 American corporations. This amounts to 5-7 percent of the market capitalization of American firms. The process was facilitated by the confluence of divestiture, corporate downsizing, and privatization of state and federal assets.
Dramatic increases have occurred elsewhere as well. In Argentina - 40 percent of all firms offered LTI last year (compared to 20 percent in 1997). In Belgium, the swing was even more impressive - from 25 percent to 75 percent.
Hong Kong went from 25 percent to 50 percent. China - from 5 percent to 45 percent. Germany tripled from 20 to 60 percent. Italy jumped from 20 to half of all companies. Spain galloped from 5 to 50 percent. Even staid Switzerland went from 20 percent of all firms offering LTI - to 60 percent.
Stock options are gaining in popularity in central Europe as well. More than 10 percent of the employees of S&T, a Vienna-based IT solutions provider, owned stock options by the end of 2000. The company operates mainly in Slovenia, Slovakia, and the Czech Republic - but is fast expanding in a host of other countries, including Bulgaria and Russia.
"Internet Securities" - a publisher of emerging market news and information based in Bratislava, Bucharest, Budapest, Prague, Sofia, and Warsaw- also rewards its employees with stock options. The list is long and is getting longer by the day.
Watson Wyatt, a human resources consultancy, conducted a detailed survey among firms in CEE (central and east Europe) in 1999. It traced the introduction of non-wage employee benefits to the fierce competition for scarce human capital among multinationals at the beginning of the 1990's. Later, as qualified and skilled personnel became more abundant, employers faced the need to retain them.
Perks such as cars, death and disability insurance, medical benefits, training, and relocation and housing loans have become the norm in the leading EU candidates - Poland, Hungary, Czech Republic, the Baltic States, and Slovenia. Such habits are spreading even as far as Kazakhstan, where most workers enjoy supplementary medical benefits. But progress is by no means uniform. In some countries, such as Croatia, supplemental coverage extends to less than one quarter of the work force.
LTI programs are offered mainly by IT and telecom companies - 63 percent of the 25 surveyed by Watson Wyatt had an ESOP in place. But, as opposed to the practice in the West, few, if any, firms in CEE limit eligibility to the upper hierarchy. Still, management enjoys more sizable benefits that non-executive employees.
Watson Wyatt note that offering enhanced retirement benefits is fast becoming a major attraction and retention technique. Where state provision of pensions is insecure or dwindling - Russia, Bulgaria, Hungary, Slovenia - close to 20 percent of all workers had supplementary retirement funds provided by their employers in 1999.
Their ranks have been since joined by other pension-reforming countries, such as Croatia and Romania. Where pension reform has stalled - e.g., Lithuania and the Czech Republic - less than 1 percent of all workers enjoyed employer retirement largesse in 1999.
There is a convergence between East and West. Privatization in post-communist CEE countries often took the form of management and employee buyouts (MEBO). Employees ended up with small stakes in their firms, now owned by the managers. This model proved popular in countries as diverse as Croatia, Macedonia, Poland, Romania, Slovakia, and Slovenia.
In Poland, more than 1000 small and medium enterprises were privatized by "liquidation" - a management cum employee lease-buyout. Leveraged ESOP's - employees purchasing company shares over many years and on credit - played a part in at least 150 major Hungarian privatization deals.
Russia has become the country with the largest employee-ownership in the world. More than two thirds of the 12,000 medium and big Russian enterprises privatized after 1992 are majority owned by employees. But MEBO also characterized privatizations in France, the UK, Nigeria, Sri Lanka, Chile, Argentina, Pakistan, and Egypt, among many others.
More than 4 percent of all Dutch firms - c. 2000 in all - are partly employee-owned. More than 12,000 French companies sold $10 billion in shares to their employees - an average of $1000 per employee. Profit sharing schemes in firms with less than 50 employees are compulsory in France. More than a quarter of the workforce - some 5 million people - are covered by 16,000 such schemes. Ten thousand other, voluntary, plans cover 2.5 million workers.
Sixty percent of all MEBO's in the former East Germany relied on public financing. The government of British Columbia in Canada is equally involved through its "Employee Share Ownership Program". Chile provided employees with subsidized loans to purchase shares in privatized firms in what was dubbed "labour capitalism". Egypt encouraged the establishment of almost 150 Employee Shareholder Associations.
Initially, MEBO resulted in gross inefficiencies as the new owners looted their own firms and maintained an insupportably high level of employment. The newly private firms suffered from under-investment and poor management. Shoddy, unwanted, products and deficient marketing led to poor sales, massive layoffs, and labour conflicts. Employees were quick to turn around and sell their privatization vouchers or shares to their managers, to speculators, or to foreign investors.
Yet, as foreign capital replaced corrupt or inapt indigenous managers and as workers became more sophisticated and less amenable to manipulation - employee ownership began to bear fruit. China has learned the lesson and has introduced a gradual transition to employee ("social") ownership of enterprises at the grassroots, local community, level. It also strives to emulate Japan's extensive and successful experience since the early 1960's.
Employee ownership is evolving in ways the fathers of socialism would have approved of. Employees throughout Asia, Africa, and Latin America - egged on by the likes of the World Bank and regional development institutions - now form numerous collectives and labour or producer cooperatives. Some firms are even owned by trade unions through their proactive pension funds.
Jacquelyn Yates describes a typical cooperative in her essay "National Practices in Employee Ownership":
"... The employees own their firms. Typically, prospective members work for a probationary period, must apply to join the cooperative and are screened by a membership committee. Labor cooperatives vary in the percentage of their employees who are members. A common guideline is to take no more members than the cooperative can guarantee to employ on a full-time basis. Members make a capital contribution in kind or in cash, sometimes through payroll withholdings. This is the member's account value, which will be refunded (with or without interest), at the time of separation from the enterprise.
Governance is usually based on one vote for each member, and the elected directors of the enterprise set overall policy and hire top management. The main benefits of membership are job security, participation in the distribution of profits, and above average social benefits. Sometimes membership means participation in enterprise losses or making additional contributions to the reserve. In some countries, the assets of the cooperative can never be distributed to its members, preventing them from realizing long-term appreciation in the cooperative's value, but creating an incentive to continue it over many years."
Yates reviews other practices, such as the labour banks and the workingmen's funds. The former are financial institutions that invest in the shares of companies that employ their depositors. Workingmen's funds are collectively owned portfolios of the employer's stock owned by employees and they were first tried in Sweden. Similarly, the UK and Ireland have legalized the employee stock ownership trust.
Employee ownership of firms is a controversial issue with strange bedfellows on both sides of the raging debate. Thus, the idea has been fiercely resisted in the past by both employers and unions. There is no social consensus regarding the voting rights of stocks owned by employees, their voluntary or compulsory nature, their tax treatment, their relationship to retirement accounts, the desired length of holding period, the role of the unions and the state, employee representation on the board of directors and so on.
It is ironic, though, that the ostensible triumph of capitalism resulted in the resurgence of employee-ownership of the means of production. It seems that to preserve industrial peace as well as to motivate one's workers - sharing of ownership and its attendant pecuniary benefits is called for, on a scale which far exceeds anything dreamt of in socialist countries.
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