They Own the Place

By Frederick Ungeheuer

In thousands of American companies large and small, the employees are starting to act as if they own the place. Well, they're entitled, because they do. Meet the new breed of hard-driving capitalist: the employee stockholder. At Oregon Steel Mills in Portland, the chairman's secretary has earned $500,000 in company stock, and a few of her colleagues have become paper millionaires. At Quad/Graphics, a Wisconsin printing company, the average five-year employee owns shares worth $250,000. In Avis car-rental offices across the U.S., employees are touting their stake in the company with lapel buttons that put a new twist on their old "We Try Harder" slogan: OWNERS TRY HARDER.

The Employee Stock Ownership Plan, or ESOP, has rapidly come of age. Ten million U.S. workers, about one-fourth of all corporate employees, are enrolled in an ESOP, up from 3 million only a decade ago. More than 9,800 companies in the U.S. offer such programs, including 1,500 in which employees own the majority of the stock. By giving workers a stake in the company's success, enthusiasts say, the programs boost morale and productivity. But the popularity of ESOPs, which were initially created in the 1950s, has been fueled in the 1980s by an unintended and somewhat controversial application: as a double-edged tool useful for both financing corporate takeovers and staving them off.

Thanks to hefty tax breaks that the Government allows for ESOPs, investors who launch a takeover can reduce their borrowing costs if they set aside part of the stock for employees. At the same time, corporations seeking to repel raiders can use an ESOP as a way to put a chunk of the company into relatively friendly hands. "Every corporate treasurer is looking at it," says Paul Mazzilli, a principal at the Morgan Stanley investment firm. In recent months, three major corporations -- J.C. Penney, Ralston Purina and Texaco -- spent a total of $1.75 billion on ESOPs to shore up their takeover defenses. Procter & Gamble announced plans in January to spend $1 billion to boost its ESOP from 14% of outstanding shares to 20%, partly to ward off raiders.

The most hotly contested use of an ESOP is at Polaroid, which has put 14% of the company's stock into employees' hands as a maneuver in its bitter six- month battle against a takeover bid by Shamrock Holdings, owned by the Roy Disney family. Because Massachusetts-based Polaroid is incorporated in Delaware, where an anti-takeover law requires that bidders must get 85% ownership of a target company to gain control, the ESOP is leaving Shamrock with almost no room to maneuver. When a Delaware court rejected Shamrock's challenge of the ESOP, Polaroid's workers "jumped up and down with joy," said Nicholas Pasquarosa, chairman of the employee committee. "We have developed loyalties here the way you do in a family." Shamrock is appealing the decision.

Pioneered in the 1950s by Louis Kelso, a San Francisco lawyer and economist, ESOPs were slow to catch on. But Kelso eventually created a fertile financial climate for his idea by enlisting the support of Russell Long, the populist Democrat from Louisiana. Before retiring from the Senate Finance Committee in 1986, Long initiated more than 20 bills to encourage creation of ESOPs.

One tax incentive allows a company sponsoring an ESOP to deduct not only the interest on the loan to buy stock for the plan but also the principal. Another tax break gives banks and other lenders a 50% deduction on their income from ESOP loans, which enables them to charge lower interest rates to companies that borrow for such programs. "These are the kinds of tax incentives that corporate owners dream of," says ESOP expert Joseph Blasi of California Polytechnic State University in San Luis Obispo.

Because Kelso's method of paying for the stock-purchase plans was to borrow against corporate assets, ESOPs also gave rise to the leveraged buyout. But Kelso never intended his technique to be used for buyouts that would put all of a company's stock in the hands of a few investors and top managers. "That is a perversion of my idea," says Kelso, now 74. "Instead of making economic power more democratic, they make it more plutocratic."

This was not the case at Avis, which in late 1987 was bought by its workers for $1.75 billion. For Avis employees, who borrowed all the money for the deal, the ESOP ended ten tumultuous years in which the company had five corporate owners. "We needed stability, once and for all," says Chairman Joe Vittoria, 53, who has worked in the industry since 1961.

In the Avis program, the company's 24 million shares are held in a trust and gradually released to employees as the debt is paid off over a 17-year period. Vittoria reserved 13% of the stock for key managers, "the 132 people I cannot afford to lose," who initially got at least 294 shares each. The other 12,300 employees were given a first-time allocation of two shares for every $1,000 in salary. Since each share is worth about $5 and the average Avis employee earns about $20,000 a year, this amounted to $200 or so. But the 1988 allocation will be seven shares, which are growing in value, per $1,000 in salary.

"Over time they'll be able to watch the value of that stock jump," says Avis Treasurer Gerald Kennell. One catch: employees must stay at least five years before they can cash their shares.

The ESOP program has boosted the company's performance, in part because managers have put their employees' new motivation to good use. Avis has also found that its customers support employee ownership, which the company touts in its ads. One TV spot shows a satisfied customer pointing to an Avis rental clerk and saying, "I know the owner."

If a company thrives, ESOP participants can grow a nest egg far beyond the means of most wage earners. At Quad/Graphics, which prints hundreds of catalogs and magazines, including a regional edition of TIME, the value of ESOP shares has risen from 6 cents in 1975 to $5 currently. The company's 3,500 workers own 18% of its stock, with the prospect of eventually acquiring an additional 12%. In the case of Stone Construction Equipment, a small firm in Honeoye, N.Y., company heir Alan Stone no longer wanted to run the operation, so he sold it two years ago to his 200 employees for $4.5 million. Since then, annual revenues have jumped from $12 million to $30 million. The company's shares are scheduled to be distributed to employees within ten years.

For all their promise, ESOPs can mean sacrifices for workers. In many instances, employees accept wage concessions in return for their stock. The United Steelworkers of America has saved dozens of failing mills in such wage- for-stock trade-offs. In distressed industries faced with low-wage foreign competition, says James Smith, a U.S.W. staffer in Pittsburgh, "one of the ways American workers can compete is by having some investment income along with a lower labor income." But an ESOP is no guarantee that a company will thrive. Despite its stock plan, New Jersey's Hyatt Clark Industries, a ball- bearing maker, collapsed in 1987 because of poor labor relations.

The ESOP surge has raised some eyebrows in Congress. For one thing, ESOPs were never intended as a way for corporate managers to entrench themselves against takeover bids or for corporate raiders to enrich themselves. For % another, the cost of providing the tax breaks is running as high as $3 billion a year at a time when deficit cutting is urgent.

But for now the ESOP may be politically secure. Few legislators can be expected to go along with reducing an incentive that in most cases is likely to boost the spirits and competitiveness of America's workers.