Reasons for ESOP Plan Termination, Alternate Bonus Program, Five Errors in Equity Plan Design

The December 14, 2007 Employee Ownership Update is online and discusses the following:

• Repurchase Not Major Driver of ESOP Plan Termination
  
• Useful Analysis of Proposed Changes in Taxation of S ESOP Synthetic Equity in Rangel Bill
  
• Stewardship-Sequenced Payouts: An Innovative Idea for Bonuses
  
• New Article Looks at Five Common Errors in Equity Plan Design in Closely Held Companies
  

Reasons for ESOP Plan Termination

The Update discusses the results of the final report of the reasons for ESOP plan termination. The results are consistent with our discussion in Why the Number of ESOPs is not Growing at a Faster Rate.

The second phase of the study obtained data from administration firms representing about 1/3 of the ESOP population. According to the results, less than 2% of the companies terminated their plans each year, which is half the rate of DC plans in general. The study found that over half received an attractive offer they could not turn down, even though they could handle the repurchase obligation. The remaining reasons were split between the following:

• Companies that were dissatisfied with the ESOP for reasons other than repurchase
  
• Companies that were doing well financially but could not handle the repurchase obligation
  
• Companies that were in financial difficulty

The Update also notes the following:

"The study also found that 49% of all companies in the sample were majority ESOP-owned and 40% were S corporation ESOPs. S ESOPs were about half as likely to report that difficulty with repurchase was a cause for plan termination as C ESOPs."

The Report concludes with the following:

"The data provide considerable encouragement that ESOPs are an increasingly stable and significant business form, not a transitional tool."

More information on the first phase can be found here:

ESOP Terminations

Reasons for ESOP Termination/ESOPs and Economic Development/Next Step in Tribune Transaction

Rangel Bill Analysis

The Update discusses the blog post discussed in Detailed Description of Rangel Proposal with Examples.

Alternate Bonus Program

This section discusses an article from the 4th Quarter 2007 WorldatWork Journal:

"Executive Stewardship Incentives from Innovative Bonus-Payout Methodology

By Timothy S. Clark, The George Washington University Balaji Krishnamurthy, Ph.D., LogiStyle
Instead of the conventional approach of concurrent payout of bonuses, a sequential methodology ensures those with less influence get due rewards before those with more influence, providing clearer incentives for the application of that influence in ways that benefit broad sets of stakeholders. This paper introduces stewardship-sequenced payout."

The Update describes an alternate system of paying bonus that is considered to be more responsible and more credible to employees and shareholders:

"The concept is simple: bonuses are paid at LogiStyle when shareholder return targets are met. If they are, then bonuses are paid to lower-level employees until their bonus targets have been met. The bonus triggers cascades up through however many layers of the company the company sets, with the CEO getting a bonus only if everyone else's bonus targets are met. To recognize the additional uncertainty, the size of the CEO bonus could be increased over what it might have otherwise been."

Five Errors in Equity Plan Design

The Update provides a link to Five Key Errors in Designing Equity Compensation Plans in Closely Held Companies, and article that discusses the following five errors and provides five tips to building a dynamic model:

1. Error One: The 10% Solution
   
2. Error Two: Most of the Equity to Be Given Will Be Given Out Up Front
   
3. Error Three: Unless We Sell or Go Public, No Exercise Is Allowed
   
4. Error Four: Only "Key" Employees Will Get Equity
   
5. Error Five: How Much Each Employee Gets Will Be Based on Some Number I Read or Heard