International Business Project Report

CHAPTER ONE

1.0 INTRODUCTION

1.1 Background

The many successes of ESOP companies may largely be attributed to enhancement of employee productivity. These productivity effects are becoming increasingly noticed across the world. Many studies have found that ESOPs or similar plans were associated with higher levels of productivity in US companies (Kumbhakar and Dunbar, 1993; Hallock et al., 2004; Robinson and Wilson, 2006; Sesil et al., 2007; Kramer, 2008; Kim and Ouimet, 2009). Jones and Kato (1995) used panel data to estimate production functions and reported the introduction of employee ownership on average led to a 4-5% increase in productivity in Japanese firms. Kruse et al. (2011) analyzed the effects of employee ownership, profit and gain sharing, and broad-based stock options (shared capitalism) on employee attitudes, turnover, and performance among applicants to the ―100 Best Companies to Work For in America‖ competition, and found shared capitalism has favorable effects on employee intent to stay and raises firm performance.

Other studies showed no direct increase in productivity from ESOPs (Dunbar and Kumbhakar, 1991; Pugh et al., 2000; Bakan et al., 2004; Bryson and Freeman, 2004) and two studies found that employee ownership’s effect on productivity is conditional. Ohkusa and Ohtake (1997) found that ESOPs that do not take into account employee performance, and ESOPs given as part of a pension plan do not incentivize productivity to the same extent as profit sharing ESOPs that reward productivity directly in the short term; Bryson and Freeman (2004) found a similar link between employee ownership and labor productivity only when a profit-sharing scheme was in place, and further found that this effect is proportional to the percentage of employees covered by the profit sharing scheme. The above studies on ESOPs and productivity have mainly been conducted in developed countries. In the US and many other developed countries, ESOPs serve as alternative pension plans and involve complex governance issues and sometimes tax deductions, but China’s ESOPs were introduced solely as employee incentive schemes. China’s ESOPs are not tax deductible and employee shareholders in China play no role in corporate restructuring decisions and corporate governance. Due to China’s institutional structure, the benefits of China’s ESOPs are not mixed with or altered by the effects of tax legislation or ESOP pension programs, so these results may be considered isolated, pure results of the ESOPs themselves. This case study focuses on the most famous ESOP in China, Huawei Investment & Holding Co., Ltd, to analyze ESOP’s effects on productivity. This paper seeks to contribute to the literature on the effects of ESOPs on productivity in a developing country.

2.0 LITERATURE REVIEW

2.1 Introduction

This chapter will review the critical literature of current knowledge including substantive findings, theoretical and methodological contributions to the area of Employee Stock Ownership Plan (ESOP) and the relevance of Employee Stock Ownership Plan in productivity of any organization which has been done by various researchers.

2.2 Employee Stock Ownership Plan (ESOP)

Of the three recognized categories of employee ownership (producer cooperatives, joint partnerships, and ESOPs), employee stock ownership plans (ESOPs) are the most widely accepted in the U.S. business community. In many the countries in United States the study founded that the employee stock ownership plans are very common in the firms the national center for employee ownership evaluates that there are 10500 private and public firms which are using employee stock ownership plans and the NCEO also founded that there was 0.25 million participants in the employee stock ownership plans in 1975 and it increases to 5 million participants in 1990. And in 2007 it increases with 8 million and the total number of participants become 13 million (hu & izumida, 2008).

ESOPs are a comparatively long period phenomena which did not enjoy widespread approval by employers until the passage of the Employee Retirement and Income Security Act (ERISA) of 1974. This act, which prohibits any loan between a sponsoring employer and its deferred employee compensation plan, allows ESOPs to be exempted from this prohibition. In essence, ERISA allows an employer to establish an ESOP as part of its retirement program, then borrow capital from it.

This capacity of ESOPs to serve as a potential source of capital is not the only incentive to interest employers. There are also substantial tax savings to be harvested by companies offering ESOPs. The Deficit Reduction Act of 1984 permits owners of independent businesses to defer the taxation of gains made by the sale of stock to an ESOP if the gains are reinvested within a twelve-month period. It should be noted that in order for an employer to be eligible for such tax savings, a minimum of 30% of the company's ownership must be held by the ESOP.

ESOPs have also been used as a method for the management of publicly-traded firms to discourage hostile takeovers. As an example, when Freedom Savings of Florida was confronted with an unwelcomed takeover, its management immediately sold 300,000 shares of newly issued stock to Freedom Saving's newly created ESOP. This tactic promptly precluded the investors who instigated the takeover from gaining controlling interest. Although such methods are often draconian in terms of ownership dilution, they are nonetheless a powerful anti-takeover tool for management. Perhaps the most publicized use of an ESOP in recent years has been its use as a means by which employees can buy out companies which otherwise would have closed.

ESOPs have also found a use in collective bargaining agreements. During periods of retrenchment and severe costcutting, employers have discovered that ESOPs (more succinctly, shares of ownership in the firm) can be traded in exchange for wage and benefit concessions from the employees. This quid pro quo arrangement has been used to some extent in the airline and automobile industries during the early 2000s. On an ever increasing basis, academic and practitioner journals have been presenting yet another incentive for employers to initiate ESOPs—improved employee commitment. Commitment can be broadly defined as the degree to which employees identify with their organization and their willingness to exert considerable effort on behalf of that organization. Employees who are highly committed to the goals of their organizations and have a positive attitude toward that organization, should also have a strong desire to come to work and contribute toward the attainment of those goals.

As a result of employee ownership allegedly improving employee commitment, the advocates of employee stock ownership contend that ESOPs can produce tangible benefits for firms by increasing productivity, improving profitability, enhancing employee loyalty, and reducing turnover. All of the tangible benefits are ascribed to the expectation that ESOPs lead to a better motivated and more efficient labor force. It is this motivational use of ESOPs that is of primary interest to this study. Particularly, this dissertation investigated whether or not there was an association between employee stock ownership and employee performance.

2.3 Types of Employee Ownership

There are three classifications of employee ownership: producer cooperatives, joint partnerships, and ESOPs. Producer cooperatives are by far the oldest and can be traced to medieval times. Under this arrangement, the business is totally owned by its employees, although the proportion of ownership may vary widely from employee-owner to employee-owner. Each worker-capitalist, regardless of the amount of his investment in the cooperative, has an equal say in all decisions involving the organization—one man, one vote.

The second form of employee ownership is the joint partnership. It differs from producer cooperatives in that joint partnerships are not 100% employee owned. The founder of the business still retains a portion of the ownership in the organization. The ratio of ownership between the founder and employees varies greatly from firm to firm, as does the amount of control (voting rights) enjoyed by the employees.

Finally, ESOPs are by far the most common and most complex form of employee ownership. Their inception is generally dated as 1958. This was the year, that Louis Kelso published The Capitalist Manifesto which called for the revitalizing of productivity in the United States through the creation of employee stock ownership plans.

2.4 Relationship between ESOPs and Employee Productivity

O'Halloran (2012) confirmed the statistical significant association between ESOPs and employees' turnover whereas the earlier work of Curme and Stefanec (2007) opposed the correlation between the above-mentioned variables. Nevertheless, numerous authors confirmed that there is strong positive linkage between ESOPs and the organizational performance (Goddard, 2001; Bauer, 2004; and Brown and Sessions, 2006). Interestingly, the Green and Heywood confirmed that the employees' motivation is affected by the ESOPs to some extent. However, this study was conducted in the developed economy thus, there is no conclusive evidence from the emerging economy (Pakistan)'s context. Additionally, the earlier work of researchers confirmed positive association between ESOPs and Job Commitment (Park and Seng, 1995) and ESOPs and firm's profitability (Jensen and McCallney, 1976; Modigliani and Miller, 1958). However, O'Halloran (2012) argued that job commitment and job satisfaction are significantly positively affected due to ESOPs. Conversely, Freeman (1978) found negative correlation between job commitment and ESOPs. Additionally, earlier authors argued that profitability and productivity of the organization is correlated with the ESOPs (Park and Seng, 1995; Krus and Blaise, 1997). On the contrary, later researchers found no correlation between ESOPs and productivity/profitability of the organizations (Pugh et al. 2000; Blues and Krus (2003). Nevertheless, these all studies have been limited to the developed economies while there is still no conclusive evidence from the emerging economies to explain the nature and strength of the variables.