Employee Stock Ownership Plans: Employee Compensation and Firm Value E. Han Kim and Paige Ouimet * Abstract Changes in wages and firm value following ESOP adoptions are related to the ESOP size. When it is small (less than 5% of outstanding shares), both mean wages and firm values increase. Since shareholders and employees are the two main claimants of firm surplus, these changes suggest small ESOPs increase productivity. Importantly, employees gain more and shareholder gain less when employee job mobility increases after ESOP initiations, implying the productivity gains are shared between employees and shareholders according to their bargaining power. Large ESOPs have neutral effects on wages and shareholder value, indicating productivity gains no greater than the value of ESOP shares granted. Some large ESOPs seem to be motivated by reasons unrelated to improving group incentives and co-monitoring: cash conservation by small and young firms, leading to wage cuts, and worker-management alliance to thwart takeover threats, causing wage increases unrelated to productivity gains. April 14, 2011 JEL classification: G32, M52, J54, J33 Keywords: ESOPs, Group Incentives, Worker Mobility, Worker-Management Alliance, and Cash-constrained firms. \* E. Han Kim, the corresponding author, is at Ross School of Business, University of Michigan, Ann Arbor, Michigan 48109; email: [email protected]. Paige Ouimet is at Kenan-Flagler Business School, University of North Carolina, Chapel Hill, NC 27599; email: [email protected]. A previous version of this paper was circulated under the title ―Employee Capitalism or Corporate Socialism: Broad-based Employee Stock Ownership.‖ We are grateful for helpful comments and suggestions by Sreedhar Bharath, Joseph Blasi, Amy Dittmar, Charles Hadlock, Diana Knyazeva, Doug Kruse, Francine Lafontaine, Margaret Levenstein, Randall Morck, Daniel Paravisini, Joel Shapiro, Clemens Sialm, Jagadeesh Sivadasan; seminar participants at INSEAD, North Carolina State Universiy, University of Hawaii, University of Michigan, University of Oxford, the US Bureau of Census, and Washington University at St. Louis; and participants at 2010 American Finance Association Annual Meetings, 2009 Conference on Financial Economics and Accounting, Labour and Finance Conference at University of Oxford, Madrid Conference on Understanding Corporate Governance, the Census Research Data Center Annual Conference, and the International Conference on Human Resource Management in Banking Industry. We acknowledge financial support from Mitsui Life Financial Research Center at the Ross School of Business. The research was conducted while the authors were Special Sworn Status researchers of the U.S. Census Bureau at the University of Michigan and Triangle Census Research Data Center. We thank Clint Carter and Bert Grider for their diligent assistance with the data and clearance requests. Any opinions and conclusions expressed herein are those of the author(s) and do not necessarily represent the views of the U.S. Census Bureau. All results have been reviewed to ensure that no confidential information is disclosed.
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Employee Stock Ownership Plans: Employee Compensation and Firm Value
E. Han Kim and Paige Ouimet*
Abstract
Changes in wages and firm value following ESOP adoptions are related to the ESOP size. When
it is small (less than 5% of outstanding shares), both mean wages and firm values increase. Since
shareholders and employees are the two main claimants of firm surplus, these changes suggest
small ESOPs increase productivity. Importantly, employees gain more and shareholder gain less
when employee job mobility increases after ESOP initiations, implying the productivity gains are
shared between employees and shareholders according to their bargaining power. Large ESOPs
have neutral effects on wages and shareholder value, indicating productivity gains no greater than
the value of ESOP shares granted. Some large ESOPs seem to be motivated by reasons unrelated
to improving group incentives and co-monitoring: cash conservation by small and young firms,
leading to wage cuts, and worker-management alliance to thwart takeover threats, causing wage
increases unrelated to productivity gains.
April 14, 2011
JEL classification: G32, M52, J54, J33
Keywords: ESOPs, Group Incentives, Worker Mobility, Worker-Management Alliance, and
Cash-constrained firms.
\* E. Han Kim, the corresponding author, is at Ross School of Business, University of Michigan, Ann Arbor, Michigan
48109; email: [email protected]. Paige Ouimet is at Kenan-Flagler Business School, University of North Carolina,
Chapel Hill, NC 27599; email: [email protected]. A previous version of this paper was circulated under the title
―Employee Capitalism or Corporate Socialism: Broad-based Employee Stock Ownership.‖ We are grateful for helpful
comments and suggestions by Sreedhar Bharath, Joseph Blasi, Amy Dittmar, Charles Hadlock, Diana Knyazeva, Doug
Kruse, Francine Lafontaine, Margaret Levenstein, Randall Morck, Daniel Paravisini, Joel Shapiro, Clemens Sialm,
Jagadeesh Sivadasan; seminar participants at INSEAD, North Carolina State Universiy, University of Hawaii,
University of Michigan, University of Oxford, the US Bureau of Census, and Washington University at St. Louis; and
participants at 2010 American Finance Association Annual Meetings, 2009 Conference on Financial Economics and
Accounting, Labour and Finance Conference at University of Oxford, Madrid Conference on Understanding Corporate
Governance, the Census Research Data Center Annual Conference, and the International Conference on Human
Resource Management in Banking Industry. We acknowledge financial support from Mitsui Life Financial Research
Center at the Ross School of Business. The research was conducted while the authors were Special Sworn Status
researchers of the U.S. Census Bureau at the University of Michigan and Triangle Census Research Data Center. We
thank Clint Carter and Bert Grider for their diligent assistance with the data and clearance requests. Any opinions and
conclusions expressed herein are those of the author(s) and do not necessarily represent the views of the U.S. Census
Bureau. All results have been reviewed to ensure that no confidential information is disclosed.
Broad-based employee stock ownership plans (ESOPs) are common in the U.S. The National
Center for Employee Ownership (NCEO) estimates that as of 2010 there were over 10,500
private and public U.S. firms with ESOPs. The plans show an increasing long-term trend; the
NCEO estimates the number of participants in ESOPs was one-quarter million in 1975, five
million in 1990, and 13 million in 2007. In our sample, the median ESOP controls 6.7% of the
firm’s shares outstanding, representing an average market value of $18,643 (in 2006 dollars) per
employee.
Earlier studies based on stock price reactions to announcements of ESOP adoptions show
ESOPs are, on average, good news for shareholders, unless they are used to entrench managers.1
However, the literature on ESOPs offers little evidence on how employees – the participants – are
affected by this plan. In this paper, we attempt to shed light on how ESOPs affect employee
welfare by examining their wage changes following ESOP adoptions.
Using micro-data on employee compensation at the establishment (workplace) level from
the U.S. Bureau of Census, we find, on average, cash wages increase following the
implementation of an ESOP. Our definition of cash wages includes all forms of taxable ordinary
income, such as regular pay checks, bonuses, and commissions. The data also reveal significant
cross-sectional variation. Employees benefit the most when participating in a small ESOP,
defined as an ESOP which never controls more than 5% of the firm’s outstanding stock.
Following the adoption of a small ESOP, cash wages increase on average by 6.1%. Cash wages
do not include ESOP shares granted to employees; hence, the average compensation increase is
greater than 6.1%. The wage estimates are obtained by panel regressions using a control group of
non-ESOP firms matched by industry, year, size, average firm wage, and trends in wage changes
prior to the ESOP initiation. Our estimates control for establishment- and year fixed effects and
industry- and state mean wages, among others.
1 See Gordon and Pound (1990), Chang and Mayers (1992), Chaplinsky and Niehaus (1994), Beatty (1995), and
Cramton, Mehran, and Tracy (2008).
2
These gains to employees do not come at the expense of shareholders. Shareholders also
benefit. We find an average increase in industry-adjusted Tobin’s Q of 17% following the
adoption of small ESOPs.2 Since employees and shareholders are the two main claimants to total
firm surplus, from these gains we infer small ESOPs are associated with an increase in employee
productivity.
The evidence of employee and shareholder gains can be interpreted as causal effect of
ESOPs on firm surplus or as evidence of selection biases associated with the timing of the ESOP
implementation. ESOPs may increase productivity by improving group-based incentives and co-
monitoring (Kandel and Lazear, 1992; Jones and Kato, 1995; Blasi, Conte, and Kruse, 1996;
Kruse, Freeman and Blasi, 2010). Alternatively, a generous manager may implement an ESOP
when she anticipates higher future profits and wants to share them with employees.
To differentiate between these interpretations, we explore a prediction unique to the
causal interpretation. The causal story suggests that small ESOPs increase productivity and
employees and shareholders share the gains according to their relative bargaining power. Thus,
exogenous changes to employees’ bargaining power whould change the gains to shareholders and
employees. We proxy for exogenous shocks to employee bargaining power by changes in
employee mobility, as measured by a Herfindahl index of employer concentration within each
industry and geographic location of work place. We find that when employee mobility increases
at ESOP firms, wage gains are greater and shareholder gains are smaller. These results are not
due to ESOP firms’ own relocation of establishments. Furthermore, they are unique to ESOP
firms and do not reflect an industry-location wide relation between worker mobility and wages.
Since there is no reason to believe the selection story would predict such findings, these results
support our causal interpretation.
2 These gains in Tobin’s Q are high and do not imply any firm can increase shareholder value by 17% by adopting a
small ESOP. Our results are estimated using a set of firms which chose to adopt ESOPs – presumably a set of firms
which expected greater valuation effects than non-ESOP firms. As such, our estimation likely represents the upper tail
of possible average valuation impacts.
3
However, not all ESOPs are associated with both shareholder value and cash wage gains.
We find no significant changes in firm value or cash wages following the adoption of large
ESOPs, defined as ESOPs controlling more than 5% of the firm’s outstanding common stock at
any point in time. These estimation results do not include the value of the ESOP shares granted,
which is not trivial.3 However, even when the value of the ESOP shares are taken into account,
the average gains associated with large ESOPs are substantially less than those with small ESOPs.
The difference between large and small ESOPs does not necessarily imply that large
ESOPs cannot achieve productivity gains similar to those observed following small ESOPs.
Instead, a substantial portion of large ESOPs appear implemented to achieve objectives unrelated
to improving team effort and co-monitoring, clouding the average estimation results. We identify
two alternative motives, one predicting wage cuts and the other predicting wage increases.
Wage cuts should follow if ESOPs are implemented to conserve cash by substituting cash
wages with ESOP shares. Such a motive is likely to apply mainly to large ESOPs. Employees
value ESOP shares less than their market value because the sales restriction on ESOP shares
limits employees’ ability to diversify. (Employees cannot sell ESOP shares until they leave the
company or are close to retirement age.) Diversification restrictions matter because the share
prices are correlated with employee job security and wages. Thus, issuing shares through ESOPs
is more costly than issuing shares in the open market, unless the issuer has very limited (costly)
access to external equity due to asymmetric information. Since the information gap tends to be
greater for smaller and younger firms, we construct a cash constrained index using firm size
(small) and age (young). Hadlock and Pierce (2010) find size and age are the two key firm
characteristics significantly correlated with financial constraints. Our data show large ESOP
adoptions by high index firms (small and young) are followed by significant cash wage cuts. In
contrast, large ESOPs by low index (large and old) firms are followed by increases in cash wages.
3 The average market value of shares granted through large ESOPs in our sample is $26,796 in 2006 dollars per
employee, equal to 5.06% of annual wages if the shares were allocated equally over 10 years.
4
A motive predicting wage increases unrelated to productivity gains is the worker-
management alliance hypothesis suggested by Pagano and Volpin (2005), wherein management
bribes employees possessing control rights through ESOPs with above-market wages. The
purpose is to garner worker support in thwarting hostile takeover bids. Large ESOPs become an
especially effective anti-takeover device when the state of incorporation enacts business
combination statutes (BCS), which impose a temporary moratorium on takeover bids if a
sufficiently large block of investors, such as a large ESOP, vote against it. Thus, according to this
hypothesis, wages at firms with large ESOPs in place should increase following the passage of
BCS in their state of incorporation. Using a difference-in-difference test with BCS as an
exogenous shock, this is indeed what we find. Wages at these firms increase by an average of
7.3%, as compared to a group of control firms.
This paper contributes to the literature on several fronts. First, it fills an important void in
the employee stock ownership literature: Are employees financially better off as the result of
owning company shares? The answer seems affirmative, except for cases involving cash-
constrained firms using large ESOPs as a means to conserve cash.
Second, our wage results add to the literature on how firm surplus is shared between
suppliers of labor and capital (e.g., Akerlof and Yellen, 1990; Bhaskar, Manning, and To, 2002;
Manning, 2003). We measure employee mobility by the Herfindahl index of employer
concentration at the industry-location level. Using this measure as the proxy for employee
bargaining power vis-à-vis shareholders, we demonstrate the bargaining power affects employee
share of the surplus arising from their own productivity gains.
Third, previous studies document that ESOPs reduce the probability of takeovers
(Chaplinsky and Neihaus, 1994; Rauh, 2006), depriving shareholders of the opportunity to earn
large takeover premiums. Our evidence on wages identifies a more direct, previously
undocumented cost to shareholders when ESOPs are used as an anti-takeover device—higher
wages. This finding is also related to the post-BCS state-wide wage increases documented by
5
Bertrand and Mullainathan (2003), who attribute the wage increases to managers’ pursuit of
―quiet life‖. Our firm-level evidence identifies large ESOPs as an important channel through
which the pursuit of quiet life leads to post-BCS state-wide wage increases.
Finally, we shed some light on the controversy over whether cash constrained firms use
equity-based compensations as a means to conserve cash.4 The wage reductions following large
ESOP initiations at small and young firms render credence to the argument that cash conservation
with equity-based compensations is a relevant motive for firms with limited access to external
equity market.
The rest of the paper is organized as follows. Section I provides more details on ESOPs,
develops hypotheses, and briefly describes test outlines. Section II describes the data. Empirical
results concerning employee compensation and firm valuation are presented in Section III and IV,
respectively. Section V concludes.
I. Hypotheses Development
In this section we provide institutional details about ESOPs and review the relevant
literature to develop hypotheses. While the primary objective of this paper is to understand
employee welfare implications of ESOPs, we interpret our evidence in the context of different
motivations for ESOP implementation. The initial focus is on the motivation most often stated by
firms initiating ESOPs--improving incentives and team efforts to enhance worker productivity.
We also review studies on two other motivations: worker-management alliances to thwart hostile
takeover threats and substituting cash wages with ESOP shares to conserve cash.
A. Institutional Details
ESOPs are a type of tax-qualified pension plan.5 To qualify for tax benefits, the plan must
allocate shares in a broad-based manner to its employees. Usually, all full-time employees must
4 For example, Core and Guay (2001) argue firms implementing broad based stock option (BBSO) plans are more cash
constrained, whereas Ittner, Lambert, and Larcker (2003) find evidence that more cash constrained firms are less likely
to adopt BBSO plans. 5 ESOPs provide tax-advantages because for tax purposes qualified firms can deduct dividends paid on stock held by an
ESOP and dividends used to repay ESOP loans.
6
participate in the plan. Shares must be allocated equally to all employees or based on relative
compensation, seniority, or some combinations thereof, which helps prevent discriminatory share
allocation.
ESOPs allocate both cash flow and control rights to employees, creating a new class of
stakeholders, owner-employees. In public corporations, ESOPs must allow employees to vote
their shares. These rights are typically held by employees for an extended length of time because
employees cannot sell their ESOP shares until they leave the firm, although some exceptions are
made to allow employees to diversify their holdings as they get near retirement age.
B. Productivity Gains
Requiring employees to hold ESOP shares for an extended period can help align
employee incentives with shareholder value. How the alignment effect works for a typical
employee may differ from how equity-based incentives work for top executives, who have more
direct influence on overall firm performance than a typical employee. A vast majority of
employees may feel they have little impact on stock price, casting doubt on the ability of personal
incentives through ESOP shares to alter behavior in tasks requiring additional effort or sacrifice.
This also makes ESOPs different from other pay-for-productivity schemes such as piece
rate compensation, which can be effective when individual output is easily observed and
quantified (Lazear, 2000). With an ESOP, workers are not compensated for their individual
productivity; instead, they are rewarded when the productivity of the firm as a whole increases.
This introduces a free-rider problem (Kruse, 1996), diluting the incentives for employees to put
forth greater individual effort.
Kandel and Lazear (1992) argue the free-rider problem can be overcome through peer
pressure. Workers covered by an ESOP can profit as a whole if everyone agrees to work harder;
that is, solve the free-rider problem through collective collaborative activities such as peer
pressure and co-monitoring. If employees as a group can observe one another’s work and
influence behavior through peer pressure, cooperation becomes more likely, resulting in a high-
7
work regime. Although an ESOP alone may be insufficient to increase worker productivity, an
ESOP implemented in a corporate culture promoting group cooperation and co-monitoring may
have a substantially positive impact on productivity.
Survey evidence confirms that ESOPs encourage co-monitoring. Kruse, Freeman, and
Blasi (2010) survey over 40,000 employees from 14 companies with employee ownership plans
as part of the NBER Shared Capitalism research project. This survey, conducted between 2001
and 2006, asks employees how they would respond if they observe a co-worker underperforming.
They were given three options: 1) talk directly to the employee; 2) speak to a supervisor; or 3) do
nothing. An anti-shirking index based on the answers provided by the employees reveals that
those with company stock are much more likely to actively respond to shirking by a co-worker.
The team incentives and improved co-monitoring through ESOPs also may mitigate
inefficiencies in monitoring. Milgrom (1988) shows workers over-invest in tasks that are easily
observed by their bosses. Thus, even if workers do not shirk, their effort may be sub-optimally
allocated across tasks. By aligning team incentives and the focus of co-monitoring with
shareholder value, ESOPs may help reduce inefficiencies in how employees allocate their efforts.
B.1. Related Evidence
Jones and Kato (1995) estimate changes in productivity at Japanese firms following the
adoption of an ESOP by a Cobb-Douglas production function. They find that an ESOP adoption
in Japan leads to a 4-5% increase in productivity, starting about three years after the adoption.
However, the typical Japanese ESOP in their sample is allocated 1% or less of outstanding shares,
quite different from the typical ESOP observed in the U.S. Faleye, Mehrota, and Morck (2006)
look at only large employee share ownership blocks and disagree with the view that ESOPs are
conducive to productivity gains. They argue when employees control five percent or more of
voting stocks, firms have lower Tobin’s Q, invest less, grow more slowly, and create fewer new
jobs. These arguments are based on cross-sectional evidence.
B.2. Hypotheses and Test Outline
8
We examine small and large ESOPs separately, using 5% as the demarcation point. For
each group, we estimate how wages and firm valuation change following ESOP adoptions,
relative to a control group of matched firms that never adopt ESOPs. Since employees and
shareholders are the two main claimants of firm surplus, we infer productivity gains or losses
based on their combined changes associated with ESOP initiations. Although the inference is
indirect, this approach also helps identify whether gains to employees or shareholders arise at the
expense of the other claimant. In addition, directly estimating productivity would greatly reduce
our sample size because such estimates are feasible only for manufacturing firms.
If productivity indeed increases following ESOP adoptions, how are the gains shared
between employees and shareholders? Akerlof and Yellen (1990) argue that workers will demand
a ―fair‖ wage. One definition of a fair wage could include a share of firm profits. As profits
increase, workers will demand higher wages (a ―fair‖ share of the surplus) and be more inclined
to shirk or even quit if wages fall short. Empirical evidence consistent with the rent-sharing view
include Hildreth and Oswald (1997) who find that wages increase following shocks to firm-level
productivity, suggesting employees capture a share of productivity gains.
Employees’ share of productivity gains is likely to depend on workers’ bargaining power,
which may depend on worker mobility. When worker mobility is low and employees have few
alternative employment opportunities, the threat to shirk or quit matters less, giving employers
greater bargaining power (Bhaskar, Manning, and To, 2002; Manning, 2003), which in turn
enables employers to retain more of the surplus for shareholders. Conversely, when worker
mobility is high, employers may have to share a larger fraction of the surplus with employees.
To test these predictions, we develop a Herfindahl index of employer concentration
within each industry and location of work place and use it as a measure of worker mobility within
that industry-location. Because greater employer concentration tends to offer less outside
employment opportunities and makes employees less mobile, we predict that wages at ESOP
firms with productivity shocks will increase more following a decrease in employer concentration,
9
compared to a set of control firms. Since this prediction is unique to the causal interpretation, it
allows us to address the causality issue.
C. Worker-Management Alliance
Pagano and Volpin (2005) develop a theoretical model showing employee control rights
through ESOP shares give rise to a worker-management alliance.6 Management bribes employees
with above-market wages, which give employees incentives to vote with the management in the
event of a takeover contest. Shareholders pay for this alliance in two ways: (1) higher wages and
(2) a lower probability of receiving a takeover premium.
The second prediction of the alliance hypothesis is consistent with earlier findings by
Gordon and Pound (1990), Chang and Mayers (1992), and Rauh (2006). In addition, Chaplinsky
and Neihaus (1994) and Rauh (2006) show that ESOPs significantly reduce the probability of a
takeover.
C.1. Hypothesis and Test Outline
Our test focuses on the first prediction: wage increases. To distinguish this wage increase
from wage increases due to sharing productivity gains, we examine the impact of an exogenous
shock on wages at firms with large ESOPs in place. The shock is the enactments of business
combination statutes (BCS) by the firms’ states of incorporation, which Romano (1987) and
Bertrand and Mullainathan (2003) argue are mostly exogenous. In BCS states, if a sufficiently
large block of investors unaffiliated with management, such as a large ESOP, vote against a
hostile takeover bid, the bidder must wait three to five years before pursuing the target again.
Because courts have established holders of ESOP shares as ―outside‖ investors, BCS makes
ESOPs an especially effective anti-takeover device. Indeed, Rauh (2006) finds a significantly
lower takeover probability for firms with employee ownership incorporated in states with BCS in
effect. Since BCS makes employee support against hostile takeover bids more valuable, we
6 See Atanassov and Kim (2009) for evidence in support of the worker-management hypothesis in the context of
corporate restructuring around the world.
10
predict management’s incentives to bribe workers covered by large ESOPs will increase
following the passage of BCS, leading to higher wages.
D. Cash Conservation
Firms may seek to conserve cash by offering stocks to employees in exchange for lower
cash wages. While this motivation has received limited attention in the ESOP literature, Core and
Guay (2001) argue that cash conservation is a key motivation for implementing broad based stock
option (BBSO) plans, providing evidence that these plans are more common at firms with large
financing needs and high costs of external finance. However, subsequent studies provide
contradictory evidence. Using a different sample, Ittner, Lambert, and Larcker (2003) find more
cash constrained firms appear less likely to adopt BBSO plans. Oyer and Schaefer (2005) also
report mixed evidence: BBSO plans are less common at firms with positive cash flows but are
less likely to be adopted by firms making large investments requiring substantial cash outlays.
Underlying this empirical debate is a theoretical issue: Is substituting equity-based
compensation for cash wages an efficient cash conservation strategy for a publicly traded firm?
To be efficient, the costs associated with compensating risk adverse employees for additional risk
must outweigh the costs associated with accessing more traditional sources of external finance
(Oyer and Schaefer, 2005).
D.1. Hypothesis and Test Outline
ESOP shares impose risk on employees, some of which can be diversified by other
investors but not by employees. Because the value of the ESOP shares is correlated with firm
performance, which affects employee job security and wages, an ESOP share is worth less to risk
averse employees. This makes issuing shares to employees more costly than issuing shares to the
public. Thus, we do not expect firms to issue shares to employees to conserve cash unless their
access to external equity is limited (very costly). Young and small firms tend to have more costly
(difficult) access to external equity (Hadlock and Pierce, 2010). Thus, we conjecture when
11
younger and smaller firms adopt ESOPs, the cash conservation motivation is more likely to be at
work and wages fall subsequent to the adoption of ESOPs.
II. Data Construction, Empirical Design, and Summary Statistics
Our data on ESOPs cover US public firms from 1982 through 2001. We end the sample
period in 2001 because a change in the reporting method of establishment-level identifiers used
by the Census in 2001 makes it difficult to link post-2001 observations to earlier observations. To
identify firms with ESOPs and the first year of ESOP implementation, we conduct a two-step
Factiva search. In the first step, we search Factiva using the terms ―ESOP‖ and ―employee stock
ownership plan.‖ We read all articles and note the first date a firm is mentioned as having an
ESOP.7 In the second step, we run additional Factiva searches using each identified firm’s name
and ―employee stock‖ to obtain further information on its ESOP.8 With this additional search, we
are able to accurately identify the year of ESOP initiation for 410 unique firms. 9
We determine the size of ESOPs by reading annual proxy statements. In most cases,
ESOP share ownership is reported only if the plan has more than 5% of the firm’s common equity.
We assume the ESOP controls less than 5% of the firm’s outstanding shares if the proxy
statement does not report specific numbers concerning ESOP size. The ESOP database is then
matched to Compustat and Center for Research in Security Prices (CRSP) databases for
accounting and stock market variables.
7 This process yields 739 unique public firms with ESOPs over the sample period. Of these firms, we drop 35 firms
with total assets less than $10 million in 2006 dollars. The lack of press coverage on such small firms makes it likely
that we missed other similar-sized firms with ESOPs, wrongly identifying them as non-ESOP firms. This potential
error is important as our control group is obtained from firms in Compustat without identified ESOPs. 8 The purpose of the first search is to identify all firms with ESOPs and to identify the first year of ESOP
implementation, which we assume is the first year the firm is mentioned in an article as having ESOPs. In the second
search we obtain more articles because we use less restrictive search terms. We also read the articles more carefully. In
doing so, we occasionally find ESOPs that were established prior to the date the article was published. For example, the
first article mentioning the firm and an ESOP refers to the ESOP as having been implemented 5 years ago. We exclude
these cases out of concern that their inclusion would introduce a survivorship bias. The failure to observe any news
articles at the time the firm implemented the ESOP may have occurred because, at that time, the firm was too small to
receive adequate press coverage. As the firm grows over time, media attention increases, and we later observe an article
about an ESOP implemented in earlier years. Had the firm failed to grow, the firm would not have attracted media
attention and we never would have observed the ESOP. Thus, inclusion of those ESOPs would bias toward finding a
positive correlation between ESOP implementations and firm performance. 9 If a firm underwent a bankruptcy or was dropped from Compustat for a year or more, we assume the ESOP was
terminated unless other information is present.
12
The ESOP database is also matched to the Longitudinal Business Database (LBD)
maintained by the U.S. Bureau of Census, a panel dataset that tracks all U.S. business
establishments with at least one employee or positive payroll from 1975 to the present. An
establishment describes any facility with a separate physical address, such a factory, service
station, restaurant, and so on. The database is formed by linking years of the Business Register
(formally called the Standard Statistical Establishment List). The Business Register is a Census
Bureau construct based primarily on information from the Internal Revenue Service of the U.S.
Treasury Department.10
It contains information on the number of employees working for an
establishment and total annual establishment payroll. The LBD links the establishments contained
in the Business Register over time and can be matched to Compustat using a bridge file provided
by the US Census.
This Census data is an improvement over the wage and employment data reported in
Compustat. For one, the Census data is available at the establishment level which allows us to
identify changes at each facility instead of relying on firm-level aggregate data. Second, we are
able to observe the state of location for each facility, making it possible to control for geography-
dependant mean wages. Finally, the majority of active firms in Compustat do not report employee
compensation, and the reported employee count and wage data can be unreliable because
personnel information is subject to looser reporting and auditing requirements than financial
variables.
To construct a set of control firms, first we calculate for each ESOP firm 1) total assets, 2)
the average firm-level wage per employee, and 3) the change in average firm-level wage per
employee prior to the ESOP initiation. The change in wages is used to ensure that ESOP firms
and matched firms exhibit a similar trend in wages prior to the year of matching. The change in
wages is defined as (wagest-1 – wagest-2)/wagest-2, where t is the year of ESOP initiation.
10 See Jarmin and Miranda (2002) for more information.
13
We estimate the same variables for a set of potential control firms, which includes all
firms in Compustat that belong to the same industry in the same year that never issued an ESOP.
Industry is classified by the 3-digit SIC code. We estimate the absolute percent difference
between the potential control firm and the ESOP firm on all three variables. Specifically, for
each variable, we calculate a percent difference as (valuecontrol – valueESOP) / valueESOP. These
percent differences are summed up, and the control group is chosen as those firms with the
smallest total differences. For each ESOP firm, we identify the three nearest neighbor matches.
Because we identify the match from the same pool of firms, in some cases a control firm is
matched to multiple ESOP firms. To maintain a sample of independent observations, we require a
match firm appear in the control group as a unique firm by dropping the ―repeats‖.
ESOP firms are included in our sample for the five years before and the ten years after
the ESOP is initiated. We begin five years prior to capture the most current information and
extend to ten years afterward because ESOP shares must be granted to individual employee
accounts within ten years. Observations after ten years are excluded to reduce the impact of
changes unrelated to the ESOP occurring well after the initiation. We also exclude observations
after an ESOP termination to ensure that our baseline is not picking up post-termination effects.11
The same time series is used for the matched group. We keep matched firms in our sample for the
five years before and the up to ten years after the match.
Table 1 lists the number of new ESOP adoptions and observation counts in our ESOP
database by year. It identifies 4,594 firm-year observations between 1982 and 2001 with the
11 There are 56 ESOP terminations (138 plant-year observations) in our ESOP database. Terminating an ESOP is a
complex legal procedure. The firm must be able to legally justify why the ESOP was value-increasing for the firm in
the past but is now value-decreasing; otherwise, it is open to lawsuits from ESOP holders and shareholders. Thus, it is
more common to ―freeze-out‖ an ESOP. A freeze-out usually is not announced officially, so is difficult to identify. In
our sample, firms that elect to freeze-out their ESOP are still recorded as having an ESOP, which is literally true
because the ESOP still exists. There are also some firms that have rolled up their ESOP into a 401-K plan. Such 401-K
plans may still be recorded in our database as an ESOP, which is not completely off-base because they still represent
employee stock ownership.
14
median ESOP controlling 6.70% of shares outstanding.12
Samples used in the subsequent tables
are smaller than the full sample because a number of observations could not be matched to the
Census LBD database. 13
Table 2, Panel A, provides summary statistics of the relevant firm level variables. The
first column details firms that later initiate an ESOP, over the pre-ESOP period of up to five years.
The second column describes firms over the post-ESOP period of up to ten years. The third
column details firms with large ESOPs over the post-ESOP period. An ESOP is considered large
if, at any point during the lifetime of the plan, it controls more than 5% of the outstanding
common shares. We choose this demarcation point because proxy statements only detail the size
if the ESOP controls more than 5% of the firm’s equity. In addition, 5% is often used as a
threshold for various disclosure requirements, presumably because it signifies an important
source of control rights. Of the 410 ESOPs in the sample, 225 achieve a size of 5% or greater at
some point during their lifetime. The median and the mean ownership of these large ESOPs is
12.20% and 18.35% of shares outstanding, respectively. The fourth column summarizes the set of
matched firms over the up-to-16-year period from five years before to ten years after the matched
date.
The summary statistics indicate ESOP firms are more profitable and have higher leverage
as compared to control firms. Furthermore, ESOP firms are larger and valued lower as measured
by (industry-adjusted) Tobin’s Q. The lower valuation is most noticeable for large ESOP firms.
Financial leverage increases following ESOP initiations because they are often debt financed.
Panel B of Table 2 provides summary statistics of relevant payroll information at the
establishment level. We include all establishments owned by either our ESOP group or the
control group. Both pre- and post-ESOP firms have more employees per establishment than the
12 We cannot estimate the mean because proxy statements do not report the size for ESOPs with less than 5% of
outstanding shares. 13 Census confidentiality policy limits the disclosure of the exact sample which was matched to the Census LBD
database.
15
control group. Wages are significantly higher at pre-ESOP firms than at the control sample, and
the difference between these firms increases substantially after the adoption of ESOPs.
III. Employee Compensation
Our empirical investigation begins with the estimation of the relation between employee
cash compensation and the presence of an ESOP, followed by an investigation of the relation
between firm value and ESOPs. Since employees and shareholders are the two main claimants of
a firm’s total surplus, these estimates allow us to draw inferences on how the adoption of an
ESOP is related to firm productivity.
The Census compensation data provides establishment-level annual payroll, which
includes all forms of compensation taxed as ordinary income, such as salaries, wages,
commissions, and bonuses. However, the compensation data do not include the value of ESOP
shares given to employees and, hence, underestimates total employee compensation. Our measure
of wages per employee is the ratio of annual payroll (in thousand dollars, normalized to 2006
dollars) to the number of employees and excludes the value of ESOP shares granted to employees.
This variable is calculated at the establishment level.
A. Univariate Analysis
We begin by examining how wages change around the ESOP initiation. Table 3, Panel A
provides average log wages per employee (in thousands) over a five-year window surrounding
the year of ESOP initiation (year 0), separately for small ESOP firms, large ESOP firms, and the
control group. The five-year window covers -2 to +2 years surrounding the year of ESOP
initiation. We use the log of wages per employee because wages are highly skewed. We do not
consider years beyond the five-year window because the high rate of establishment entry and exit
leads to significant changes to the sample over time. That is, the samples used to calculate the
year 0 average and the year + 5 averages are quite different. However, this is not a concern in the
next section where regressions control for establishment-fixed effects.
16
Because wages are affected by location- and industry-specific factors, Panel B of the
Table adjusts for mean wages in the state of location and in the same industry in the same year.
Unexplained wages are residuals from the following regression:
Wagesit= α0 + 1state-year mean wagesit + 2industry-year mean wagesit + μit (1)
Subscripts i and t indicate establishment i and year t, and wages are the log of the average wage
per employee. State-year mean wage is the log mean wage per employee in the state of location
of the establishment in the same year. Industry-year mean wage is the log mean wage per
employee matched to the establishment’s industry and by year.
Both panels reveal wage decreases prior to the ESOP initiation. Both raw and
unexplained wages show declines from year -2 to year -1 for both small and large ESOP firms.
One concern upon seeing this pre-initiation trend is that it may predict higher wages post-ESOP if
wages follow a mean-reverting process. This is why we require that firms included in our control
group have similar trends in raw wages prior to the year of matching. The last column of Panel A
shows that the control group also experiences a decline in raw wages from year -2 to year -1.
This decline in wages is reversed starting the year of ESOP initiation. For ESOP firms,
both the raw and abnormal wages increase sharply in years 0 and +1, and year +2 wages stay
substantially higher than that in year -1. The raw wages also increase for the control group;
however, unlike the ESOP firms, the control group shows no improvement in unexplained wages,
which remain negative throughout the five-year window. This difference between the treatment
and control groups suggests that workers enjoy higher wages following ESOP adoptions.
B. Multivariate Analysis
The univariate analyses do not control for relevant establishment and firm characteristics.
In this section, we estimate the relation between ESOPs and employee compensation at the
establishment level in a differences-in-differences like approach using all treatment and control
firms meeting our sample construction criteria over 1982 to 2001. The baseline regression is:
Wagesit= ηt + θi + α0 + α ESOPit + Zit + μit (2)
17
Subscripts i and t indicate establishment i and year t, and ηt and θi are year- and establishment
fixed effects. Year fixed effects capture economy-wide effects on wages, and establishment fixed
effects control for time-invariant establishment characteristics. ESOPit includes ESOP and
ESOPg5 indicators: ESOP is equal to one if the firm has an ESOP; and ESOPg5 is equal to one if,
at its maximum, employees control more than 5% of outstanding shares through the ESOP. The
regression estimates the mean difference in wages before and after ESOP adoptions, after
controlling for other firm characteristics.
The set of control variables, Zit, include state-year mean wages measured for the state of
location of an establishment in the same year, excluding the establishment itself from the mean.
This variable controls for changing local conditions affecting wages over time (Bertrand and
Mullainathan, 2003). We also control for industry-year mean wages, the mean wages of all
establishments operating in the same industry as the establishment in the same year, excluding the
establishment itself from the mean. To control for changing establishment and firm characteristics,
we include establishment age and total sales at the firm level. We also control for financial
leverage because some ESOPs are debt financed.14
Berk, Stanton, and Zechner (2010) argue that
higher leverage imposes greater risk on employees, resulting in higher wages in equilibrium.
Wages at establishments owned by the same firm may be correlated, understating the
standard errors. We correct standard errors for clustering at the firm-level. In addition, we
exclude transition periods, the year of the announcement of ESOP adoption and the year after
because ESOP implementation takes time. Jones and Kato (1995) show that it takes about three
years before ESOPs show effects on worker productivity.
B.1. Basic Results
The first column in Table 4 reports estimation results of the baseline regression. As
expected, establishment-level wages are highly correlated with the concurrent average wages in
the same state and the same industry. However, the coefficient on ESOP is insignificant. This is
14 In a leveraged ESOP, the firm purchases the shares to be allocated to the ESOP using a new debt issuance.
18
because treating all ESOPs alike with a single ESOP indicator masks important heterogeneity
across ESOPs of different size. When Column (2) adds an indicator for large ESOPs, the
estimation result reveals a sharp difference between small and large ESOPs. The coefficient on
ESOP indicates a significant wage increase following the adoption of a small ESOP.15
The
magnitude of the coefficient implies a 6.1% average wage increase following the initiation of
small ESOPs. Since the mean wage at pre-ESOP firms is $40,522 (Table 2, Panel B), the 6.1%
increase amounts to $3,114 (in 2006 dollar). Because the value of the ESOP shares allocated to
employees is not accounted for, these wage increases underestimate total compensation increases.
This positive relation between ESOP adoptions and wages applies to only small ESOPs.
The coefficient on ESOPg5 is negative. Because the coefficients on the ESOP indicator variables
are cumulative, the combined coefficient on ESOPg5 is 0.061 – 0.077, or -0.016. Column (3)
enters ESOPg5 alone and shows an insignificant coefficient, indicating no changes in wages
following large ESOPs.
B.2. Value of Shares Granted through Large ESOPs
Looking at wage changes alone understates compensation changes because the value of
ESOP shares is unaccounted for, and the underestimation is greater for large ESOPs. The average
size of shares granted to employees through a large ESOP is 18.35% of the firm’s market
capitalization.16
The average market capitalization of a firm with a large ESOP is $3.5 billion in
2006 dollars and has 23,959 employees. Thus, the average large ESOP has a total value of $642
million, which translates into $26,796 per employee. Given that the average annual wage for
workers at these large ESOP firms is $52,981, the value of the ESOP shares allocated would be
equal to 5.06% of annual wages if the shares were allocated equally over ten years.
15 In a typical down-sizing, low wage workers are fired first, which may lead to an increase in mean establishment
wages due to the shift in the worker composition towards higher-paid employees. This is an unlikely explanation for
our finding because the mean employment at ESOP firms over the sample period increases by 4.1%, which is
comparable to the mean employment increase of 4.2% at the group of control firms. 16 We do not have the equivalent statistic for small ESOPs because, as mentioned earlier, proxy statements do not
provide the percentage held in ESOP accounts if it is below 5%.
19
Risk-averse workers will value ESOP shares less than cash wages because of the sales
restrictions on ESOP shares and their associated risk. Thus, even when we account for the value
of shares granted, the average compensation changes associated with large ESOPs are less than
those associated with small ESOPs. However, the value of the shares granted through large
ESOPs seems substantial, suggesting that employees are better off, on average, following the
adoption of large ESOPs.
B.3. Robustness
Bertrand, Dufflo, and Mullainathan (2004) point out standard errors from difference-in-
differences tests can be biased in the presence of serial correlation in the dependant variable.
Thus, we follow an alternative estimation procedure they suggest. In step 1, we estimate the
following regression:
Wagesit= ηt + θi + α0 + Zit + μit.
Subscripts i and t indicate firm i and year t, and ηt and θi are year- and firm fixed effects. Each
observation reflects the equally-weighted mean of all establishment observations for that firm-
year. Zit is the same set of control variables as in the baseline regression. This first step regression
is estimated on the full sample of both ESOP and control firms.
In step 2, we use the estimated residuals from step 1, but retain these values only for
ESOP firms, thus, our sample in step 2 is limited to firms which either currently have an ESOP or
will adopt an ESOP in the future. In addition, we use only one observation for each firm for the
pre-ESOP period and one observation for each firm for the post-ESOP period, where each
observation reflects the equally-weighted mean of all establishment observations for that firm-
year. We then regress the residuals on the ESOP dummy variables.
Table 5, Column (1) shows a positive and statistically significant coefficient on ESOP,
illustrating the robustness of the significant wage gains following the adoption of ESOPs. In
column (2), we add the indicator for large ESOPs. The coefficient on ESOP hardly changes and
remains significant, while the coefficient on ESOPg5 becomes insignificant. As noted by
20
Bertrand et al. (2004), this type of test has limited power to reject the null. Nevertheless, the
insignificant coefficient for large ESOPs calls for further investigation of large ESOPs, which is
conducted in the later section. There we identify an important sub-group of large ESOP adoptions
followed by wage cuts, while the rest of large ESOPs are associated with wage gains.
C. Worker Mobility
The main inference that can be drawn from our results so far is that employees are
generally better off financially following ESOP adoptions. In this and the following sections, we
provide additional evidence suggesting the relation is causal – that ESOP adoptions cause wage
changes. Because we control for establishment fixed effects, we are controlling for time-invariant
establishment characteristics. Thus, our concern is that a time-varying omitted variable may
predict both the timing of ESOP establishment and future wage changes. For example, a CEO
may expect strong profits in the future and decide to establish an ESOP and increase cash wages
to share these expected gains with his employees. In this case, we would expect to observe higher
wages at ESOP firms even though the ESOP itself did not cause the wage increases.
By contrast, our primary hypothesis is that ESOPs increase productivity through
improved team incentives and co-monitoring and that labor captures a fraction of these gains in
the form of higher wages. To separate this casual interpretation from the non-causal story, we
investigate how shocks in employee mobility affect the division of the gains. We hypothesize that
if ESOPs increase productivity, then the surplus will be shared between employees and
shareholders according to their relative bargaining power. We proxy employees’ bargaining
power by their mobility and predict that employees will capture more of the surplus as their
mobility increases.
C.1. Measuring Mobility
To construct a measure of worker mobility, we assume (1) labor markets are
geographically constrained due to pecuniary and non-pecuniary costs of moving and (2) workers
prefer to remain employed in the same industry due to industry-specific human capital. These
21
assumptions allow us to measure worker mobility within an industry-location pair. We classify
industry by three-digit SIC code and geographic location by Metropolitan Statistical Area (MSA).
Then, we calculate a Herfindahl index of employer concentration for each industry-MSA pair.
This index is created in a manner similar to a traditional sales-based Herfindahl index, except the
measure is based on the fraction of the industry’s workforce employed at establishments owned
by a firm, rather than the fraction of industry sales.
In the first step, we sum the total number of workers at all establishments linked to a firm
for each industry-MSA pair.17
The firm’s share of employees is the number of its employees
divided by the total employees in that industry-MSA pair. The Herfindahl index is then calculated
as the sum of the squares of the employee share of all firms in that industry-MSA pair. This
measure is estimated on an annual basis. Employees at an establishment are defined as having
high (low) mobility if the establishment’s industry and MSA combination has a Herfindahl value
in the bottom (top) sample quartile. We assign indicator variables for high- and low worker
mobility.
C.2. Specification
The specification is the baseline regression with two additional independent variables: the
worker mobility indicator and its interaction with the ESOP dummy. This specification allows us
to interpret the coefficient on the interaction term as the effect on wages at ESOP firms following
an exogenous shock to worker mobility. To do so, we need to 1) ensure the result is not driven by
a firm’s endogenous decision to move and 2) control for any direct relation between worker
mobility and wages affecting all firms in a given industry-location pair.
17 We start by using all establishments included in the Standard Statistical Establishment List (SSEL) available through
the US Census. The SSEL identifies the total count of employees at all public and private U.S. business establishments.
It also includes information on the establishment industry (SIC code) and location (state and county Federal
Information Processing Standard (FIPS) codes). Using the state and county FIPS codes, we map each establishment
located in an MSA to its appropriate MSA. An MSA is defined by the US Census as a geographic area that consists of a
core urban area (which can be as small as 10,000 people) and all surrounding but integrated counties. The link between
FIPS and MSA is provided by the US Census for 1981, 1983, 1990, 1993, and 1999 at:
http://www.census.gov/population/www/metroareas/pastmetro.html. We use the most recent link for each match to
Excluding endogenous changes to worker mobility is important because a firm may
choose to move to locations where worker mobility is higher at times when the firm is better able
to afford higher wages, causing a positive correlation between worker mobility and wages. Our
specification avoids this endogenous change because the Census assigns a new identification
number to any establishment changing location. Consider an establishment moving from a low
worker mobility location to a high worker mobility location. In our data, this is identified as an
establishment in the low-worker mobility location for the years it is located in the first MSA and
then as a separate establishment in the high worker-mobility location in the new MSA for the
years the establishment is located in the second MSA. Thus, assuming no further changes to
worker mobility for this establishment, this establishment will not be reflected in the coefficient
of the high worker mobility dummy. To be reflected in this coefficient, the same establishment
must be observed with both a high and a non-high worker mobility classification. When a firm
moves an establishment, the establishment will be assigned a new identifier after the move, which
means the post-move establishment will have no pre-move observations. Thus, although moves
by firms will affect the local worker mobility, it will not affect our estimate of the coefficient on
the worker mobility dummy variable.
Controlling for the direct relation between worker mobility and wages is also important
because worker mobility may affect wages at all firms, as employees with more bargaining power
demand higher wages. This effect should be stronger at firms recently experiencing a productivity
shock. The fair wage hypothesis of Akerlof and Yellen (1990) suggests employees’ estimation of
a fair wage is made relative to other groups. In our case, shareholders are the benchmark group.
Thus, if ESOPs increase firm surplus and shareholders gain, employees may demand their share.
Such demands are more likely to be met when employees’ external employment opportunities
increase, giving them greater mobility and greater bargaining power. Thus, we expect to observe
wage increases at ESOP firms following an increase in worker mobility. At control firms, we may
also observe a positive relation between wages and increases in worker mobility, however,
23
without a recent productivity shock, there may be little to no new surplus that can be shared. Thus,
this specification is a joint hypothesis test. We expect to observe a significant positive coefficient
on the interaction term of high worker mobility and ESOP if 1) ESOP firms, on average,
experience a productivity shock greater than the average productivity shock at non-ESOP firms
and 2) increased worker mobility enables employees to take a greater share of productivity gains.
C.3. Estimation Results
Table 4, Column 4, includes the indicator for high worker mobility and interacts it with
the ESOP indicator. The interaction term shows a positive and significant coefficient, indicating
that wages at ESOP firms increase as worker mobility increases. Notice that because of
establishment fixed effects in the panel regression, identification is obtained when a non-high-
mobility establishment’s worker mobility increases sufficiently enough to be classified as high-
mobility. Hence, the switches to the top quartile of worker mobility are likely to represent large
increases in employee bargaining power.
This result is consistent with a causal relation between the ESOP and wage increases.
The ESOP leads to an increase in productivity at the firm, creating a surplus. This surplus is then
shared between employees and shareholders according to their relative bargaining power. Such a
finding is not predicted by a selection story in which generous managers time an ESOP
implementation when anticipating greater productivity in the future.
The coefficient on the high worker mobility dummy is insignificant, which may be due to
the presence of offsetting relations between worker mobility and wages for control firms.
Endogenous location decisions may predict a negative relation between our measure of worker
mobility and wages. Firms may choose to enter local labor markets where they anticipate
downward wage pressure in their industry. However, an increase in the demand for industry-
specific skills and worker mobility due to new entries may offset the possible negative relation
due to the location choice.
24
Column 5 includes the indicator for low worker mobility. The interaction term between
the low mobility indicator and the ESOP indicator is insignificant. This implies that ESOP
employers do not take advantage of a decrease in worker mobility to reduce the fraction of
surplus given to employees. The asymmetric results between Columns (4) and (5) could be due to
stickiness in wages. Although employers have to grant higher wages to retain workers with
improved mobility, reducing employees’ share of productivity gains may make it difficult to
sustain the productivity gains, especially if they arise from improved incentive- and team effects.
D. Worker-Management Alliance
Another causal scenario developed in the hypotheses section is that the top management
bribes employees with above-market wages to garner worker support in thwarting hostile
takeover bids (Pagano and Volpin, 2005). This anti-takeover motive is more relevant to large
ESOPs because the number of voting rights matters in takeover battles.
Large ESOPs become more effective anti-takeover devices when states of incorporation
of the ESOP firms enact BCS, providing the incentive for management to strengthen their
alliance with employees. BCS were enacted at the state level in a staggered fashion during our
sample period; New York was the first state to pass it in 1985. Romano (1987) and Bertrand and
Mullainathan (2003) argue that the enactment of BCS is exogenous to most firms incorporated in
the affected states. Using a difference-in-differences like approach, they document significant
increases in wages following the enactment of BCS, which they attribute to management’s pursuit
of quiet lives after BCS relieves them of hostile takeover threats.
To check whether the wage increases accompanying ESOPs are reflecting the state-wide
BCS effect, we estimate the BCS effect on wages in Table 6, column 1. The regression
specification is similar to that in Bertrand and Mullainathan (2003), although data and some
control variables differ. Table 6, Column (1) shows a positive but insignificant coefficient on the
BCS indicator. This result is weaker than that reported by Bertrand and Mullainathan (2003),
perhaps due to different samples. They examine all firms in manufacturing industries over the
25
period 1976-1995, while we cover all industries but limit the sample to ESOP firms and our
matched control firms over the period 1982-2001.
The worker-management alliance hypothesis predicts greater wage gains following the
passage of BCS at firms with large ESOPs in place. Thus, we compare the difference between
large ESOP firms and control firms by adding an interaction term between large ESOPs and the
BCS indicator. The result is reported in Column (2).18
It shows a positive and significant
coefficient, implying that the effect of BCS passage is greater at firms with large ESOPs in place,
in comparison to the control firms or firms with small ESOPs. The coefficients indicate that, on
average, worker wages at firms with large ESOPs increase by 7.3% after the adoption of BCS. In
an unreported regression, we add an interaction term between ESOP and BCS. The result shows
an insignificant coefficient, indicating the positive effect of BCS on wages is unique to large
ESOPs.
These wage increases at large ESOP firms post-BCS imply that management strengthens
its alliance with employees when BCS makes their voting rights through ESOP shares especially
effective in thwarting hostile bids. The results also identify a firm-level channel for the state-wide
BCS effect on wages documented by Bertrand and Mullainathan (2003). In addition, our result is
inconsistent with the non-causal story, which says nothing about possible impacts the passage of
the BCS may have on wages of firms with large ESOPs.
E. Cash Conservation
The third causal scenario developed in the hypotheses section is that some large ESOPs
are motivated to conserve cash by substituting cash wages with company shares. Such ESOPs
18 Column (2) also contains a new control variable, Yeardifg5, which is the number of years since the initiation of a
large ESOP and is set to 0 for firms without large ESOPs. The variable is added to control for possible dilution of the
effect of a large ESOP over time as employees leave the firm with their shares. Because BCS were never repealed, the
average year distance from ESOP initiation for the sample captured in the BCS*ESOP interaction dummy variable will
always be greater than the average year distance from ESOP initiation for the sample captured by the ESOPg5 dummy
variable, raising the possibility that the interaction term could be picking up the dilution effect. That is why Yeardifg5
is added as a control variable.
26
will lead to wage cuts and are most likely to be observed at firms that are cash constrained and
that have difficulty raising external equity through regular channels.
Since small and young firms tend to have more difficulty accessing the market for
external equity, we construct CCindex, a continuous variable measuring how small and young a
firm is relative to the rest of the sample. First, we calculate the distance in firm age and size (total
assets in 2006 dollars) from the sample means. Then, both of these distances are normalized by
the sample standard deviation.19
These two variables are then summed to create a cash
constrained score, which gives higher values to younger and smaller firms. We find the score
highly skewed; thus, we rank firms based on the score. We divide the ranked value by 100 and
define it as CCindex, with the numerical values ranging from 0.01 (the least cash constrained) to
slightly under 10 (the most cash constrained). This variable is calculated for ESOP firms at the
time the ESOP is initiated; for control firms, at the time the firm is matched to an ESOP firm.
The results using this cash constrained score are reported in the last two columns of Table
6. Column (3) adds CCindex to the baseline regression and interacts it with ESOPg5. The
interaction term is negative and significant, indicating that post-ESOP wages are lower, the more
cash constrained an ESOP initiating firm is at the time of an ESOP adoption. The coefficients on
ESOP, ESOPg5, and CCindex*ESOPg5 indicate substantial wage cuts following large ESOPs
implemented by cash constrained firms. However, those implemented by least cash constrained
firms (i.e., those with the lowest ranking in CCindex) are followed by wage increases.20
To investigate whether the cash constraint hypothesis also applies to small ESOPs,
Column (4) adds the interaction term CCindex*ESOP, which shows an insignificant coefficient. It
appears the cash conservation motive applies mainly to large ESOPs. If a firm chooses to use
19 For firm age, this variable is calculated as: [Firm age – mean age]/sample standard deviation of age. The same
normalization process is used for firm size. 20 The 100 least constrained firms represent roughly the bottom deciles out of 946 ESOP and control firms, with
CCindex values ranging from 0.01 to 1. For a CCindex value equal 1, the coefficients imply about a 0.9% average
wage increase.
27
ESOPs as a means to conserve cash, it is unlikely to do it through small ESOPs, which by
definition means issuing less than 5% of equity.
In sum, lower post-ESOP wage gains associated with large ESOPs appear to be driven by
the substitution of cash wages with ESOP shares by cash constrained firms with limited access to
external equity. Large ESOP adoptions by the least constrained firms are followed by positive
cash wage increases. Although the magnitude is smaller than the wage gains associated with
small ESOPs, employees receive more company shares through large ESOPs than small ESOPs.
Therefore, we conclude that ESOPs are followed by significant increases in employee
compensation, except for large ESOPs by small and young firms.
IV. Firm Valuation
Our investigation of wage changes shows that employees are in general better off with
ESOPs. This is consistent with our hypothesis that ESOPs increase worker productivity through
improved team incentives and co-monitoring and workers capture a share of the productivity
gains. This causal interpretation is buttressed by the evidence that worker wages at ESOP firms
increase as worker mobility increases. However, our evidence does not rule out the possibility
that employees gain at the expense of shareholders through their control rights newly bestowed
through ESOPs. In this section, we address this issue by investigating how ESOPs affect
shareholder value.
Firm valuation is proxied by industry-adjusted Tobin’s Q. Q is measured as fiscal
yearend market value of equity plus market value of preferred stock plus total liabilities divided
by the book value of total assets. Following Bebchuk and Cohen (2005), we measure industry-
adjusted Q by subtracting the median Q matched by industry (three-digit SIC code) and year. The