As the Russian economic crisis intensifies, with increasing frequency people are questioning and will continue to question whether the existing system of property ownership and production management is the right one in general, and to ask how it can be changed. The results of the present version of oligarchic capitalism have been such that only people who possess, as our politically correct Western colleagues put it, “a high level of alternative talent” now undertake to openly defend the rationale for its existence. However, the majority of the suggested improvements boil down to a return to state ownership of the means of production in one form or another. At the same time, people somehow forget the recent experience of the last years of the USSR, an experience that it is difficult to call exclusively positive.
It is interesting that the advocates of the two approaches, despite their seemingly diametrically opposed views of things, wholly agree on one point. Both think that most people need some kind of overseer or foreman who will determine what they actually have to do, based on some sort of reasons external to these people. In one case, this is the oligarch capitalist, and in the other, it is the state bureaucrats appointed to manage a given industrial installation. For some reason, it is thought that the solutions of these overseers will be more effective from the standpoint of the common good, though historical experience often indicates the complete opposite.
There is an alternative approach, however, one that has been well known in the United States for quite some time and now is gaining familiarity in Europe as well. This approach is linked with the name of the banker Louis O. Kelso, the first person to develop a financial mechanism that ensures workers the opportunity to become owners of their employer company without having at their disposal the sums of money needed for direct purchase of the company but incommensurate with their wages.
When Louis Kelso was 16, America’s Great Depression began. This unhappy experience prompted him later to think long and hard about the economic causes of the growing property disparity between the few large owners of businesses and the bulk of the population, rapidly growing poorer, as well as about the consequences ensuing from this. In the process of these reflections, he became acquainted with the American philosopher Mortimer Adler, and in collaboration with him wrote an extremely interesting work, The Capitalist Manifesto. In this book, it was asserted that the author of the Communist Manifesto, Karl Marx, was basically completely correct in his analysis of the capitalist mode of production, but absolutely illogical in his conclusions. In fact, by describing the mechanism of the concentration of capital in the hands of a few and the antidemocratic consequences of increasing the level of such concentration—consequences reflected in the increased exploitation of the workers, loss of their social rights, and further impoverishment—Karl Marx drew the completely illogical conclusion that to struggle against this, one must increase the concentration of capital to the limit, by placing it in the hands of the state and making the state an absolute oligarch. As Kelso and Adler saw it, the far more natural conclusion that followed was that to overcome the negative consequences, one must decrease the concentration of capital, by creating conditions in which every worker is simultaneously also an owner of capital.
Painter: Viktor Tikhomirov
However, if workers are to become co-owners, they must buy part of the capital from the company owner. For that, they would need sums of money incommensurate with what they could save from their pay as employees. And then Louis Kelso, a professional financier, devised and proposed for that purpose a financial scheme that now, in a similar form, is widely used in investment financing and well known under the name LBO (Leveraged Buy-Out). In 1956, this scheme was employed in California, in Palo Alto, where the publisher of a profitable group of local newspapers promised his employees that when he retired they would be given “first right of refusal”: the first chance to purchase the business. This is considered the first successful experience of using an ESOP (Employee Stock Ownership Plan). Thanks to this plan, the newspaper’s employees were able to buy 72% of the shares without spending a penny of their own savings.
In brief (and in simplified terms), the mechanism for putting an ESOP into effect boils down to the following: The employees set up a trust (equivalent to a managing company), which on their behalf takes out a bank loan and buys shares in the enterprise. These same shares function as collateral for the loan. Further, the dividends due on these shares go toward paying the interest on the loan and paying off the principal. As the loan is repaid, the shares are released as collateral and distributed to the personal accounts of the company employees in the trust. In principle, the mechanism is similar to that used in an MBO (Management Buy-Out); however, it includes not only the group of top managers, but also all the company employees.
Of course, in practice this mechanism is far more complicated, primarily in the details of optimizing taxation. Recognition of the social significance of the problem resulted in the U.S. Congress’s passage in 1974 of a legislation package (known as ERISA) giving substantial tax advantages to companies and banks that put ESOP plans into effect.
After freeing the shares from use as collateral, the ESOP trust participates in managing the company as a shareholder, nominating its representatives for the board of directors, and taking part in the work of shareholders’ meetings. Dividends on the shares are distributed by the trust among the employees. To prevent dispersal of the shares, certain restrictions usually are placed on the disposal of them: for example, an employee does not have the right to sell his/her shares while employed at the company. He or she can sell them upon leaving the company or retiring. At this time the employee receives a fairly substantial sum, often exceeding his/her pension fund.
At present, more than 10 million workers in the United States are involved in ESOP plans. The well-known large companies that have introduced them include Polaroid, Chevron, McDonnell Douglas, Proctor and Gamble, Lockheed, and others.
Taking into account the scale of this phenomenon and the activeness of its enthusiasts in the United States, it is surprising that in Russian economic publications for a broad audience, information about ESOPs is virtually absent. In Soviet times, of course, any reference to the Capitalist Manifesto smacked of obvious anti-Sovietism. However, why the information continued to be absent even in later times is a puzzle, considering that the widow of Louis Kelso, Patricia, repeatedly has traveled to Russia, and with her active cooperation a translation of the book coauthored by her and her husband, Democracy and Economic Power, was published.
This book, incidentally, can be recommended for reading to anyone interested in modern economics, since the authors not only describe in detail the essence and mechanisms of an ESOP, but also give their own interesting fundamental analysis of the processes leading to crises similar to the present one.
Over the course of its more than 50-year history, the ESOP concept has proved its effectiveness many times over, sometimes even in cases when a company was close to bankruptcy. The accumulated statistics allow us to say with certainty that the economic indicators of a company practically always improve after the buy-out. This undoubtedly has to do primarily with the change in the nature of the employees’ motivation.
By becoming the owner of a block of shares, an employee becomes vitally interested in increasing the company’s profit and, what is even more important, in growing its long-term capitalization. It is well known that the leaders of companies often try to motivate their employees by giving them various bonuses tied to the amount of profit. However, here the employees have absolutely no stake in the long-term growth of capitalization, and besides, a conflict of interests arises, expressed in the fact that long-term growth of capitalization may be sacrificed in favor of a momentary increase in profit. In addition, when these bonuses are determined by the company leadership, which can both give and stop giving them, the employees still remain without rights and sense this fact.
Unlike the majority of cases, in which some of the shares of the company are controlled by small shareholders who have practically no influence on the managing of the enterprise, in the case of an ESOP the trust consolidates the employees’ shares into a significant parcel and participates in management as a unified whole, effectively representing the interests of the employees. Usually professionals are engaged to run the trust, and consequently they take part in the work of the board of directors on behalf of the employees. In principle, one can say that the mechanism for the employees’ participation in management is analogous to the democratic system of political governance, the difference being that because the object of management is far smaller in size, the probability of abuses and deception of the voters is far lower. In their book, Louis and Patricia Kelso call the ESOP concept the “missing half of democracy,” meaning that political democracy signifies little when people without economic rights are trying to put it into effect, and wide use of ESOPs makes democracy really worthy of its name.
One can say that participating in an ESOP radically alters the status of an employee. He is turned from a day laborer into a partner with equal rights. His labor not only gives him pay, but also is accumulated in the capital of the company, a share of which he can later receive in the form of money, while his right is guaranteed by law and does not depend on anyone’s goodwill. He, along with other employees, can influence the determination of the company’s strategy. Of course, this is associated with restrictions and shortcomings, which are present in any democratic mechanism, but with carefully developed procedure, the probability that this mechanism will work effectively is extremely high, as practice indicates.
Of course, everything set forth above makes sense if the company is profitable, but in the majority of cases this already is in the hands of the company’s leaders and its employees. And the mechanism for participation in management gives the employees an opportunity to have an influence on that. But again, practice indicates that usually they do this rather effectively. Of course, this requires certain additional intellectual efforts. Here the attitude “I do what’s written in the instructions, but you guarantee to provide me wages,” of course, is also possible, but then, most likely, one cannot expect any special miracles.
Let us return to the situation in the Russian economy. We have no wish to subject to detailed analysis all the negative trends and factors that are in play today – this is an unhappy task and would take up a great deal of space. We will limit ourselves to the general assertion that the situation is extremely sad, and accomplishing some positive changes will require the active participation of as many people as possible, both from the standpoint of exercising the collective intellect in search of a solution, and from the standpoint of direct participation in daily activity. However, the hope that the masses suddenly will be ablaze with enthusiasm, drop everything, and start thinking and working day and night to get Mr. Deripaska or Mr. Abramovich out of debt (the names can be replaced by any you like more or less) smacks of excessive optimism. Therefore it makes sense to search for other approaches. The ESOP concept is a completely acceptable variant of such an approach, and it already has been tested in practice in the United States for half a century. In recent times, European advocates of ESOPs have been very active, creating EFES (European Federation of Employee Share Ownership) and successfully developing the approach, in the former socialist countries as well.
The complexity of large-scale introduction of ESOPs is related to the fact that if it is to work successfully, the state must cooperate in creating the necessary legal basis, including the guarantee of an optimal tax environment (analogous to ERISA), because if this is begun in present-day Russian conditions, there is a chance of being subject to double or even triple taxation, which will ruin it in its initial stages. Although in the rapidly intensifying crisis, the organization of political lobbying for passage of such laws brings to mind the saying, “When you’re ready to go hunting, it’s too late to start feeding the dogs,” it probably is still better late than never, and it makes sense to go about it energetically. Especially as the politicians must understand that the concept being suggested can very seriously improve the political climate and the economic situation in the country, and they ought to be interested in introducing it without delay.
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First, as stated earlier, the ESOP will make it possible to add that “missing half of democracy.” People will obtain a mechanism that allows them to influence the operation of their companies and gives them the certainty that they will be rewarded for their efforts, rather than being left no better off than when they started.
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It will make it possible to influence large numbers of people to work on searching for ways to overcome the crisis “at the regional level”.
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It will allow people of the older generation to have greater confidence in their post-retirement future.
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It will allow people to sense their participation in life in the country and to see more justice in the organization of this life. It is generally known that at the present time, the level of political activity and all other public activity by the bulk of people is extremely low, though this does not suit everyone by any means.
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It will make it possible to find new approaches to solving Russia’s very serious problem of “monocities.”
Probably one can also give examples of other positive consequences of introducing this concept, but the chief one undoubtedly is as follows: The problems in the economy are so serious that they can be solved only by involving the majority of people in this process. For that, one needs an approach that would clearly demonstrate that these people will be equal participants in this process and will be rewarded for their efforts, rather than being builders of the next “bright future” for somebody else. The ESOP concept has proven, in practice, its workability as such an approach. It would be foolish not to try and use it in Russia.
© The U.S. Russia Center for Entrepreneurship
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