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ESOPs have an advantage during a recession

Nov 09, 2020

Companies with Employee Stock-Ownership Plans (ESOPs) might have a better chance of surviving recessions compared to companies that don’t have an ESOP, according to Ana Fidan Kurtulus and Douglas L. Kruse, who wrote How Did Employee Ownership Firms Weather the Last Two Recessions?  The authors compared ESOP company data with Standard & Poor’s (S&P) national data on publicly traded firms from 1999-2010. 

In the data, they found better odds for survival in employee-owned firms.  In any given year, the likelihood of disappearance was 5.2 percent for firms with ESOPs, compared to 7.6 percent for firms without employee ownership.  When bankruptcy or liquidation were involved, the likelihood of disappearance was twice as high for companies with no employee ownership (.4 percent compared to .2 percent).

Their research shows a correlation, not causation, but regardless it is encouraging for companies with ESOPs.  

Other support for employee-owned firms comes from a study by the McDonough School of Business at Georgetown University, which showed that S-corporation ESOPs (S-ESOPs) can particularly thrive during a recession.  

During the 2008 recession, Georgetown’s researchers said S-ESOP companies performed better than non-S-ESOP firms along a number of dimensions, including job creation, revenue growth, and providing for workers’ retirement security.  S-ESOPs not only helped their workers with retirement, they also hired during the recession when other companies were cutting jobs. 

Having an ESOP is often an advantage for companies. But just having an ESOP isn’t enough to weather the storm alone.  Here are some practical tips for managing an ESOP through a recession and toward recovery: 

Apply for loan forgiveness

The U.S. Small Business Administration (SBA) is administering the Paycheck Protection Program (PPP) which provided loans to small businesses so they could keep employees on their payroll.  The PPP closed in August, but eligible companies can apply for loan forgiveness if they took out a loan under this program.  Getting part or all of the loan forgiven decreases financial burden and frees up money for investment back into the company. 

Involve employees in the decision-making process

Traditionally, companies consider furloughs or layoffs when they’re faced with a budgetary shortfall.  However, companies with an ESOP can put the dilemma and decision to their employees, who may come up with creative alternatives such as a temporary wage reduction, moving to a four-day week, or forgoing bonuses.  When employees feel like they have a say in how the company is managed, they become more invested in helping it succeed. 

Making smart changes if needed

If a reduction in workforce is necessary, or if there's an anticipated high retirement rate forthcoming, a company may have to pay out part of its ESOP.  This can cause a cash-flow issue.  In order to avoid potential problems, companies can make changes to the ESOP and its distribution policies, if trustees, administrators, employees and legal counsel agree.  Always fully vet changes to the ESOP before taking action; failure to do so could lead to legal consequences.

Recessions come in cycles with upswing in the economy generally following.  Research has indicated that companies with an ESOP in place have better odds of survival.  Management should focus on keeping the lines of communication open while you plan for the economy to recover. 

An employee-centric approach means everyone has a say in the outcome of the company and works toward this outcome together.  Plus, the company is positioned to benefit when the economy recovers because they have experienced employee who can immediately take advantage of market opportunities. 

How Wipfli can help

Our teams provide clarity and confidence when evaluating your ESOP. See our ESOP Services web page to learn more or read these additional ESOP articles: 

5 reasons companies are choosing ESOP structure
How to avoid biggest mistakes in ESOP valuations
How to manage your ESOP during COVID-19
Developing owner-employees in your ESOP
Is there a problem with your ESOP?

Author(s)

Francis P. Egan, CFA, ASA
Senior Manager, Valuation Litigation and Transaction Services
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