The producers

They produce money for the company, generate wealth for the investors and
lead to improved productivity by incentivising the workforce. But a spate of
high-profile corporate collapses have tarnished the image of employee share
ownership schemes and left individual employees nursing huge personal losses.
Keith Rodgers investigates

When reality returned to the financial markets three years ago and the
dotcom boom turned to bust, few tears were shed for the thousands of employees
who were left clutching worthless share options. The greed and excess that had
come to characterise the new economy had left a sour taste, and outside the
high-tech sector, those 20- and 30-somethings who’d failed to make their
millions received little sympathy.

In practice, of course, the majority of people who lost out when the bubble
burst weren’t flamboyant entrepreneurs heading internet start-ups, but ordinary
individuals who’d jumped into a thriving new sector. Many had left steady jobs
in exchange for relatively modest salaries, hoping their reward would come
further down the line when their share options kicked in. As such, their option
programmes were serving exactly the purpose they were set up for – providing a
medium-term incentive that rewarded and retained the brightest talent.

Today, it’s not just in Silicon Valley that the mention of share ownership
invokes wry smiles. In December last year, United Airlines sought bankruptcy
protection, signalling the end of the largest experiment in employee ownership
in the US and leaving tens of thousands of employees holding a collective stake
in virtually nothing. And a spate of high-profile corporate collapses on both
sides of the Atlantic has left individual employee shareholders nursing huge
personal losses; many of them watching their life-savings disappear as the
value of their company’s stock tumbled.

While these high-profile collapses have generated a lot of publicity,
advocates of employee ownership have been fighting back hard, pointing to the
numerous success stories that demonstrate how share ownership can work

Share option schemes and stock purchase plans are important weapons in
helping companies develop a culture of ownership, and serve as a valuable tool
in improving retention. They also tend to go hand in hand with more liberal,
open management approaches – although it’s not always clear whether employee
ownership encourages that kind of management style, or vice versa.

So how can organisations get their ownership schemes right? To begin with,
experts counsel them to think clearly about the objectives of any scheme,
particularly in terms of how widely it’s applied. If you’re going to introduce
a selective scheme restricted to certain employees, how will you determine
eligibility? Is it based on seniority, on merit, or on some other criteria?

While companies like Science Applications International Corporation (SAIC)
have developed sophisticated mechanisms to allocate shares on the basis of
individual performance (see ‘the good’ far left), others, like Corey Rosen,
executive director at the National Center for Employee Ownership in California,
argue that it makes more sense to put a scheme in place for everyone and create
a culture of ownership. Schemes designed for employees which ‘add value’
generally reward people at the top but leave a vast swathe of individuals
demotivated, he claims.

In addition, organisations need to establish what the schemes are setting out
to achieve. Most ownership programmes are long-term, designed to retain key
performers over a period of years and generate loyalty through the perception
of ownership. If business priorities are shorter-term, it may be that stock
options or simple profit-share schemes are more suitable. As Michael Keeling,
president of the US ESOP Association, points out: "Most people who have
made a good life out of ownership started a business, stayed with it and nursed
it along."

There are also some important caveats to bear in mind. Organisations need to
manage employee expectations carefully – ownership should generate a feeling of
greater involvement in the company, but that doesn’t mean every management
decision is going to be made by committee. In addition, companies that choose
to go down the share options route need to keep one eye on pending legislation,
particularly a proposal that outstanding options should be treated as expenses
from January 2004. Organisations like the Employee Share Ownership Centre in the
UK are lobbying hard against the proposal, which will hit sectors like hi-tech
particularly hard and impact companies running all-employee schemes.

The good: Merit-based employee ownership at SAIC

If there’s a debate about how widely
employee ownership should be extended and what criteria should be used, Science
Applications International Corporation (SAIC) has put its stake firmly in the
camp of merit-based allocation.

The IT services company, which has 1,000 employees in the UK
and 40,000 worldwide, is one of the most experienced protagonists of employee
ownership, following the principle ever since it was set up in 1969 by CEO Dr
Robert Beyster.

Beyster is reputed to have been frustrated at his previous
company that profits his department was generating were being reinvested
elsewhere, and set out to build an organisation where those doing the work had
a say in the company’s future.

According to HR director Julia McGlashen, some 90 per cent of
SAIC staff own shares today, which have been awarded or purchased through
several different distribution models.

To begin with, each regional business unit is given a pool of
shares to allocate every year to key employees, based on the recommendation of
divisional managers and subject to approval by a global committee. Only those
who have made an ‘outstanding’ contribution to business goals are eligible. The
global committee ensures that ownership is getting into the hands of the ‘right
people’ – it looks at the amount of stock key employees own as a multiple of
their salary, and may check back if, for example, a relatively new employee is
accumulating a lot of shares.

Second, the company offers a year-end bonus to no more than the
top 50 per cent of employees, comprising a mixture of cash, vested stock (which
they own outright) and vesting (which they gradually get to own over a period
of years). The vesting stock, says McGlashen, is "the glue to tie good
people in". In addition, the company may match share purchases made by key
employees, offering, for example, two shares for every one they buy. A
first-time buyers’ programme has also been established.

Finally, individuals are able to trade shares each quarter. The
price for stock in the privately-held company is determined through a process
that’s approved by the Securities & Exchange Commission, using external
appraisers and factors such as the group’s operating profit.

McGlashen, who recently completed MBA research into the
ownership model, argues that it has contributed to several key business outcomes.

For one thing, she says, it has directly helped reduce
turnover. Five years ago, SAIC launched a programme to improve communications
about the scheme, acknowledging that a one-off training session on something of
this complexity wouldn’t be sufficient to improve take-up. Through a
combination of different communications strategies – using the web, one-to-one
communications, lunchtime briefings and so on – the firm managed to increase
participation and reduce attrition.

McGlashen’s research has also shown that employee owners
generally want to stay at a company and want to be satisfied in their roles –
so when a problem does come up, they tend to resolve it and move on. She also
found that as soon as the value of an employee’s shares reaches 10 per cent of
their salary, it starts to have an impact.

The ugly: Employee ownership and
the collapse of United Airlines

When United Airlines filed for
Chapter 11 Bankruptcy protection in December, it cast a shadow over the
effectiveness of employee ownership projects within major companies.

Signalling the end of the largest employee stock ownership
(ESOP) venture in the US, the collapse prompted questions about how much
responsibility the ownership culture bore for the airline’s demise.

Some observers suggested that United’s unions – whose boardroom
representatives had the right of veto over a number of strategic decisions –
had too much power, reflecting the fact that they controlled 55 per cent of the
company through their ESOP. They also argued the company had caved in to
excessive union demands – United’s pilots were awarded a pay rise in breach of
industry standards.

That view, however, is condemned as too simplistic by share
ownership experts, who point to a range of factors contributing to the
company’s demise, from strategic business decisions to 9/11 and the recession.

Corey Rosen, executive director at the National Center for
Employee Ownership, believes the two sides initially used the ESOP scheme as a
means of achieving different strategic goals. The unions, he says, were
primarily interested in preventing United from breaking up and outsourcing work.

Management, meanwhile, wanted to use ownership as a quid pro
quo for wage concessions. Both sides got what they wanted and to begin with, the
set-up worked well. But despite the best efforts of both sides, the fundamental
disconnect between both sets of goals was never overcome.

This lack of strategic coherence appears to have been reflected
in the way the ESOP scheme was constructed. One of the key components of the
workforce, the flight attendants union, didn’t join. Also, the scheme only
lasted five years, and was effectively frozen in 2000, implying that it was a relatively
short-term measure rather than a unifying force for the long-term.

Most experts agree that the concessions handed over in exchange
for ownership caused resentment, but Rosen says this is nota common approach –
only 1 per cent of companies with ESOPs demand concessions, he says, and most
employees in ESOP schemes are paid more than their peers.

Michael Keeling, president of the ESOP Association, adds that
the collapse United’s ownership project should be seen in a broader
perspective. "In the past 30 years, millions of average Americans have
become stakeholders in the companies they work for. I don’t think one company
is going to change that evolution."

However, experts accept the collapse means there is now no
large public US company majority-owned by its staff, and this has implications
for the share ownership movement.

While ESOP and other schemes have a good track record in
smaller companies, larger organisations present greater logistical challenges.
And although many public companies with 10 or 20 per cent employee ownership
have done well, the quarterly reporting requirements of US public companies
tend to run counter to the long-term perspective that should underpin employee

The bad: the producers

In The Producers, Mel Brooks
Oscar-winning film of 1969, Max Bialystock (Zero Mostel) and Leo Bloom hit upon
the idea of getting people to buy shares in a theatrical production that is
bound to fail. Driven by greed, the pair find the worst play, the worst
director and most inept performers and wait for the production to fail –
thereby not having to repay any money to shareholders. Of course, it doesn’t,
and Springtime for Hitler becomes a runaway Broadway smash hit. The
protagonists end up in jail. A cautionary tale, it was not supposed to be taken
literally, although some of the strategies adopted by big US companies in
recent years would suggest that many CEOs are Mel Brooks fans. Ironically, The
Producers is now a runaway Broadway smash hit (no shares available).

Choosing the right scheme in the UK

Approved and unapproved schemes

Inland Revenue-approved schemes can offer significant benefits
in terms of both personal and corporate tax liability. Normally, exemptions
will be offered on both income tax and National Insurance contributions,
provided employees remain in the scheme for a certain number of years.
Unapproved schemes are typically aimed at the top-tier, where the size of award
takes it outside the scope of the Inland Revenue’s approval system.

Save As You Earn

SAYE schemes offer a large degree of security for employees
compared to traditional share option and purchase plans. According to the
Employee Share Ownership Centre (ESOC), around 1.5 million employees now
participate, with some 1,200 schemes running nationwide.

At the start of the scheme, the employer offers staff the
option to buy shares, usually at a discount to the prevailing price. Employees
then put up to £250 each month into a savings plan for a period of three or
five years. At any time staff can stop the scheme and remove any money put into
the scheme, or if they keep the scheme going they can make big returns by
converting the money into shares. As ESOC director Fred Hackworth points out,
if the shares have increased in value at the end of that period, employees can
take up their option and then sell the shares for a tidy profit. But if the
price has gone down, employees still have the money saved along with the
interest it accrued.

Share Incentive Plan

While SAYE centres on options, the Share Incentive Plan is
designed for stock purchases, and offers tax breaks by allowing employees to
buy shares out of their gross salary. Shares have to be held for five years to
gain the maximum tax advantage. The problem, particularly in the current
economic environment, is that unlike the SAYE scheme, there is no safety net if
the share price collapses.  

As Hackworth points out, companies are encouraged to offer free
shares to match each one purchased by an employee, a process that mitigates the
impact of a share decline. But few organisations have done so. Unlike other
schemes, companies can also award shares on the basis of individual
performance. But this, says Hackworth, is a complex process and the Government
and Inland Revenue are under pressure to make it more user-friendly.

Company Share Option Plan

Typically used by companies with a large number of lower-paid
employees, such as in the retail environment, CSOP schemes consist of one-off
option grants, where no money is laid out upfront.

Enterprise Management Incentives

A successful scheme designed to help high-tech and other young
companies, Enterprise Management Incentives are aimed at smaller companies,
where the total market value of options outstanding must not exceed £3m. They
provide a tax shield for share options.

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