Weekly Thoughts


Weekly Thoughts: Do You Even ESOP, Bro?

Here is something that caught our eye this week:

Do You Even ESOP, Bro?

What do Cod Vessels, John Rockefeller, and KKR have in common?

In the past year, we have spent a lot of time studying various incentive systems.  At first, our focus was on management incentive programs — like how Berkshire Hathaway compensates its CEOs — but our reading has recently turned toward understanding more broad-based employee ownership plans, which has taken us down something of an American history rabbit hole.

Our evening reading has been a bit of a throwback to our college days studying for enthralling courses with names like The Political Economies of Post-Revolutionary America: 1782-1840, since, as it turns out, the idea of sharing ownership with employees dates back to the Founding Fathers, and at its roots, is a distinctly American idea.  As Richard Freeman and Joseph Blasi, authors of The Citizen’s Share: Putting Ownership Back into Democracyexplained to PBS:

“But in researching the book, the biggest surprise was that citizen ownership — often stigmatized as ‘socialist’ or pie in the sky — has a pedigree stretching back to the American Revolution.  And it wasn’t just James Madison and John Adams. Other be-wigged early presidents of the U.S. and half the crew on Mt. Rushmore — George Washington and Thomas Jefferson — believed that U.S. democracy would work best if citizens had a broad-based ownership stake in the economy.  They too feared that extreme property inequality would prevent America from fulfilling its promise.”

The underlying premise here was that an ownership stake — whether it be of land, or business — promotes self-sufficiency, which enables the pursuit of life, liberty, and happiness.  Since the primary form of productive capital at the time was property, many of the Founders’ Post-Revolutionary policies favored the distribution of land as a form of broad-based ownership.  Increased land ownership after the Louisiana Purchase, land grants to Revolutionary War veterans, and the outlaw of primogeniture all contributed to this end.  However, these policies did not stop with land, as explained by The Atlantic:

“The founders also favored workers over owners, which helped [keep] a class of non-owners economically empowered. According to The Citizen’s Share, after the cod stock was decimated by the Revolution, Jefferson proposed a tax credit for cod vessels to help jumpstart the industry.  He wasn’t sure, though, whether the credit should go to the owners of the vessels, or to the crew of the vessels, who were also suffering financially. In 1792, Congress passed a law mandating that five-eighths of the credit go to the crew, and three-eighths go to the owners. Those who controlled the means of production were regulated, then, from taking too big a share.  ‘The leaders of the new Republic were not swayed by the cod fishery’s owners and financiers, who no doubt had the eighteenth century equivalent of K Street lobbyists pressing their cause,’ the authors of The Citizen’s Share write.”

Of course, the following centuries saw America shift from an agrarian-based economy to a manufacturing and service-based economy.  In this paradigm, the corollary to having property ownership is having a share in the income generated from business operations.  Interestingly, despite the negative connotations associated with turn-of-the-century industrialists, some of those individuals are credited with the creation of modern programs that allow employees to share in corporate profits.  As Freeman and Blasi explain, “Some famous industrialists — Charles Pillsbury of the Pillsbury Flour Mills, William Cooper Procter of Procter & Gamble, John Rockefeller of Standard Oil, George Eastman of Eastman Kodak (who invented the broad-based stock option idea in high-tech companies in the 1920s) — developed low-risk ways for employees to acquire corporate shares of their companies’ stock or profits.”

Fast forward to today, when almost half of American private sector employees participate in some form of “shared capitalism”, which means they participate in some type of compensation that is directly tied to workplace or company performance.  Of course, there are many ways for a business to share ownership with employees, and each of these come in various shapes and sizes — profit-sharing, growth-sharing, stock options, stock grants, employee stock ownership plans (ESOPs), etc., — and many believe that this ownership share should be much more available.

That’s because there are strong linkages between shared capitalism, workplace culture, and in turn, firm performance for companies of all types.  It isn’t about redistribution from owners to employees, it’s about growing the pie for everybody.  One such anecdote we have enjoyed reading about is that of KKR’s Industrials Unit, which has established a compelling equity sharing model, which extends to every employee in its US manufacturing operations.  Of course, KKR isn’t doing this out of the kindness of their hearts.  They are doing this because it’s good business. Pete Stavros, Head of Industrials, explains the philosophy behind this approach:

“One thing that is unique about industrials is that our companies tend to have a very large number of hourly workers who are absolutely critical to the success of the company but sometimes may not feel valued. These are the people working in the plants, for example, so they play a large role in determining product quality, on-time delivery, productivity and other things critical to the end result or product. Considering our entire investment thesis often rests on improving these key metrics like productivity and quality, there is no question that these critical employees need to be engaged.”

While Stravos reports some confusion and skepticism about the program at its outset, they now have a track record of using this ownership program as a mechanism for employee engagement, and many employees have benefited from large dividend and exit payments. And it has worked:

“The performance of these investments has been strong, both financially and operationally. We’ve invested nearly $4 billion of equity in investments utilizing this approach and the current value is worth more than 3x that amount. From an operational standpoint, we’ve been able to meaningfully improve the performance of the businesses, oftentimes in a truly transformational manner.”

For Chenmark, we can see the benefits of deploying some sort of shared capitalism mechanism in our companies.  That said, we are taking our time studying our options, as it’s also clear to us that a poorly implemented plan can have unintended consequences, or can be perceived negatively without the appropriate attention paid to educational support or transparent reporting.  Ideally we will be able to architect a solution that provides for significant, broad based employee participation in company outcomes while also clearly highlighting how specific daily behavior can translate into improved financial upside for the individual and the company.  We have our work cut out for us, but we are certainly optimistic about the direction in which we are headed. So, bring on that Post-Revolutionary final, we’re ready.

Have a great week,

Your Chenmark Team

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