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We have spent some time examining Why the Number of ESOPs is not Growing at a Faster Rate. One of the major components of the number of ESOPs is the ESOP termination rate. The second phase of a recent ESOP Plan Termination study found that less than 2% of ESOP companies terminated their ESOP each year. While a common perception is that the repurchase obligation is the primary reason for ESOP termination, the study found that over half of the ESOP terminations are a result of receiving an attractive offer the company could not turn down, even though they could handle the repurchase obligation. Other reasons included the aforementioned repurchase obligation, dissatisfaction with the ESOP, and financial difficulties of the company.

Sustainability of ESOP Companies Debate Intensifies discusses the sustainability of ESOPs and asks if there is "something about the ESOP model of employee ownership that makes it impossible to sustain employee ownership through an ESOP more than 10 to 15 years" and explores reasons why ESOPs are being terminated:

  1. The trustee is required to maximize the value of plan assets, causing them to accept attractive offers to purchase the company:

    Another issue of sustainability comes up with dealing with the ERISA law that the trustee of the ESOP is to maximize the value of plan assets, putting into play the question of does the trustee accept any offer to purchase the company that increases account balances? Can sustainability be changed with a tweak in ERISA law for ESOPs? Is such a tweak desired, or even obtainable given that this law is not a tax law, but a law that would be in the Congressional labor committees which do not have a history of being favorable to ESOPs as retirement savings take priority over the ESOP's ownership purpose, in the labor committees.

    As we discussed above, this is the biggest reason for ESOP termination.

  2. The company cannot support the repurchase obligation or would prefer to utilize their cash for other purposes.

  3. The second generation of leadership doesn't support the ESOP (even though they were likely selected by the same leadership that established the ESOP):

    The most intriguing one is about how the first generation of ESOP managers, particularly the first CEO of the company when it became ESOP, who loves being ESOP, plans for a succession that results in a new CEO who also values employee ownership? ESOP Association records show that many ESOP companies that drop membership in the Association due to ESOP termination have a characteristic that is simply that the company's first ESOP CEO, and sometimes CFO, have been succeeded with what is called second generation ESOP company management. Often these men and women, in the second generation, see the ESOP as a hindrance to proper use of the companies capital because repurchase obligations are soaking up so much of its available capital. Oddly, often the first generation ESOP leaders hand pick their successors, and assume that their successors will be pro-ESOP.

  4. The participants have been effectively split into a group of "haves" and "have-nots", resulting in the latter group not having the same level of participation in the ESOP. This problem can occur in mature ESOPs when the ESOP loan has been paid in full and the company hasn't adjusted its allocation strategy accordingly to ensure that new employees do not become "lesser" owners than the senior employees that were around when the loan was being repaid.

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