Your ESOP Board of Directors: Selection, Roles & Duties That Matter Most

Often, when business owners begin investigating exit strategies and discover the benefits of an employee stock ownership plan (ESOP), they’re running companies without a board of directors in place. 

In fact, it’s common for the business owner to essentially serve all board responsibilities, while also serving as president and/or chief executive.

Other companies may have a board in place that doesn’t actually fulfill the responsibilities of a board of directors. Instead, they’re often operationally focused, making shorter-term business decisions rather than governance decisions with a longer-term, strategic focus.

But making the transition to an ESOP company changes more than the ownership of the business. ESOPs are subject to the Employee Retirement Income Security Act of 1974 (ERISA), which describes fiduciaries and their obligations to ESOP shareholders (in other words, employee-owners).

Implementing an ESOP is an Act of Generosity

I have spent a lot of time talking about the top benefits of implementing an ESOP for a company, the business owner(s), management and key employees, all employees, and the local community.  These benefits include the tax and cash flow benefits and the many competitive benefits of building an ESOP ownership culture.

ESOP Corporate Governance

I talk to a lot of business owners and management that are considering implementing an ESOP and their #1 concern is control. 

On one hand business owners appreciate the control premium that an ESOP can pay for a change in control. 

On the other hand, they are very concerned about the unknown about what a change in control means and doesn’t mean. 

Fast forward a few years and many business owners will tell you that moving to a more formal board with some outside board members was one of the top benefits of implementing an ESOP. 

It is important to understand the corporate governance and ESOP stakeholders, what is an ERISA fiduciary, and the relationship between the ESOP Trustee, Board of Directors, and the ESOP Committee. 

What is Corporate Governance?

Corporate governance is how corporations manage the business affairs of the company to achieve their corporate and shareholder objectives.  

Who are the Corporate Governance Stakeholders?

  • Shareholders– The shareholders are the owners of the company. The primary responsibility of shareholders is to elect the Board of Directors. 
  • Board of Directors– The Board of Directors are responsible for corporate governance and delegate authority to officers/management. The Board represents the Shareholders, is the highest level of management in a company, and is responsible for governing the company. The Board has a corporate fiduciary obligation under state law to the Shareholders. Advising the CEO and succession planning are other key responsibilities.
  • Officers/Management– The officers/management are appointed by the Board to carry out the strategic direction of the company and are responsible for the day-to-day operations of the company.  Management hires the employees for day-to-day operations and to carry out the operational plan.

Who are the ESOP Stakeholders?

  • ESOP Plan Sponsor– The employer that establishes and maintains the ESOP.
  • ESOP Plan Administrator– The individual(s) with authority and discretion over the management of the plan. Unless another individual or entity (e.g. ESOP Administrative Committee) is specifically assigned, the Plan Sponsor is the legal Plan Administrator and decisions are made by the Board of Directors. The Administrator(s) is an ERISA fiduciary.
  • ESOP Administrative Committee– The ESOP Administrative Committee is usually appointed by the Board of Directors and serves as the Plan Administrator.
  • ESOP Trustee- The ESOP assets, which primarily consist of the stock of the company, are held in a trust and managed by the ESOP Trustee. The ESOP Trustee is the individual(s) with authority and discretion over the plan assets. For most purposes the ESOP Trustee acts as the legal Shareholder of the ESOP.  The ESOP Trustee is an ERISA fiduciary and has a fiduciary duty to act in the sole interest of ESOP Participants, maximizing the long-term value of the assets of the trust (the stock of the company). The ESOP Trustee will often vote according to the direction of the ESOP Administrative Committee. In addition to ERISA, the ESOP Trustee is governed by the Internal Revenue Code, the plan document, and trust document.  
  • ESOP Participants– The ESOP Participants are beneficial owners of the company and generally have limited legal authority.  In most cases the ESOP participants as Shareholders are represented by the ESOP Trustee.  The plan document specifies the voting rules. Unless provided by the plan document, the ESOP Trustee is not required to pass-through decisions such as voting for the Board of Directors, buying or selling stock, and exercising voting rights. In limited cases, such as a significant corporate event (e.g. liquidation, sale of all or substantially all the assets, recapitalization, merger), the ESOP Participants may have the right to have pass-through voting rights on all issues, including the election of the Board.

Corporate Governance eBOOK

What is an ERISA Plan Fiduciary?

A plan fiduciary is a person that exercises discretionary authority or control over the management of the plan or plan assets. ERISA defines the four primary duties of an ERISA fiduciary: 

  • The Exclusive Benefit Rule – An ERISA fiduciary must act solely in the interest of the plan's participants and beneficiaries while defraying reasonable plan expenses.
  • The Prudent Person Standard – An ERISA fiduciary must act with the care, skill, prudence, and diligence under the circumstances that a prudent man acting in a similar capacity...
  • Diversification – An ERISA fiduciary must diversify the investments of the plan unless it is clearly prudent not to, knowing that by definition an ESOP is "Designed To Invest Primarily In Qualifying Employer Securities".  You should also be aware of the ESOP diversification rules.
  • Follow the Plan Documents – A fiduciary must act in accordance with the plan documents.


What is the Relationship
 between the ESOP Trustee, Board of Directors, and the ESOP Committee?

  • The ESOP Trustee is selected by the Board of Directors. 
  • The ESOP Trustee generally votes the ESOP shares for the election of the Board of Directors. The ESOP Trustee will often vote according to the direction of the ESOP Administrative Committee.
  • The ESOP Administrative Committee is usually selected by the Board of Directors and generally consists of members of management. 
  • This "circular" selection process often leaves the same people in charge of the company and the ESOP. 

Building a Sustainable Ownership Culture with ESOP Corporate Governance — Part 1

Many ESOP companies strive to build and sustain a strong ownership culture that will increase shareholder value. Developing an ownership culture is an ongoing process that evolves over time.  A strong ownership culture can be driven by the CEO, sometimes referred to as the keeper of the culture, and the Board of Directors (“Board”) through corporate governance.  This two-part article series will review the various stakeholders in the corporate governance of an ESOP company, explore their roles in the process, and things stakeholders can implement to strengthen the culture.

ESOP Corporate Governance

Corporate governance is how corporations manage the business affairs of the company to achieve their corporate and shareholder objectives.

ESOP Corporate Governance

Corporate governance is how corporations manage the business affairs of the company to achieve their corporate and shareholder objectives. Legal guidance is provided by state law, the articles of incorporation, and the corporate bylaws.

ESOP Corporate Governance

What is corporate governance?

Independent Fiduciaries Do Not Eliminate Liability

We have often discussed the corporate governance conflicts that occur when the same person wears multiple hats (e.g. Seller, Board member, Trustee, etc.). One solution to reduce the conflicts is to engage an independent fiduciary.

Establishing a Non-Fiduciary Board of Advisors

The April 14, 2010 Employee Ownership Update is online and discusses the following:

Implementing a Policy on Unsolicited Offers

Responding to Unsolicited Offers to Buy discusses the issues that the CEO, Board of Directors, and trustees face when an unsolicited offer is received. It talks about how a "not for sale" resolution could make things worse, at least from a trustee perspective. The article suggests a Policy on Unsolicited Offers that should be reviewed and approved by the Board of Directors on a regular basis and provides a template:

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