tering the Plan far exceed the amount that may be charged to the Trust. Trustee's fees will exceed $50,000 annually. Mailing costs of quarterly and annual reports to participants are estimated at more than $28,000. These estimates do not include the costs of forms, printing reports, and administrative expenses.

Our broad eligibility approach also creates administrative complexities. We find that because of turnover, retirements, resignations, etc., to identify our approximately 40,000 eligible employees, we will have to deal with about 55,000 employee files. This is both a computer programming problem and an added clerical expense. And as employees leave the Company or otherwise become eligible for receiving their shares, the stock transfer volume and stockholder lists will increase materially. Since we will be adding thousands of new shareholders, there will be much additional paper work to be done.

For the most part each employee will have only a small number of sharesat least for the near future. Since it is expensive to sell a small number of shares on the exchange, an option to convert such shares to cash upon withdrawal from the Plan may be more desirable than requiring that stock be distributed with a subsequent sale. If an employee leaves the Company with only a few shares in his account, it may be more convenient to let him take the cash equivalent if that better suits his financial program.

Because of our broad, Company-wide participation, the option of computing the Company's credit on the basis of the aggregate participants' compensation is logical and desirable as set forth in Section 44C (a) (2) of S. 3241.

Most of our employees are subject to the Railway Labor Act and have representatives who bargain for them under that Act. While as a practical matter one would think unions would encourage and welcome ESOP's, it is oversimplifying the complexities and variables of collective bargaining to assume that. I suggest that ESOP's should be completely outside of the realm of collective bargaining, and, therefore, believe that Section 416 (a) (15) on page 14 of S. 3241, giving the bargaining representative the right to decline coverage, is undesirable We are looking forward to having a qualified ESOP with all of our labor force involved. We believe in the national policy which makes it possible, and the modifications in the law contemplated in S. 3241 which I have mentioned are constructive.

I will be pleased to answer any questions you have about Southern Pacific's plan.

Senator GRAVEL. Our next witness is Jonathan Conrad, First Pennsylvania Bank.

Mr. Conrad?

STATEMENT OF JONATHAN M. CONRAD, FIRST PENNSYLVANIA BANK, N.A.

Mr. CONRAD. I am a corporate lending officer in the national department of the First Pennsylvania Bank, N.A., which is a major part of the First Pennsylvania Corp., a bank holding company with $8.5 billion worth of assets. My function includes lending money to corporate clients, primarily middle market companies with sales or revenues ranging from $20 million to $200 million, although some clients may range higher in the Fortune 1,000.

This function also includes being the bank's ESOP's corporate lending specialist.

The bank and I appreciate the opportunity to testify before you today on this most important subject. I will summarize my statement at this time and request that my full written statement be included in the record.

The CHAIRMAN. Mr. Conrad, I sure am happy to have you with us today. We very much appreciate your thoughtful suggestions. We will be pleased to hear your statement.

Mr. CONRAD. In regard to the recently introduced S. 3241, ExpandedEmployee Stock Ownership Act of 1978, I agree that the major incentives provided in this bill are necessary to encourage companies to dis

tribute stockownership to their employees. I personally support this bill and feel it will be a major step in ESOP legislation.

As an ESOP lending specialist, I have, of course, a direct interest in seeing ESOP's encouraged, but I also feel that the infusion of capital, as well as the formation of capital, for a private market economy is essential, including motivating workers for more productivity. There are important issues surrounding leveraged ESOP's and ESOP's in general which I will address. In short, they are: The ESOP is a valuable instrument of corporate finance and can be used as an alternate way to raise capital, coupled with employee ownership and motivation. Banks have been reluctant and slow in getting into the area of ESOP financing, but the regulatory environment has improved, and that situation has changed.

The ESOP can improve a company's balance sheet, but further changes and incentives will help ESOP's make more sense to business. A sense of permanence in ESOP legislation is important in the business community's perspective. Increasing tax incentives, particularly for the contributions to the ESOP, will make ESOP's more flexible for business.

I am sure that the recently introduced Expanded Stock Ownership Act of 1978, under which the tax credit would be increased to 2 percent from the 1 percent presently available, is creating a major incentive for corporations to set up ESOP's in general. It is likely to double the employee's stake in the company.

First, like any employee benefit plan, the tax credit ESOP should become a permanent provision under the code beyond the present 1981 expiration period. The act would make it a permanent provision.

During the past year, I have had the opportunity to develop an ESOP specialization, and as a banker, I have found that the classic leveraged ESOP, where the loan is made to the trust, makes more sense to middle market companies which have revenues from $5 million to $200 million and need to borrow money.

The larger companies-those in the Fortune 500 which range in the $355 million to $55 billion revenues, I have found to be generally more conscious than the middle market companies of the effect ESOP's have on dilution.

Large publicly held companies are particularly concerned with how their public stockholders perceive them. For this reason, I have found that the leveraged ESOP is usually more appropriate to middle market companies and the tax credit ESOP is more suitable for larger companies which have large capital expenditures, enabling them to take advantage of the tax credit for ESOP contributions.

At this time I would like to recommend three changes and additions, one of which is not legislative.

First, the provision in the Expanded Employee Stock Ownership Act of 1978, which would allow tax deductions for dividends paid by corporations on shares of its stock held by an ESOP, unquestionably would provide a major financial incentive. As a banker, I can tell you that this would increase cash flow and, in turn, cash flow is a key to increasing the earnings of the company. That would also minimize dilution and there has been some criticism in that area, but I think we are going to see less of it with that.

Second, dilution would be minimized if the accounting profession could be persuaded to change its approach to the calculation of earnings per share. I recommend that the Senate Committee on Finance open up communications, if possible, with the accounting standards division of the American Institute of Certified Public Accountants. I discuss this in detail in my written testimony.

Further, at present deductions for contributions to an ESOP trust may not be greater than 15 percent of the covered payroll. I feel it is necessary to increase this deduction limit, and I feel that without it, there could be adverse effects on a company's financial position, particularly when the company makes contributions beyond the 15 percent. It is my understanding that Senator Gravel addresses this problem in his recent bill.

One of the areas which for ESOP provides an excellent opportunity, and a statistic that I came across that I found fascinating, is that there are over 200,000 privately owned corporations in this country with revenues in excess of $1 million. ESOP unquestionably is particularly useful for these companies. On one hand, it creates a market for their stock where no market exists and two, it solves the estate problems for the majority stockholder. And I have found in discussions with management in these companies that they are particularly interested in keeping their companies in the hands of their employees, rather than giving them away to their competition.

Generally, the question has been asked, why have banks been reluctant and slow to get into ESOP financing? I am sure that the initial problem was that the legislation was new and the concept complex. This atmosphere of confusion and mystery has been dispelled. Generally, prior to the 1977 final Internal Revenue Code regulations, it was very difficult, if not impossible, for banks to make ESOP loans.

The final Internal Revenue Code regulations relating to ESOP's should be a major incentive to banks participating in ESOP transactions. They provide definitive rules relating to ESOP loans.

The use of leveraged ESOPs, in my opinion, should increase dramatically. First, in a very difficult regulatory period just discussed, a UCLA survey of employee stockownership plans, dated December 1977, found that of 180 ESOP companies surveyed, 60 percent had leveraged ESOP's and 84 percent were nonleveraged. I feel the percentage of leveraged ESOP's in this study is encouraging, considering the prior regulatory environment.

At present, there are many incentives for establishing ESOP's. However, with the changes recently introduced in the Expanded Employee Stock Ownrship Act of 1978, coupled with other changes mentioned in my testimony, I have no doubt that many more companies will adopt ESOP's and hundreds of thousands of workers in this country will benefit from it. The sense of permanence in ESOP legislation will also be a major step in this direction.

In summary, what makes good sense to business will surely make good sense to banks in this country.

The CHAIRMAN. Thank you very much, Mr. Conrad. Let me ask you about one other thing. Your advice would be helpful.

It occurs to me that we might manage to find a way whereby somebody could insure, at least to some degree, the loss in value of the stock held by employee stock ownership trusts and if that type thing were

done, perhaps encouraged by the tax laws, then perhaps it would be easier to leverage stock ownship plans so as to have a larger share for the employees.

Now, do you have any thoughts along that line?

Mr. CONRAD. Yes; I do. This gets back to my last comment. My experience over the last year in making these loans to ESOP's and my initial problems with my senior management at the bank, who now are convinced, was that traditionally in the early stages of the ESOP legislation, people just looked to the trust and they took stock as collateral, and there were problems in taking that stock because of the fluctuations in value of the stock.

Now, with the regulations and it is just a matter of time before more banks catch onto this—it is really possible to look directly to the corporation and secure yourself as a senior creditor, just like any other bank does, because with a special guarantee arrangement, I lend to these ESOP's and I take financial covenants. I even can take security, and I am a creditor like any other creditor at the balance sheet level, even though my funds pass through the ESOP.

So, consequently, I really feel that the word is going to get out on the way you can do it right now. I think the legislation is here.

I think it is just the banks sometimes are slow in moving, and I think as the other banks are being more successful, they are going to pick up on this.

The CHAIRMAN. Is that a technique that you are using now to make loans?

Mr. CONRAD. That is correct. An opinion from outside counsel indicated that this is perfectly acceptable with all lending standards. We give it a different name, but essentially it is a guarantee with financial covenants. It is just like any term loan agreement.

The CHAIRMAN. What we need is more people like yourself who show us how the problem can be solved, even without legislation, and we very much appreciate what you are doing in the area and what you have done to finance it.

Thank you very much, sir.

Mr. CONRAD. Thank you.

[The prepared statment of Mr. Conrad follows:]

STATEMENT OF MR. JONATHAN M. CONRAD, CORPORATE BANK LENDER

My name is Jonathan Conrad.* I am a Corporate Lending Officer in the National Department of First Pennsylvania Bank N.A. which is a major part of the First Pennsylvania Corporation, a bank holding company, with $8.5 billion in assets. My function includes lending money in general to corporate clientsprimarily middle market companies with sales or revenues ranging from $20200 million, although some clients may range higher in the Fortune 1000. This function also includes being the bank's ESOP Corporate Lending Specialist.

In regard to the recently introduced S. 3241, Expanded Employee Stock Ownership Act of 1978, I agree that the major incentives provided in the bill are necessary to encourage many more companies to distribute stock ownership to their employees. I personally support this bill and feel it will be a major step in ESOP legislation. As an ESOP pending specialist, I have of course a direct interest in seeing ESOPS encouraged, but I also feel diffusion of capital as well as the formation of capital for a private market economy is essential.

*The views and opinions expressed herein are solely those of the author and do not necessarily represent those of First Pennsylvania Bank N.Ă.

HOW APPLICABLE ARE ESOP'S AS A TOOL OF CORPORATE FINANCE?

I will explain how ESOP's are used by companies as an instrument of corporate finance. As a corporate lender, I will attempt to answer the question from a pragmatic vantage point and from my own personal experience of developing an ESOP specialization on the lending side of the bank for the past year. I know of four different uses of leveraged ESOPS and the tax credit ESOP, all of which affect companies financially in different ways and they all, of course, affect employee ownership and motivation.

As a corporate lender, my primary interest is the leveraged ESOP, which usually involves lending to an established Employee Stock Ownership Trust (ESOT). By this mechanism, a company in a new stock situation in effect can borrow money using pretax dollars to amortize the loan. That is, principal payments are tax deductible as well as interest. In any case, the major incentive provided for a corporation establishing ESOPS is the tax incentive.

There are important issues surrounding the leveraged ESOP and ESOPS in general which I will address. In short they are: (1) The ESOP is a valuable instrument of corporate finance and can be used as an alternative to raise capital coupled with employee ownership and motivation. (2) Banks have been reluctant and slow in getting into the area of ESOP financing but the regulatory environment has improved, and that situation has changed. (3) The ESOP can improve a company's balance sheet, but further changes and incentives will help ESOPS make more sense to business. (4) A sense of permanence in ESOP legislation is important from the business community's perspective. (5) Increasing the tax incentives, particularly for the contributions to the ESOT, will make ESOPs more flexible to business.

TAX CREDIT ESOPS

The Tax Reduction Act of 1975, which created the tax credit ESOP or TRASOP, gave ESOPS a tremendous boost and continued to do so through the Tax Reform Act of 1976.

It is important to distinguish this type of ESOP from the leveraged ESOP. The ESOP trust can take advantage both of borrowing money and of tax credits. However, depending on the type and size of the company, one or the other forms of ESOP may be seen by the company as more advantageous. This will be examined later in more detail. As a corporate lender, I foresee many companies benefiting from combining the reinforcing feature of the tax credit with the leveraged ESOP. In this way a company can take advantage of tax deductible loan principal if the ESOP is leveraged, and the tax credit based on the investment tax credit for capital expenditures.

I am sure that the recently introduced "Expanded Employee Stock Ownership Act of 1978", under which the tax credit would be increased to 2 percent from the 1 percent presently available for contributions to the ESOT, and under which the credit would become a permanent provision of the tax code, is creating a major incentive for corporations to set up ESOPS generally.

First, like any employee benefit plan, the tax credit ESOP should become a permanent provision under the Code beyond the present 1981 expiration period. The recently introduced "Expanded Employee Stock Ownership Act of 1978" would make it a permanent provision. Any company making an extended commitment, whether for financial or employee benefit reasons, will look for a sense of permanence in our highly regulated business environment. Under present law, the current tax credit ESOP is available to 1981. This is good in one sense because companies recognize that the government is paying for the earlier contributions. However, this requires a heavy commitment for a company in the future since the company must continue the benefit into the future, beyond 1981.

The second advantage of the increase to 2 percent is illustrated by some facts gathered in a survey Hewitt Associates conducted, in January and February of 1978, of the 1,000 largest U.S. industrial companies. One of the questions directed to 144 companies was the amount each anticipated as a benefit for its average employee. "Of the 115 plans responding to the question, seventy-two plans (62.6 percent) anticipated a benefit for the average employee of less than $200 for 1977, thirty-two plans (27.8 percent) anticipated a benefit of from $200 to $500, and eleven plans (9.6 percent) anticipated a benefit of more than $500." The addi

1 Hewitt Associates. "Survey of Tax Reduction Act ESOPs." Highlights Report (January and February 1978) :3.