which may take up to ten years before they are put in service. Under the Code, a utility may take an Investment Tax Credit before these plants are put in service, based on the "progressive payments" made toward construction of these plants. However, under the Code the exposure to recapture continues until seven years after the plant is put in service. In Central Hudson's case, it is participating, as a tenant-in-common owner, with other New York utilities in the current construction of two nuclear generating facilities, one of which is scheduled to be placed in service in 1984 and the other in 1988. The possibility of the recapture of the Investment Tax Credit relating to these "progress payments" is real; for example, in New York the concept of a statewide generating company is currently before regulatory agencies. If approved this new company will purchase Central Hudson's, and other utilities', interests in two nuclear stations. Furthermore, Central Hudson may well sell all or part of its interests in generating stations toward which progress payments have been made. If a corporation sells property for which it has claimed the Investment Tax Credit, the Investment Tax Credit may, under the provisions referred to above, be "recaptured". If that corporation has a TRASOP in operation and there is a recapture of the Investment Tax Credit, the corporation has the option which, in effect, require it either to pay for the stock which was purchased by Investment Tax Credit monies which have now been recaptured, or design some method by which it can recover from the employees the stock they have received. In either case the Congressional intent will be thwarted. If the corporation has to pay, it will advance monies which, under the statute, it was not contemplated that it should pay. If it recaptures the stock, the employees are deprived of a portion of their opportunity to become participants as shareholders in the business for which they work. The problem cannot be unique to Central Hudson. The other New York utilities participating in the generating company also have a similar exposure. And utilities in other states constructing new plants may also be exposed if the project is terminated before completion or if a co-ownership interest is sold to another utility. Central Hudson feels that this conflict between the "recapture" provisions of the Code and the intent and purpose of the Reduction Act may discourage rather than encourage capital intensive employers from establishing and continuing TRASOP's. We believe that employees participating in Central Hudson's TRASOP would be discouraged if Central Hudson was forced to withdraw stock from its TRASOP due to a recapture. Furthermore, in Central Hudson's case, with approximately one-half of the shares allocated to employees being subject to the recapture provisions, the true Congressional intent, namely employee incentive, is diluted, and in the minds of many employees, more than 50% diluted. With the pall of recapture hanging over a portion of their shares, many employees simply lose interest. Central Hudson feels that this conflict should be corrected and urges upon this Committee the sponsoring of corrective legislation, principally under Section 47 of the Code, which would, in the case of a recapture of Investment Tax Credit, permit the employer to retain any such credit which has been used to fund a TRASOP. Such legislation would correct what Central Hudson believes to be a serious and fundamental flaw in this otherwise excellent concept of strengthening the free enterprise system. SILVERSTEIN AND MULLENS, Washington, D.C., August 10, 1978. Re ESOP hearings. Hon. RUSSELL B. LONG, Washington, D.C. DEAR SENATOR LONG: On July 19 and 20, the Senate Finance Committee held hearings on ESOPS generally and, in particular, on S. 3223 and S. 3241. The announcement of those hearings indicated that the Committee would be pleased to receive written testimony for the record. We are submitting this statement for inclusion in the record on the ESOP hearings. We strongly support the concept of employee stock ownership and are particularly supportive of S. 3241 since it would substantially improve the availability of ESOPS and TRASOPS. We especially support the fundamental purpose of ESOPS in providing increased equity ownership to employees through tax incentives that encourage employers to distribute their stock to employees. While the Committee is improving the methods for broadening employee stock ownership, an additional means of accomplishing broadened employee stock ownership should be considered. That is the use of direct grants of stock to employees by employers under a special form of restricted stock plan. The proposal we suggest could be called an Incentive Stock Ownership Plan or ISOP. This program would not involve the use of qualified retirement plans such as ESOPS or TRASOPs, but would simply involve a direct transfer to employees of employer stock subject to a restriction on the stock that requires the employee to continue working for the employer for the period of the restriction. The restriction could be phased-out on a gradual basis comparable to the vesting schedules now permitted for qualified retirement plans. Under present law, companies may utilize restricted stock plans as a means of compensating employees and providing employees with an equity ownership in the company. Under these plans, stock in the employing corporation is granted or sold to an employee subject to a restriction of forfeitability if the employee terminates employment before a prescribed time. In many situations, the forfeitability provision gradually lapses over a period of years so that the employee may substantially vest in the stock transferred in accordance with a vesting schedule roughly similar to what many qualified retirement plans utilize. This is a direct means of granting equity ownership in the company to the employees receiving the grant and therefore does not involve the complexity and administrative cost of a qualified plan. A hardship exists under present law in the utilization of restricted stock plans because at the time the employee substantially vests in the ownership of the stock, i.e., when the restrictions lapse on the stock, the employee must pay income tax on the fair market value of the stock at that time. Since in many cases the employee will not have sufficient cash assets to pay that tax, the employee is often forced to sell the stock in order to pay the income tax liability. As a consequence, the present income tax laws operate contrary to the interests of increasing equity ownership by forcing employees who have received vested equity interests in their employer through restricted stock plans to sell their stock in order to generate the funds with which to pay the income tax liability. Our ISOP proposal would amend § 83 of the Internal Revenue Code to permit a deferral of the income tax under a tax qualified ISOP until a subsequent event, such as the termination of the individual's employment or the sale of the stock. It is, in fact, only at the time that the employee actually disposes of the stock that he generates the necessary cash funds with which to pay the income tax liability. This deferral would permit these plans to be a major means of increasing employee stock ownership since the employee would no longer be taxed on income when he does not have the funds to pay the tax. In order to prevent ISOPs from being tax-favored devices for compensating shareholders, the availability of ISOPs should be limited to employees who own less than 5 percent of the company. This is comparable to the limit that existed for qualified stock options under § 422 of the Internal Revenue Code. Other restrictions and limitations on the use of ISOPS may be appropriate after further consideration. We would be happy to develop detailed legislative language to assist you and your staff in this matter if that would be helpful. The purpose of this letter is to bring to your attention this additional means of providing increased employee equity participation. Very truly yours, Hon. RUSSELL B. LONG, LEONARD L. SILVERSTEIN. EMPLOYER STOCK OWNERSHIP COUNCIL OF AMERICA, Chairman, Committee on Finance, DEAR SENATOR LONG: Enclosed for inclusion in the record of the ESOP Hearing held by the Committee on Finance on July 19-20, 1978, is the summary of the results of the UCLA Graduate School of Management "Survey of Employee Stock Ownership Plans," which was sponsored last year by the Employee Stock Ownership Council of America. The work was a result of several months of intense effort on the part of the student UCLA Field Study Team and their professors. We believe that the Study is an important step toward an understanding of the experiences of some of the companies which have been pioneers in the ESOP area. The full Study comprises 110 pages and includes much statistical data. For this reason, we believe that only the enclosed Summary need be included in the hearing record. Very truly yours, RONALD L. LUDWIG, General Counsel. Enclosure. SUMMARY OF THE RESULTS OF THE "SURVEY OF EMPLOYEE STOCK OWNERSHIP PLANS" CONDUCTED BY THE UCLA GRADUATE SCHOOL OF MANAGEMENT, DECEMBER 1977, AND SPONSORED BY ESOP COUNCIL OF AMERICA EXECUTIVE SUMMARY Although employee stock ownership plans (ESOPs) have received a great deal of consideration in professional journals and seminars, only liimted information is available on individual company experience with ESOPs. Recognizing the need for such knowledge, the ESOP Council of America, a tax exempt trade organization, sponsored this study by the UCLA Management field study team. The study was designed to ascertain whether the ESOP met the intended objectives of the company and the nature and extent of any problems. It was intended to provide an overall evaluation of current ESOP experience and to assist the Council in understanding the characteristics and needs of its membership. The study included a direct mail survey to 850 companies known to have ESOPS, personal and telephone interviews and a review of current literature. The results are based on the response of 180 companies, most of which were closely held corporations with 2 to 5 principal stockholders. The number of employees in the companies responding ranged from 1 to 44,000, although 82% of the sample had under 200 employees. Primarily manufacturing, wholesale, financial, construction and service industries were represented. The sample also represented 33 states, with 42% of the companies being in California. Most of the companies (87%) identified their ESOPS as stock bonus plans; the rest (13%) were stock bonus and money purchase plans. Sixteen percent of the plans were leveraged. The average length of time the plans had been in effect was three years. The benefits and advantages considered most important by respondents were improved employee motivation, tax advantages, cash liquidity and market for closely held stock. It appeared that one of the most important uses of an ESOP was for estate (or life) planning, transfer of ownership, and preservation of the firm. The problems most frequently cited as important were changing governmental regulations, administrative complexity, on-going costs and negative employee response. Even those companies generally pleased with the plan commented on the complexity, time and cost involved with the administration. Dilution, considered one of the drawbacks to ESOPs, was not considered an important factor by the majority of respondents. Also, less than 6% of those responding thought loss of confidentiality was an important problem. The risk inherent in an ESOP due to all an employee's eggs being in one basket was of concern to some, although it appeared that most felt the advantages of the ESOP outweighed the risks involved. Because most plans had been in existence only a few years, most respondents were unsure of the ESOP's effect on employee motivation. Some of the factors mentioned as relevant to the effect on employee motivation were employee age and position in the company, as well as characteristics of both the firm and the industry. Comments indicated the ESOPs had not created an esprit de corps where none existed previously. The complexity of the plan and the difficulty of making an intangible benefit appear real underscored the need for education and good employer/employee communications. Overall, most of the companies were highly satisfied with their ESOPs. They believed it was living up to expectations and that it was important to the company. The great majority also said they would install an ESOP again if given the choice. The study also showed, however, that the ESOP is a highly complex financial planning and employee benefit tool, and is limited in application. Any company considering an ESOP would do well to define its objectives and needs carefully, and should investigate the alternative ways of accomplishing goals. Plan design and implementation are also extremely important and should be undertaken with great care. Some companies felt their problems were due more to poor plan design than to improper use of an ESOP. Professional assistance is very important, but company administrators should also insure they understand the plan thoroughly themselves. One of the important contributions the ESOP Council can make is to provide such assistance to companies with existing ESOPS and to those considering one. Clearly evident in the study was the willingness of those who participated to discuss their ESOP experience as well as a strong interest in the experience of others with ESOPS and the field generally. SUMMARY OF THE RESULTS OF THE "SURVEY OF EMPLOYEE STOCK OWNERSHIP PLANS" Purpose 1. The purpose of the survey was to contact companies with ESOPS currently in operation to ascertain whether an ESOP met the intended objectives and what the major advantages and problems have been in practice. 2. To provide a source of data about the characteristics of ESOPS in existence, including specific benefits and problems. 3. To set forth any solutions devised by participants to common ESOP problems. 4. To provide a source of information for companies contemplating the initiation of an ESOP; and 5. To evaluate the effect of present government regulations of ESOPs. Participants UCLA Graduate School of Management Field Study Team: Professors: Dr. John P. Shelton, professor of finance, UCLA Graduate School of Management. Arthur H. Kuriloff, professor of accounting, UCLA Graduate School of Management. Field study team: Matthew J. Bonaccorso, Sheridan M. Cranmer, David G. Greenhut, Daphne T. Hoffman, and Niel Isbrandtsen. Methodology Questionnaires were mailed to 850 companies with ESOPS as well as to various administrators, trustees and other professional associations involved with ESOPs. Over 180 responses were received. This is roughly a 20% return, and a good response in that it appears to be a fair cross section. The survey team conducted personal and telephone interviews with company managers in order to obtain a better perspective about their experiences with ESOPS. The team also spoke to administrators, lawyers, accountants, trustees, and consultants, as well as to government officials. All the quanititative responses were entered into a computer and the results of the data analyzed and certain correlations established. The source of the data was kept confidential and is only available to the UCLA Graduate School of Management. When the ESOP Council initiates the follow-up survey to determine whether the length of time the plan is in existence affects the company's satisfaction with the plan, the factors and data gathered in the second study can be compared with the results of the first to determine possible trends. The study did not measure the degree of employee ownership and more research is certainly indicated. Further, the 22% response may indicate a selection bias. With a wider and wider base of emplovee stock ownership plans springing into existence, later studies may indicate different findings. The data and the questionnaire The results of the questionnaire used will be analyzed by proceeding step by step through the questions. The questionnaire is divided into sections A through H and is printed in the Appendix of this Summary. Section A. Company information The question related to the type of industry in which the company is involved. Question 1. The team had responses from a broad spectrum of industries: 29% responding characterized their industry as manufacturing, 17% as wholesale, 12% as financial, 10% as construction, and 9% as "service." The remainder were from numerous categories. Question 2. In the second question, "Number of Principal Stockholders," the responses were as follows: Question 3. With the third question, "Annual Sales", the percentage of firms checking each category were as follows: 8 percent checked the first, 0 to $1,000,000. 28 percent checked the second, $1,000,000 to $5,000,000. 20 percent checked the third, $5,000,000 to $10,000,000. 29 percent checked the fourth, $10,000,000 to $30,000,000, and 15 percent checked the last, over $30,000,000. Note that the annual sales figures may not provide an accurate picture of the "size" of the companies responding. There is not necessarily a correlation bettween the number of employees and annual sales. Section B. Employee information Question 4. The number of full-time employees ranged from 1 to 44,000. Eightytwo percent (82%) of the sample, however, reported fewer than 200, and the median for the sample was 90. Approximately 27 percent of the firms responding to the question as to whether there was a union, indicated they had one. Many of these firms indicated that union members were excluded from the ESOP. One large firm indicated they had to negotiate with 118 separate unions. Questions 5 and 6. Questions 5 and 6 did not provide figures which were meaningful. The data was generally as follows: Age mix for the entire sample (that is, the groups average age): The turnover rate given for the sample as a whole was about 18 percent. The questions did not provide enough information to determine if there was any difference between vested and nonvested participants. Question 7. Question 7 asked: "Has the plan had any effect on the number of people leaving each year?” 20 percent of those responding indicated yes. 80 percent said no. From reading the range of comments, it seems that the effect depends upon the individual characteristics of the firm. Many commented that the plan had not been in effect long enough to assess the impact. Other comments ranged from very positive to a qualified negative. Others included: Turnover reduced, Older employees stay, Plan not well understood, Too short a time to know, Once people are in the plan, the farsighted employees see the advantages. The owner of one company indicated that two of his employees had left his firms and used the money they received from their shares to start a competing firm. |