The electric utilities position has always been, and is now, that the exclusion of the credit should be to the individual who receives the dividend rather than to the corporation. That is particularly important to the electrical utility industry, if it is to be a capial formation provision, because any credit to the company or deduction is also a reduction in the cost of doing business and it would then most likely be flowed through in a rate case, so that no capital formation results. The second point we would make is that this bill requires that newly issued stock be used for at least half of the program. Most companies now do provide for newly issued stock in the plan, as does my company. We think it might be more appropriate if the bill would make the requirement only if the stock is selling at least at book value, because a forced sale of stock at below book value might cause some companies to hesitate about participation in this plan and you are, of course, very familiar with the evils of selling stock below book value. Our industry has had to do that, and does today in many instances, but it is not a good thing to do. That is one possibility for improvement. Third, we think the bill probably should clarify somewhat the situation in which the total credit not being utilized in the current year. That is the carry-forward and carry-back provisions, and the division of the credit if the total credit is not utilized, need clarification. And then, finally, in connection with bargaining unit employees, the current bill would make a change to provide that benefits must be extended to all employees unless specifically rejected by a labor representative. We think it is preferable that the present law continue, which requires under IRS rulings, good faith collective bargaining. I might mention that, in our industry, we know of only seven plans that do not provide coverage to all employees, and those have a minimum number of total employees involved. But we think it is important to leave that as a part of the bargaining process rather than mandate it, which would somewhat complicate that process. Finally, Mr. Chairman, let me again reiterate the strong support of the electric utility industry for the ESOP program begun under the Tax Reduction Act of 1975, under your wise and innovative leadership. We think it has benefited many employees who are becoming owners of American industry. We know it is also a capital formation help to industries such as ours, and we heartily endorse the provisions of this bill to strengthen and extend that. Thank you, Mr. Chairman. The CHAIRMAN. Let me ask you this, Mr. Thompson, how much stock does the average employee of your company have, as of now? Mr. THOMPSON. My company, Mr. Chairman, which represents about 1 percent of the total electric utility industry, is therefore a relatively small portion, but it is a significant thing for our employees. In the 3 years of the plan's existence, we have assets, when the current year of 1977 is complete, of about $2.35 million-$2,350,000. With 3,827 participants, that is an average of $616 per participant. That is a little less than the industry generally. For the industry generally, we estimate that the average participation accumulated over the 3 years is between $800 and $1,000 per participant. The CHAIRMAN. Now, is that enough stockownership to where the employees are beginning to take an interest in the matter and where it begins to reflect itself in better employee relations? Mr. THOMPSON. It is debatable as to whether that amount, in and of itself, is enough to have a strong interest, but the accumulated effect-it is beginning to build up, Senator, and as each year passes that will expand, not only with increased contributions, but the reinvestment of dividends. So I think it is certainly an adequate beginning a very significant beginning to instill in the employee a real ownership feeling, a proprietorship interest in his corporation, because he then begins to have the feelings of an owner and the understanding that this can increase. If it were to stop right now with just that $800, I would have some doubt that that would hold his interest, with inflation like it is. But the buildup potential is significant. The CHAIRMAN. Well, let me just say that it really pleases me, as one who believes in employee stockownership, to see you come here, Mr. Thompson, and testify for an entire industry. And I hope that, as we go forward in this area and amend it to make it more attractive to other industries, that the day will come when we see others speaking for industry will come and testify for an entire industry. I appreciate your statement very much. Senator Byrd? Senator BYRD. No questions. The CHAIRMAN. Senator Gravel? а Senator GRAVEL. If we were to design what is called a CSOP, which would be a consumer stockownership plan then that stock could be distributed to the people who use your utilities. The utilities seem to lend themselves readily to that approach. To establish the company, lot of capital would be needed. If we provided a device wherein you could set up a trust and borrow that capital and then use the income to pay that capital back and, at the same time, pay for the cost, the net capital would be reflected not in debt, but would be reflected in a stock. sale. That stock could then be distributed to the consumers of the utilities. That way, you would have the double incentive of having employees who are interested in the well-being of the company and consumers, like myself, who would be similarly interested in the wellbeing of the company. If we made it possible in law for you to have a plan so that your consumers could own a piece of your company, would you avail yourself of that vehicle? Mr. THOMPSON. It is an intriguing concept, Senator Gravel. I am not prepared-I have not examined the thing thoroughly-to specifically endorse the proposal that you advance, but I would say that it is intriguing and one that we would study, because we are always interested in new sources of capital. The concept itself has some appeal. We have to ask questions, of course, as to the ownership of the facility. We think it is imperative for our companies to still own the facilities that we operate. In most instances, if this is a source of capital-an additional source of capital-it would be most intriguing. Senator GRAVEL. Well, no; the company would still own it. I think I may have misstated it. The company would be the same company it is right now. The only thing is, that when you would need to get another $100 million, you would issue, or sell, stock for that $100 million. That $100 million-that stock-would be purchased by the CSOP. They would have the debt; they would retire the debt, but you would just sell stock to your own consumers. Mr. THOMPSON. What it sounds like, Senator, is a stock issue plan that would be arranged in such a manner that consumers of a utility itself would be more likely to be the purchasers as you suggest, and the public generally-that has a great deal of appeal. The details, of course, I cannot comment on, but the concept is one we would have to study with considerable interest. Senator GRAVEL. Under your ESOP plan, have you used any leverage in financing? Mr. THOMPSON. No; we have not. We made some studies of that, and I am not prepared to give the details. But for various reasons we determined, our traditional financing methods have been more appropriate, up until now. There may be some regulatory complication that lingers in my mind about that sort of leverage financing, if it involves corporate guarantees other than standing behind our own securities. It is a complex subject, Senator. All I can tell you is that we have investigated it, and we have not used it. Senator GRAVEL. As a product of that investigation, would you like to submit an additional statement as to why you have chosen not to go into the debt area for leverage Mr. THOMPSON. I will be glad to do so. I will be glad to have my finance officer submit that from my company, and if there is industry information, I will also submit that. [The following was subsequently submitted for the record:] ADDITIONAL STATEMENT OF W. REID THOMPSON On July 19, 1978, I appeared before Senate Committee on Finance on behalf of the Edison Electric Institute and my company, Potamic Electric Power Company. My testimony was presented in support of the Expanded Employee Stock Ownership Act of 1978, S. 3241. In the course of my appearance, Senator Gravel asked whether Potomac Electric Power Company had elected to lever our ESOP program. When I stated that we had studied the matter and had elected not to finance our operations by means of a leveraged ESOP, Senator Gravel asked me to provide the rationale for this decision. I have done so in the paragraphs below: As you are well aware, the capital investment requirements of the electric utility industry are the most intense of any industry and are projected at nearly $600 billion over the next 15 years. Because we must generate that investment within certain debt to equity ratios and under constant regulatory review, the capital requirements which may be funded with debt are directly dependent upon the amount of new equity capital which is generated. With the enactment of the original investment credit related ESOP provisions in 1975, we at Pepco performed a study of the opportunities for the generation of investment capital through use of the ESOP program and found that the program is an excellent source of investment capital for the company, while at the same time offering motivation for increased employee productivity by expanding employee participation in corporate ownership. Our study of the ESOP included a review of the potential benefits of a leveraged ESOP. The primary benefit of leveraged ESOP is that the leverage could lead to further increases in employee ownership of the company. One of the underlying principles of the leveraged ESOP, however, is the corporate guarantee of ESOP debt. Our study also revealed that a guarantee of ESOP debt by the Company would require regulatory approval and we felt that regulatory authorities would not respond favorably to such a proposal. Our study further indicated that the company's guarantee would be considered by the investment community as an additional debt of the corporation, and would serve to increase rather than decrease ratio of debt to equity. This guarantee would, therefore, have a substantial adverse effect upon the rating of our senior securities, a substantial impact upon the manner in wihch we may generate investment capital and would serve to increase our cost of service. Senator GRAVEL. What I am beginning to discern here is that people think it is a good idea, but nobody is being aggressive, thus far, in really expanding it. You could get 10 times the rapid expansion into employee ownership if you did some leveraging. I know everybody is borrowing money Mr. THOMPSON. I would be delighted. I want to refresh my own memory of the reasons and I would be delighted to furnish my answers for the record, and for you, Senator. Senator GRAVEL. I think that would be very important to us. What it might show is one, the policy attitudes; and two, some structural constraints that may exist in the debt market area that we may want to address and correct. I would just ask you and the other members that have testified thus far if they want to make comment as to why there has been no use of debt leverage. I think the committee would find that information most valuable. Mr. THOMPSON. We will do so. Senator GRAVEL. Thank you. The CHAIRMAN. Senator Packwood? Senator ROTH. No questions. The CHAIRMAN. Senator Danforth? Senator DANFORTH. No questions. Mr. THOMPSON. Thank you very much, Mr. Chairman. The CHAIRMAN. Thank you, sir. [The prepared statement of Mr. Thompson follows:] STATEMENT OF W. REID THOMPSON, EDISON ELECTRIC INSTITUTE My name is W. Reid Thompson. I am Chairman of the Board and President of Potomac Electric Power Company and Chairman of the Board of the Edison Electric Institute (EEI). The Edison Electric Institute is a national association of investor-owned electric utilities which represents 99 percent of the investorowned electric utilities in this Country and its members companies supply 77 percent of all electricity users in the United States. I am appearing today on behalf of EEI as well as my own company. It is a particular pleasure for me to appear as a representative of the industry that is probably the greatest user of the form of employee stock ownreship plan created by the Tax Reduction Act of 1975, and expanded by the Tax Reform Act of 1976. A 1977 study reveals that 42 of the 233 investor-owned electric utilities, including most of the larger utilities and representing more than half of all electric utility employees, had implemented employee stock ownership plans, and many more had plans under consideration. The equity which has accrued annually to industry employees through these plans in their companies has grown significantly from 23 million dollars in 1975, to 67.7 million dollars in 1976 to nearly 100 million dollars in 1977. Out of an industry total of 416,000 employees, 223,000, or more than half, are eligible for participation in plans in effect for 1977. 33-902-78-7 ENDORSEMENT OF S. 3241 We heartily endorse the Expanded Employee Stock Ownership Act of 1978, S. 3241, which will open the door to much greater use of employee stock ownership plans and accordingly will extend their benefits to many more corporate employees. The measure will further economic democracy by broadening the ownership of corporation stocks and will strengthen our economy by promoting capital formation and stimulating higher employee productivity. COMMENTS ON S. 3241 Because our industry is so deeply involved with employee stock ownership plans, I would like to comment on a few of the specifics of S. 3241. Most significantly, the bill increases the credit based on investment to two percent. The bill also takes a major step in furthering employee ownership of stock in labor-intensive corporations by providing an alternative credit based on payroll. The increased credit based on investment will advance employee ownership while providing an important source of capital for capital-intensive industries such as the electric utility industry. The alternative credit based on payroll will greatly increase the number of situations in which establishment of an ESOP is worthwhile. It will expand ESOP participation in segments of industry which have previously realized little or no benefits from the Tax Reduction Act ESOPs. In short, S. 3241 has the potential of broadening employee ownership of all corporations while strengthening such corporations financially. Another very constructive feature is elimination of the contributory requirement that now must be met if maximum advantage is to be taken of the Tax Reduction Act form of ESOP. The handling of matching contributions of participants presents serious administrative problems. Also, many employers already have contributor benefit plans that use up the arbitrary six percent of compensation limit that IRS says is as far as is safe to go with mandatory employee contributions in order to avoid a danger that plans are discriminatory and therefore cannot be qualified plans. A Tax Reduction Act ESOP can hardly be discriminatory, but if this IRS rule is applied with present law in effect it means that either there will be no contributory ESOP or that other benefit plans or the ESOP will have to be cut back. This is a problem that under the present law requires a solution, whether it be S. 3241 or some other measure. We are pleased, also, that an individual who is not an employee at the end of the plan year need not participate in that year. The present requirement of allocating contributions among all persons who were participants at any time during the year presents real problems. It is extremely difficult to trace many ex-employees a year later to deliver ESOP distributions for the final period of employment. Elimination of the possibility that minimum tax will result from adoption of an ESOP will greatly encourage adoption of ESOPs. Also, we greatly appreciate the continuation of the importance provision which correctly recognizes that the credit is not a factor that can in some manner be applied to reduce the rates of regulated public utilities. We wish to note, and urge your consideration of four suggested improvements of S. 3241: First, the provision that in some circumstances permits the deduction of dividends paid to an ESOP is a step in the direction of integrating the corporation and personal income taxes, an idea whose time has come. The utility industry is on record as endorsing the concept of integrating individual and corporate income taxes. However, the industry position is that integration should be effected at the shareholder level. We therefore suggest that the bill be revised to allow the shareholder whose dividend has flowed through an ESOP a credit or an exclusion rather than to permit the corporation to take a deduction. Second, transferred employer stock should not have to be new-issue stock if market value of the stock is less than book value. Although the requirement of S. 3241 relates to only half of the value that is transferred, the possibility of dilution of interests of existing shareholders would be a real deterrent to use of an ESOP. Our industry is all too familiar with stock selling below book value. Third, the bill does not anticipate and adequately cover situations in which the total credits of a corporation are not utilized in the current year. There is a considerable amount of uncertainty under present law as to the sequence of use of the components of the credit allowed by Section 46. Another sequence-of-use |