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Creating perpetual motion that moves companies forward

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For centuries inventors have tried to create perpetual motion machines — devices that would run endlessly unless stopped by an outside force. The first recorded attempt by Robert Fludd was the water screw. Unfortunately, it didn’t work. Almost 400 years have passed with countless attempts but no one has produced a viable working example.   

While the scientific world has yet to perfect the perpetual motion of physical objects many companies have found a perpetual motion machine of sorts for their business in the form of an Employee Stock Ownership Plan (ESOP).   

Refresher: What is an ESOP?

An ESOP is a qualified defined contribution retirement plan that is invested primarily in the stock of the sponsoring company. ESOPs have many advantages. They can assist with a company’s ownership succession, help owners create liquidity to diversify their investment portfolios, and help employees be better prepared for retirement. An ESOP provides the business owner with a great deal of control over the timing and extent of the sale. 

ESOPs can also help a company perform better. The ESOP aligns the goals of the employees with those of the company through ownership. This alignment creates a loop of continual positive reinforcement that creates the perpetual motion. As the company grows, employees are rewarded more so employees work harder and the company grows more. The cycle is summarized in the following diagram:

Employee owners are more productive

It is intuitive to think that employees with an ownership position are more productive than those without.  After all, the more productive they are the better the company performs and therefore the greater the financial benefit to them.

A recent survey supports this belief. Seventy-six percent of respondents indicated that their ESOP positively affected the overall productivity of employees, according to The Employee Ownership Foundation’s 21st Annual Economic Survey of ESOP Companies.[1] 

More productive employees drive higher profits

Companies invest significant resources to increase employee productivity. They hire consultants, upgrade technology and train their staff to make them more productive. Their motivation is simple: More productive employees drive higher profits. 

Most companies with employee stock ownership plans are privately held so detailed information about profits is generally not available. However, insight as to firm performance can be seen through employment levels. A recent study found that although overall U.S. private employment in 2008 fell by 2.8 percent, employment in the surveyed S-ESOP companies rose by approximately 2 percent.[2]  It is unlikely that these firms would have hired additional staff unless profits remained strong. 

Higher profits result in higher stock price

Stock price is directly impacted by organizational performance. Most ESOPs are privately held corporations, so there is no real time market rate established. Rather, ESOPs are required to get an annual independent valuation of stock value. 

The Annual Economic Performance Survey referenced earlier also asked respondents about their stock price. Eighty percent of respondents stated the company’s stock value increased in 2011 as determined by an independent valuation.[3]  This is an impressive result given the slow economic recovery the United States was experiencing at that time.  Higher stock price increases ESOP account balances

ESOP account balances are impacted by two primary factors:

  1. Contributions made to the plan;
  2. Changes in stock price.

Better organizational performance boosts stock prices, allowing companies to make larger contributions to the ESOP. In addition, rising stock value increases the value of the overall ESOP balance. This is important to participants as the ESOP can be a significant part of their retirement assets. According to Corey Rosen, the cofounder and senior staff member of the National Center for Employee Ownership, S Corporation ESOP balances were three to five times higher on average than 401(k) plans. 

ESOP account balances reinforce the value of ownership

Many of the 11,000[4] ESOPs in the country plan celebrations around the distribution of the annual ESOP retirement plan statement. These celebrations allow the participants to reflect on what has happened in the past year, and more importantly, reinforce the value of employee ownership.  

Employees understand how their actions impact the success of the company and how company success ties directly to their retirement plan balance. Many companies with ESOPs educate their staff throughout the year to reinforce this line of sight and to cultivate the culture of ownership. 

There is scientific consensus that a true perpetual motion machine cannot exist.[5] However, there is consensus that the perpetual motion of positive reinforcement in the ESOP structure can and does increase performance. 

Nonetheless, the overwhelming majority of empirical studies have concluded that employee ownership leads to markedly improved performance:

  • ESOP firms outperform matched nonESOP firms;
  • The same firm performs better postadoption compared to preadoption (or after termination of employee ownership); and
  • Employeeowners within a given firm outperform employees who do not share ownership rights.[6]

ESOPs create a perpetual motion that benefits both the sponsoring company and the employees.   

[1] Employee Ownership Foundation’s 21st Annual Economic Performance Survey of ESOP Companies. The  ESOP Association.  September 6, 2012. 

[2] Resilience and Retirement Security:  Performance on S-ESOP Firms in the Recession.  Phillip Swagel and Robert Carroll.  Georgetown University/McDonough School of Business.  March 23, 2010. 

[3] Employee Ownership Foundation’s 21st Annual Economic Performance Survey of ESOP Companies.  The ESOP Association.  September 6, 2012.

[4] National Center for Employee Ownership, as of the end of 2011.

[5] Derry, Gregory N. What Science Is and How It Works. Princeton University Press. p. 167

[6] S Corp ESOP Legislation Benefits and Costs:  Public Policy and Tax Analysis.  Steven F.Freeman and Michael Knoll, University of Pennsylvania.  July 29, 2008. 


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