Three Cheers for ERISA and Good Governance

One theme of most speakers at our conferences is that ownership culture makes employee-owned companies outperform their competitors. People say that because it’s true and supported by data from many independent researchers. The NCEO is proud to have contributed to that finding.

Another reason for that outperformance, I believe, is that employee-owned companies simply invest more in each employee. That’s partly just the simple math of their larger-than-average contribution to employee benefit plans, but in practice, they also provide greater benefits, from tuition reimbursement to flexible schedules to professional development. ESOP companies may outperform simply because they invest more in their employee-owners.

But neither ownership culture nor workforce investments are the whole story. On this, the 50th anniversary of the Employee Retirement Income Security Act of 1974 (ERISA), let us acknowledge the key role of these less warm-and-fuzzy aspects of employee ownership. ERISA and the companion provisions of the Internal Revenue Code (the “Code”) provide compelling tax incentives for companies to become employee-owned, and in return, Congress wrote ERISA and the Code to impose some requirements with teeth.

Those requirements evoke strong feelings among employee ownership advocates. Whenever you hear someone say that ERISA and the Code’s requirements make ESOPs complex, please remind them that ESOPs can be simple. And then remind them that much of what ERISA and the Code require can be restated simply as good governance.

All who believe that good governance creates stronger businesses should see these requirements as one of the reasons that ESOP companies outperform non-ESOP companies. Let me give some examples.

When an ESOP company buys another company, that’s a business transaction, and it involves a genuine negotiation. One party is the seller, and the other is the ESOP trustee, who has a fiduciary obligation to be loyal to the interest of plan participants. The trustee is obligated to assess the value of the shares and the fairness of the transaction. Those requirements are neither simple nor naïve, and many companies consider concrete improvements to their business before the trustee determines fair market value. Before they sign the sales agreement, company owners may create detailed plans for management succession, overhaul core processes, adopt new infrastructure, or invest in a more thoughtful strategic plan. Those changes increase the price the seller receives, and they also increase the value of participants’ shares.

ERISA’s requirements for good governance continue after the transaction. Trustees are increasingly insisting on increasing the number of independent directors on the boards of ESOP companies. They may ask about important risks; in the NCEO’s finance working group meeting today, for example, the speaker recommended that an ESOP company board should review the company’s cyber insurance policy. There are many other examples.

But maybe the most important mechanism that ensures good governance for ESOP companies is the annual valuation. The valuation is performed by an independent firm that is accountable to the trustee and, therefore, to the interests of plan participants. The valuation examines the company’s performance, evaluates the company’s strategy, compares the strategy to the projections, and analyzes the company’s direction. The valuation analysts kick the tires on the projection, assess the depth of the management team, and weigh the company’s preparedness for external threats to the business. The thorough analysis by well-informed experts provides ESOP companies with some of the insights that the executives in a public company would receive from the thousands of buyers and sellers of their shares in the open market.

Finally, having an ESOP provides the discipline of focus. Privately held companies can be operated for any legal purpose, and sometimes they defer to the possibly quirky beliefs of a sole owner. ESOP companies retain discretion, but the trustee serves as a backstop to ensure that the company operates in a way that reasonably protects the value of corporate assets.

So let’s celebrate ERISA for its vision. Our special September 2024 newsletter issue on ERISA discusses hopes for what ERISA would accomplish, and it narrates the plot twists over the last fifty years. Aspects of the vision have changed, but the ESOP companies that exist because of ERISA continue to be more competitive, to build middle-class wealth, and to strengthen our communities. ERISA accomplishes this mission by creating the kinds of employee ownership companies that we all think about when we think of employee ownership: engaged owners who are taking stewardship of their businesses, looking out for each other, and dreaming of new ways to be stronger. But even if this reason is less heralded, ERISA also accomplishes its mission by creating a compelling path for companies to practice good governance.