ESOP's Fable: Down but Not Out

ESOP's fable: down but not out Although Congress cut a key tax advantage for ESOPs, banks still find financing them attractive Like Aesop's animal stories with their didactic twists, what is happening with ESOPs is demonstrating that what Congress gives, Congress can take away. Last fall, it curtailed tax advantages for lenders to some employee stock ownership plans--the popular programs that have enabled many workers to buy stock in their companies. The cutback was a disappointment for banks that found ESOP financing to be a lucrative, high-growth business. Will that business now disappear? Bankers active in the field don't think so, although they believe it will shrink in overall size and shift in emphasis. Be your boss. When the idea of ESOPs was first introduced about two decades ago, it was argued that enabling employees to buy a substantial share--even a controlling share--of the company they work for would provide them with the best possible incentive. They would have a chance to share in the company's prosperity. Congress bought the idea and provided tax advantages, both to companies that sponsored ESOPs for their own employees, and to lenders who financed the acquisition of shares by the employees in their corporate customers' plans. The tax incentive that appealed most to lenders was the so-called 50% tax exclusion. That is, if a bank advanced the funds to buy a company's shares on behalf of employees participating in an ESOP, the tax on the lenders' interest income would be reduced by half. Many lenders made the most of this opportunity by explaining ESOPs to corporate prospects and by using some of the tax benefit to shave lending rates to ESOP customers. In many cases, they syndicated pieces of deals to other lenders and thus obtained fees. Some banks felt the business had so much potential that they set up specialized ESOP financing units. And grow it did. According to the ESOP Association, a trade group in Washington, D.C., about 10,000 companies in the country now have some form of ESOP. About 1,000 companies a year have set up the plans in each of the last few years. While most firms with ESOPs are small companies, in the last year or two some large, publicly-held companies have adopted them, too. These large firms have caused the rate of financing growth in dollar volume to really take off. One unofficial estimate is that ESOP financing volume in the first half of 1989 was about $11 billion, compared to $3 billion in the first half of 1988. In the first half of 1989, over 80 Fortune 500 companies announced plans to start ESOPs. And there's the rub: this large-company interest in ESOPs was perceived by Congress to be unhealthy. These companies, aided and advised by their investment bankers and attorneys, were discovering that ESOPs could be highly useful as a defense against hostile corporate raiders. …