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ESOB the stock ownership plan
By Gage McKinney Mactseath Hardwood Co.
This is the concluding section of contributing editor Gage McKinney's article on ESOPs. The first part appeared last month, beginning on page 9 of the lune issue. -ed.
tln light of these inherent risks Manley warns that "ESOPs are only for winners." Manley's firm, the Commonwealth Group of San Francisco, advises that only a sound, profitable company with a payroll of $200 thousand or more consider establishing an ESOP.
The thorniest problem facing a privately held firm with an ESOP is how to price its stock. Normally, with the help of experts, a company appraises its stock by comparing the firm's earning growth with that of publicly-traded firms in its industry and by analyzing its net book value and return on capital. This valuation must be supported if challenged by the IRS, but the service will not approve a valuation in advance. The chance exists too that a dissident employe can successfully challenge the valuation if it was not done in good faith.
K. E. MacBeath points out the addi tional drawback that the expense of administering his company's ESOP has doubled since it was organized. And he fears that an increasing num- ber of governmental regulations will make ESOPs impossible to administer and will negate the tax advantages. Manley argues, however, that all profit sharing and pension plans have become snarled in red tape. Recent legislation actually makes ESOPs more desireable than other compensation programs, he says.
Despite the potential drawbacks to employees and employers alike, ESOP is gaining much favorable attention in business circles and on Capitol Hill. In a hearing last December before the Joint Economic Committee on ESOPs. Assistant Secretary of the Treasury Charls Walker gave ESOP his department's blessing. ESOP is not regarded as a tax loophole, he said. He called it instead a "desirable device for broadening stock ownership."
An article recently published by Fortune (March '76) thoroughly exposed ESOP's flaws, only to conclude by urging Congress to take action to facilitate the creation of more ESOPs. By broadening capital ownership ESOPs might help to create a better business climate in society at large, the article said.
Although new in application and public attention, ESOP is not a new concept. The brainchild of San Francisco attorney and economist Louis O. Kelso, the concept was first explained in a book by Kelso and Patricia Hetter, Two-Factor Theory: The Economics of Reality (1967). The book's subtitle, "How to Turn Eighty Million Workers into Capitalists on Borrowed Money and Other Proposals," expresses Kelso's high hopes for ESOP.
Kelso established the first ESOP nearly 20 years ago, but the bandwagon did not begin rolling until Senate Finance Committee Chairman Russell B. Long (D-La.) became excited by Kelso's ideas and began using his power to engineer tax breaks for ESOPs. The first legislation to sanction the ESOP concept was the Regional Rail Reorganization Act, enacted January 1974. It authorized the Consolidated Rail Corp., which operates Northeastern railroads, to establish an ESOP.
Also in '74 Congress enacted the Foreign Trade Act, which gave special preference to companies with ESOPs involved in a federally-guaranteed loan program for businesses hurt by foreign competition. In '75 the complex and often contradictory Pension Reform Act (ERISA) singled-out ESOP as the only employe benefit plan which can be used as a vehicle for corporate borrowing. The Tax Reduction Act of '75 extended a further l% tax credit for investment in capital equipment to corporations with qualifying ESOPs.
Currently Congress is considering the so-called Accelerated Capital Formation'Act, which would abolish the
Story at a Glance
How a Western hardwood wholesaler established an Employee Stock Ownership Plan (ESOP) for their workers what an ESOP is and how it works some see it as the "dawn of people's capitalism," others consider it tar too risky.
15% celling on employer contributions to an ESOP and make dividends paid on ESOT-held stock tax deductible to employers. The bill, introduced by Rep. Frenzel of Minnesota, has 70 sponsors in the House.
Kelso's ESOP concept is the first major answer to the Keynesian economics which have dominated American economic theory since World War II. According to Kelso capital, rather than labor. is the basis of wealth. His schemes to turn workers into capitalists could revolutionize the structure of the U.S. economy, and his ideas are gaining wider acceptance.
DISCUSSING lumber industry application of ESOPs are (left) Robert Manley, president of The Commonwealth Group, an investment banking and financial planning firm that specializes in ES0P financinq, and Robert Kelso, father of the ESOP eoncept.