RE: Ellerman Chapter on ESOPs

[Michael Harrington <mharrington@milken-inst.org>]

David - 
thanks for the chapter - now I think I remember your book on The Democratic
Worker-Owned Firm. I found the chapter very interesting because it offered a
little different perspective than my own on employee ownership and the idea
of economic democracy.

Before I get into that I should say that I don't think it really addresses
Kelso's macroeconomic claims about "binary economics" or "two-factor theory"
in a critical fashion beyond dismissing or ignoring them. (I'm not a member
of a flat-earth society but I do believe there is some merit to the claim
that the distribution of capital ownership does matter to the macroeconomy
as well as to the firm.) I especially liked your comparison of political
democracy to ownership-based economic democracy and the discussion of human
rights vs. ownership rights - it sharpens some of the philosophical issues. 

That said, it seems to me that your discussion veers more toward industrial
organizational issues and then on to financial accounting analyses. Your
points about the issues of control and governance of the firm and the role
of labor are well-taken but IO is a different issue than capital ownership
and another puzzle that Kelsonians really don't address directly. But it is
an important issue that I agree you can't really separate from the ownership
one. I suspect that firms have evolved as hierarchical structures rather
than democratic ones for important functional reasons relating to
coordination and information costs. Thus we have labor contracts rather than
partnership sharing. In the meantime ESOPs adhere to the proven material
success of the property rights paradigm and shun "stakeholders' rights"
beyond ownership. 
But I also think the evolution of the firm has a lot to do with who is
willing to assume residual risk and this is something the ESOP can address.


Your financial analysis of the ESOP is insightful on the tax issues but I
was looking for something that focused on the difference between renting
capital (borrowing) and owning capital (equity). Returns on equity
theoretically and empirically exceed the cost of debt (interest), due to the
distribution of ex-ante risk through residual claimancy and subordination.
Otherwise why would anyone ever borrow to invest. This provides the
financial leverage to which you allude.

Thus, when an ESOP borrows to buy equity, the expectation is that profits
will exceed interest costs and that is what pays for ESOP shares--this is
enhanced by the differential tax treatment of equity and debt. Risk shifts
from former owners to employees and they get paid for it. If they are
successful (lower costs, expand markets, improve productivity, increase
profits), their incomes should reflect that. If not, they will be an unhappy
lot. 
The risk of falling profits then is an important one. Who pays for losses?
the banks won't assume that risk nor will the previous owners. I think the
intransigence of risks associated with ESOP valuations is one of the major
impediments. Kelsonians suggest a form of risk insurance - which may need to
be subsidized.
Dilution is another important consideration as financing new investment with
equity goes against the very human desire to leverage a good thing by not
expanding equity partners. 

Anyway, I will revisit your book as I think it raises a lot of important
related issues to ESOP-type ownership. 

Cheers,
Michael Harrington

 

-----Original Message-----
From: Dellerman@worldbank.org [mailto:Dellerman@worldbank.org]
Sent: Wednesday, October 06, 1999 7:21 AM
To: Michael Harrington
Subject: Re: book chapter





Sure, I thought they were going to post it, but here it is in word 97.
(See attached file: ESOPkels.doc)
cheers, David





Michael Harrington <mharrington@milken-inst.org> on 10/05/99 07:43:32 PM


To:   David P. Ellerman
cc:

Subject:  book chapter




Dear David,
Deborah Olson forwarded to me your email mentioning your critique of Kelso's
binary economics. I would be very interested in reading it. I am a political
economist doing research on broadening ownership at the Milken Institute - a
quasi- think tank in Santa Monica.
Hopefully you can email it? Thanks,


Michael Harrington, Ph.D.
The Milken Institute
1250 Fourth St.
Santa Monica, CA 90401

mharrington@milken-inst.org
(310) 998-2699




_______________________________
David Ellerman
Economic Advisor to the Chief Economist
World Bank, Room MC4-335
1818 H St., NW
Washington, DC 20433
Ph: 202-473-6368
Fx: 202-522-1158