RE: dilution and risk

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

Shann,
I'm a little confused about the last paragraph here. As Charles says,
eventually the employees are bearing equity risk in the ESOP firm and this
represents their accumulated capital in the business, which is also where
they work. What is their diversification/exit strategy? This is tangible
wealth that must be diversified across the economy, otherwise you will
continue a divergence of wealth and incomes.
If I work and accumulate shares in the buggy-whip industry because I'm a
good buggy whip craftsman and I like it, wouldn't I be wise to invest my
capital in broadband technology or something equally attractive? (This is
only way I can afford to be a social scientist...) 
Regards
Michael



-----Original Message-----
From: Shann Turnbull [mailto:sturnbull@mba1963.hbs.edu]
Sent: Thursday, October 21, 1999 7:33 AM
To: ownership@cog.kent.edu
Subject: Re: dilution and risk


Yes I am discussing the situation of employees not putting up any cash.
This is a feature of many ESOPs. 

Employees obtain a contigent equity as soon as such a plan is in place.
This can make good sense to other equity holders as it can align the
interests of principals and agents. Employee could be in a situtation of
getting equity without any additional personal exertion than for what they
are already paid .  Some plans may place employment and/or performance
conditions on the vesting of equity from the ESOT to employees.  

In practice, diversification of a contigent equity does not become an issue
to employees who obtain the opportunity of getting equity without putting
up cash.  In any event any diversification of such contingent equity would
be against the interest of other stockholders who are seeking to align
employee interests with their own.

In the case of an owner-owned firm under diversification is indeed and
issue and provides the rationale for issuing shares to employees to share
the risk and to do so with people who can act to reduce the shared risk.
This is why owners assist employees to obtain shares without putting up
their own funds.  It also provides for succession and estate planning, etc.

Regards

Shann


At 11:24 PM 21/10/1999 , you wrote:
>At 06:13 PM 10/21/99 +1000, you wrote:
>>Dear Ownership Group
>>
>>Point 1 of Charles Upton's posting diverts the debate from a valuable
>>feature of ESOP's and a process of self-financing economic development.  
>>
>>Point 1 assumes that it is the employees who have to accept the risk of
>>financing business expansion.  Many ESOPs are designed so employees need
>>neither utilise their own funds to obtain an equity interest or become
>>exposed to the liabilities incurred to finance the issue of new shares to
>>the ESOP trust used to finance expansion of the business on their behalf.
>>In such situations the employee is in a no lose situation to make
>>irrelevant the statement of Charles Upton that "Optimal portfolio theory
>>requires diversification".
>
>The only way that employees could always be in a no-lose situation would be
>if they never acquired any equity interest in the business.  One they do,
>they have something to lose.  Is Turnbull sugessting that employees never
>acquire any equity interest in the business.  I think not.  Once I have
>equity capital, then there is something to lose.  
>
>Perhaps Turnbull means that employees acquire their interest without
>putting up any up front cash.  But someone is putting up the cash, and that
>cash has an opportunity cost. 
>
>As to diverting the debate, I didnt know I was doing more than pointing out
>a fact.  The underdiversification issue is an issue in any owner-owned or
>employee-owned business, 
>
>
>Charles W. Upton
>2324 Exline Circle
>Hudson OH 44236
>
>Department of Economics
>Kent State University
>http://www.personal.kent.edu/~cupton
>
>

Shann Turnbull
P.O. Box 266 Woollahra, Sydney, Australia, 1350
Phone: 02 9328 7466 office; 02 9327 8487 home
Fax: 02 9327 1497 home & office.  Mobile 0418 222 378
Outside Australia, replace first "0" with "61" after international access
code
Life long E-mail: sturnbull@mba1963.hbs.edu
http://www.mpx.com.au/~sturnbull/index.html