Re: Yes, the Earth is Round (3) There are ESOP alternatives!

[Shann Turnbull <sturnbull@mba1963.hbs.edu>]

In response to David Ellerman's posting on October 19, he states that "the
attenuated-right scheme amounts to a partial expropriation which may cause
a political problem to more people than 'bankers'".  He then goes on to set
up straw man of considering "rent controls" which I do not consider and are
not required to introduce attenuated rights/dynamic stakeholder
ownership/ownership transfer to "Democratise the Wealth of Nations" on a
voluntary basis encouraged with incentives as set out in my 1975 book of
that name.

David is expressing the view of Louis Kelso and his disciple Norm Kurland
that my proposals to change the rules of ownership amount to
'"expropriation".  However, I have never advocated that new rules for
democratising wealth should be introduced by force only through incentives.
 In regards to land ownership, Norm is inconsistent as he supports this
idea but without mentioning any incentives when he stated in point 10 of
his posting to all main discussion groups on September 27th, which I quote:

"Perhaps the most dramatic and politically appealing act that the state 
can undertake is to adopt legislation that would gradually transfer land 
ownership and land use policy from a tiny land-owning class and their trusts, 
or in the hands of government at any level, directly to the hands of the 
people through Community Investment Corporations (CICs)" 

In "Democratising the wealth of nations" I describe Co-operative Land Banks
(CLBs) which like CICs would own community land but with each resident
owning shares in the CLB according to the area used by their Perpetual
Lease (PL) over their residence.  (Details are in articles cited in my web
page).  Non residents could invest in rental housing, offices and other
commercial activities with the security of a 25 year lease which would mean
that all residual values would be captured by the residents at the end of
the lease.  However, investors would obtain the incentive to invest by not
having to pay the cost of acquiring land as they only rent their site.
This could reduce their investment cost from around 15 to 30%!  The future
value of the expected cashflows from their investment would not be
materially reduced by the 25 year time limit as the Present Value of a
dollar received in 25 years time discounted at an equity discount rate is
negligible.   The 15% to 30% discount on the immediate cost of the
investment created by not needing to purchase land would be a number of
orders greater the PV of any cash after 25 years. There are numerous
examples of investors  investing in leasehold sites even when they are
required to pay a substantial up front lease premium as there are examples
of bankers lending against the security of lease.

The above should provide compelling evidence that commercial investors who
are subject to the discipline of opportunity costs would be very much
attracted to invest in CLB improvements of all types rather than in other
sites with traditional land tenure arrangements.  I will excuse David for
describing my proposals are "a funny suggestion" on the assumption that he
was not aware of the details.

Residents of the investment properties would accumulate deferred
co-ownership rights of their a homes and apartments at the tax depreciation
rate of say 4% consistent with the 25 year ground lease.  (The investor
gets 100% of cashflow rights to income and control as stakeholder rights
are deferred but can be sold by the tenant to new tenants who would
accumulate their own co-ownership usage rights in the PL and CLB shares, cf
some ESOPs).  In other words, investors would to write off their ownership
rights at the same rate at which they wrote of their investment cost as
mentioned in my last posting.  However, their repair and maintenance costs
could be considerable lower than that usually budgeted for as there is now
an incentive for the tenant to look after their residence because they and
their heirs acquire ownership of a perpetual lease over their residence
and/or which their deferred rights they can sell to a new tenant.  

David closed his posting with a quote from Brookings advocating that new
shares be issue to employees as General De Gaule introduced into France in
a more limited way.  This proposal is a step towards the proposal in my
book for distributing ownership of corporations to their stakeholders.  The
tax incentives for introducing this on a voluntary basis are discussed in
my article 'Stakeholder Governance: A cybernetic and property rights
analysis', Corporate Governance: An International Review, Blackwell, 5:1.
pp. 11-23, January, 1997.
http://papers.ssrn.com/sol3/paper.taf?ABSTRACT_ID=11355 (Full text by
e-mail on request).  The competitive advantages of engaging strategic
stakeholders in the governance of corporations is more fully developed in
'Stakeholder Co-operation', Journal of Co-operative Studies, Society for
Co-operative Studies, 29:3, pp 18-52,  (no.88), Manchester, January, 1997.
 Full text from: http://papers.ssrn.com/sol3/paper.taf?ABSTRACT_ID=26238

Regards

Shann Turnbull

At 12:17 AM 20/10/1999 , you wrote:

>This is in response to several EMs, one from Michael Harrington on 8/10 and a
>brief one on 10/14, and to an intervening one from Shann Turnbull on10/13.
>
>1. I am abit puzzled by the continuing criticism of orthodox economics that 
>they
>don't understand the "productivity of capital"!  This is one of the kooky
>aspects of Kelsoian economics--the idea that capitalist economists don't know
>about the productivity of capital because of the journalistic emphasis on the
>statistic of "labor productivity" which is sometimes shortened to
>"productivity".  Please crack any text and read about capital theory.  I am 
>just
>baffled how anyone could really think capitalist economists have fallen
down on
>their job to emphasize the productivity of capital.
>
>Perhaps the logic is like this.  Kelsoians discover that the earth is
round and
>then after some bizarre reasoning conclude that the moon is made of green
>cheese.  When others deny that the moon is made of green cheese, the
Kelsonians
>accuse them of not realizing that the earth is round.  Let me assure all
>Kelsonians within earshot that conventional economists really do understand 
>that
>capital is productive.  The disagreement must lie somewhere else!
>
>Anyway on to substantive issues.
>
>2. One of the issues about ESOPs is who ends up paying for ESOP shares?  MH
>dodged the issue by modeling it as a case of borrowing money to buy equity and
>then paying off the loan with the proceeds from the equity.  MH is trying to
>model the ESOP on the limiting case of a 100% leveraged buyout where the ESOP
>trust, in effect, plays the role of the acquisition shell.  But ESOPs work for
>any percent of ownership, and the general result I referred to is that without
>any productivity effect on workers or changing wage demands and things of that
>sort, then the value of the shares that end up in the workers hands comes from
>dilution and tax breaks. In the near 100% or 100% buyout case, there are no
>other shareholders to dilute so the LBO enterprises often ended up having to
>partially decapitalized to make the payments for the loans that financed the
>LBOs (remember the 80s?)--sort of a self-dilution.  Alot of the hoopla in the
>80s was about all the productivity improvements that the new management was
>going to make to be able to pay off the loans without decapitalizing the
>companies.  I will submit my paper on "Who Pays for ESOP Shares?" to the
>discussion list.  It gives a derivation of these results.
>
>In general, ESOP loans are hardly paid for out of dividends (as I pointed
out).
>If they were, then indeed it would be a trivial transaction to analyze, namely
>borrowing to buy equity and paying the debt off strictly from that equity.
>
>To better see the problem, perhaps one should focus on the shell game involved
>in the two descriptions of the ESOP transaction.
>
>ESOP descriptions often involve a type of "shell game" of switching
between two
>quite different interpretations of the transaction.  The front-end is
described
>as an equity injection?a purchase of shares at full market value.  And the
>back-end of the transaction is described as paying off a loan with pretax
>dollars.   But if the front-end is described as shares being purchased with
>money borrowed by another party (the ESOP), then it should be added that the
>corporation itself pays off the other party's loan with the ESOP contributions
>[the corporation and ESOP can only be identified in the 100% case].  And
if the
>back-end of the transaction is described by paying off a loan with pretax
>dollars, then it should be added that the company has already "paid for" the
>cash injection (the loan) with the transfer of shares to the ESOP.   But ESOP
>descriptions often focus on either the front-end equity injection or the
>back-end tax-favored loan payments without giving the effect of the whole
>transaction.
>
>In fact, the company pays twice for the money it receives in an ESOP loan,
once
>with the new shares issued to the ESOP (a quid pro quo transaction) and the
>second time with the loan payback.  The tax break on the loan payback reduces
>the 100% dilution of the second time the funds are paid for to whatever is
left
>after the tax break.  If the company is in a 40% bracket, then 40% of the ESOP
>shares value is paid by the tax break and the remaining 60% is dilution.  This
>is all shown rigorously in the aforementioned paper.
>
>If the ESOP loan buys say 10% of the shares, then the company (which is 90%
>different from the workers) is paying off the loan which means less value to 
>the
>equity (90% owned by others) and that is dilution.  But the company gets the 
>tax
>break to pay off the loan that way, so the dilution is less than it would
>otherwise be due to the tax break.  One has to carry through this analysis to
>see why the stuff about "self-liquidating loans" was intellectual fog to cover
>up the dilution.
>
>MH's attempt to use CAPM-style arguments is a non-starter since one can go
>through the whole analysis of dilution & tax breaks under conditions of
>certainty (so clearly the risk premium on equity is not the essence of the
>argument).  Suppose a model has characteristics A and B, with A presented as 
>the
>cause of B.  But then one takes another model without A and finds that B is
>still there, so A (worker risk-bearing) was apparently not the cause of B 
>(value
>of shares ending up in worker hands).
>
>Naturally one should also be cautious about attributing the CAPM risk 
>premium to
>some special productivity of capital since it derives from the assumed
>risk-averse nature of the economic agents, not from a characteristic of the
>capital goods or financial capital.
>
>
>Let me move on now to Shann's EM of 10/14.  He starts off with saying that
>according to his interpretation of my Chapter 6, I don't understand "that
>productive assets provide a source of greater productivity, income and
growth."
>Many thanks, Shann, for pointing that out.  I guess I must have missed that.
>[You see Vic, I am learning already from this debate so it isn't totally
>stupid.]
>
>Shann goes on to say that the dilution argument is possible only because
>"bankers" don't enforce "ownership sharing" where the latter I think means
>Shann's form of expiring (dynamic) property rights in capital (like the 
>expiring
>property rights in intellectual capital).  Perhaps this would be a good 
>place to
>comment on that idea.  There already are examples of essentially such property
>rights, namely ownership of rental properties in rent-controlled districts.
>With no de facto or de jure subletting, then the people living in those
>apartments are in effect getting part of the rental (being allowed to not 
>pay it
>to the property owner) so the rental control has the (well-known) effect of
>attenuating the property right.  This does not model the time-change in
Shann's
>expiring equity rights but it does model the attenuation and that is the
source
>of the problems.  There is firstly a problem with the switchover.  The
owner of
>the property might have bought it for full price so the imposition of the
>attenuated-right scheme amounts to a partial expropriation which may cause a
>political problem to more people than "bankers."  Secondly, there are 
>well-known
>supply effects.  Given a choice, no one would build rental properties in
rental
>controlled areas.  Or to be more precise, if the rent controls took away say
>half the return, then one would only build super profitable properties so that
>the attenuated rate of return to invested capital would be normal.  Thus the
>effect of this suggestion would be to cut down on the production of the
capital
>to which the attenuated property rights apply, a funny suggestion from one who
>is accusing others of not appreciating the productivity of capital.
>
>Anyway, moving on, Shann goes on to say that the chapter shows that "Ellerman
>believes that economic development is created by the productivity of labor
>rather than the productivity of productive assets..."  In other words,
Ellerman
>must not realize that the earth is round since he does not buy our conclusions
>that the moon is made of green cheese.
>
>The next few paragraphs talk about Harold Moulton's notion of "procreative
>assets" which are "a special class of productive assets which over their
useful
>life create more value than the cost of their establishment and operations
>before the transfer of any value in the form of interest payments and taxes.
>That is, all procreative assets must by definition become self-financing.  It
>would seem that modern economists no longer use the concept of procreative
>assets and so have lost an intellectual tool to ..."  Shann, you really
have to
>take a peek at any economics or corporate finance text.  That is simply the
>ordinary notion of a capital asset which might yield a profit after the
>subtraction of all costs of acquisition and operation.  That is perfectly
>ordinary capital theory in Samuelson's or any other text.  How could you
>possibly think that is some sort of discovery??
>
>I don't think I will be long for this debate if I am called upon to explain 
>that
>capitalist economists really do understand the notion of capital goods
that are
>profitable to buy and operate.  If that is supposed to be the discovery that
>Kelsoians have made, then I think we have a clue why economists don't take
>Kelsoians seriously.  Actually, Kelso discovered something much more important
>which I spelled out in the chapter but which could be rephrased as a way to
>dilute absentee shareholders in favor of workers all under a verbal
smokescreen
>about the wonders of "capital."  Now that really is an accomplishment!
>
>The dilution + tax break argument is still the starting point to
understand the
>key point of who pays for ESOP shares, and, so far, the commentators have not
>engaged the argument.  Ranting that others don't appreciate one's discovery of
>the round earth will not do.
>
>Instead of wasting your and our time with such a banality from Moulton, the
>first president of the Brookings Institution, why don't you read Brookings
>himself?  He suggested
>
>
>     to  require  that  [interstate]  corporations  should reincorporate 
>under a
>     federal  incorporation  act;  which  act,  while securing to capital a 
>fair
>     return  at  a  fixed rate of interest and dividends, risk considered, 
>would
>     divide  all  additional  profit  or  accretions in the form of labor 
>shares
>     between  the  employees  (management  and  labor)  in  the  ratio  of 
>their
>     individual  contribution,  probably  as  recorded  by  their wage or 
>salary
>     compensation.  [Brookings,  Robert  S.  1932,   The Way Forward.  New 
>York:
>     MacMillan, 17-18]
>
>
>     This  reform  would consist largely in the rental of capital by the 
>workers
>     and  management,  stabilizing a fair rental return for it while leaving 
>the
>     workers  and  management  as their remuneration all the profits. 
>[Brookings
>     1932,  The Way Forward.  New York: MacMillan, 73-74]
>
>
>
>
>
>_______________________________
>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
>
>

Shann Turnbull
P.O. Box 266 Woollahra, Sydney, Australia, 1350
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