RE: dilution and risk

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

This message is in response to the question raised by Michael Harrington in
his posting of October 22.

Yes I agree that "eventually the employees are bearing equity risk" even if
they did not have to dip into their own pockets to acquire their equity.
This is also a common problem for many family owned firms be they inherited
or started up by the existing owners.  For many marginal firms they do not
have the cashflow to diversify.  

But let me point out that the first order problem is to get more people
"connected" with ownership in a way so as to increase their negotiable net
worth and control rights.  Once this has been achieved then we become
concerned with the second order problem of under diversified risk.  I do
not want to assert that we can resolve both problems as satisfactorily
together as fully as we may like.

One message that Louis Kelso drummed into his audiences during the tour I
organised for him in Australia in 1975 was that "nobody gets rich by
putting all their eggs in many baskets but by putting them all into one
basket and watching it like hell".  After all, one of the objective of
democratising ownership is for people to take responsibility for their
personal wealth, the wealth of their community and the commons in general.

However, there are various strategies to consider.  One is to establish
pension plans independently of ESOPs.  Another is to have some
diversification of investments within the ESOP.  Another is for workers to
change jobs to convert their ESOP entitlements to cash and/or other
investments to obtain diversity.  Alternatively they could change
employment to another ESOP owned company to accumulate a portfolio of ESOP
entitlements in a number of firms.  

The proposal in my 1975 book "Democratising the Wealth of Nations" is that
consumers and suppliers as well as employees would earn "fly-buy" like
points to equity in all firms from which they purchased goods and services
according to their trade/patronage.  In this way all individuals would
build up a diversified stake in the means of production and exchange to
create a stakeholder economy with a universal income provided by dividends
received from their diversified portfolio of patronage equity.  For those
with jobs it would create what Kelso described as a "two income economy".

Cheers

Shann

At 03:29 AM 22/10/1999 , you wrote:
>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

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