Re: dilution and risk

["Charles W. Upton" <cupton@kent.edu>]

----- Original Message -----
From: Shann Turnbull <sturnbull@mba1963.hbs.edu>
To: <ownership@cog.kent.edu>
Sent: Sunday, October 24, 1999 2:55 AM
Subject: RE: dilution and risk


> 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.
>

I cannot see the basis for saying that one is a first order problem and the
other is a second order problem.  Most problems are simultaneous, and I
raise the issue of diversification to make the point that there are
tradeoffs. You cannot raise ownership stakes without increasing the
underdiversification of the owner, whether it be the original founder(s) or
the employees via an esop.

> 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.
As to the social agenda, note that people begin to take responsibility for
the wealth of their community and the commons in general when they own a
diversified portfolio.  The percentage of households owning common stock has
risen significantly in the past few decades and we can already see this
having some impact on different legistlation.  Some commentators suggested
that the reason Democrats are less resistant to lower tax rates on capital
gains, for instance, is that the percentage of the population owning common
stock has (according to one report) risen to 51%.


> 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.
>
Of course to the extent an ESOP consists of a diversified portfolio, whether
acquired  by purchases or job switching, but which does not consist of
shares of the company for which an individual works, it is an ESOP in name
only.

> 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
>