Investors focusing on setting standards for executive pay rarely address an essential issue: how equity should be allocated among employees in a company, from the chief executive officer to the rank and file. To investors, the point of sharing equity with employees is to improve corporate performance. There are a lot of theories and assumptions about how this should be done, but few compensation plans are driven by research on what actually works.
A rarity a generation ago, by 2002 about 40% of all U.S. workers who worked for companies that issued stock had rights to acquire ownership in their employer in one way or another, according to an estimate of the National Opinion Research Center. Experience with the idea ranged from the fabulously successful — Starbucks Corp., Microsoft Corp., Publix Super Markets Inc., Whole Foods Market Inc. and Southwest Airlines Co. — to the disastrous — UAL Corp., Enron Corp. and WorldCom Inc., for example.
Research consistently shows broad-based employee ownership improves corporate performance and generates positive returns for shareholders, while compensation plans focused only on senior executives have no effect or a negative effect on performance.
Using both original research and an analysis of all the existing research, Douglas L. Kruse and Joseph R. Blasi, professors at Rutgers University, concluded that broad-based stock-option programs — including employee stock ownership plans — tend to improve performance in key measures over what would have otherwise been expected. Increasing executive equity awards was negatively correlated to subsequent corporate performance, they found.
In response to calls for reform by investors, Congress and others, about 40% of companies have reported they will eliminate broad-based employee equity plans, while almost none will eliminate executive plans. Some companies will cut back on options for executives, but replace them with other kinds of equity; some will even reduce the already outsized grants to somewhat less absurd levels. Many will introduce some performance criteria for these plans, although the history of such approaches suggests the criteria will be changed if the executives do not receive the equity they expect.
In short, companies are ignoring what the research finds works better.
Institutional investors are largely complicit in this effort, although the California Public Employees' Retirement System and California State Teachers' Retirement System have policies to discourage excessive executive equity programs in favor of broader ownership by employees. Many other investors, including money managers, focus mostly on arbitrary limits to dilution, restructuring performance plans for executives or urging boards to be more diligent and independent.
Broad ownership programs are not always desirable, as witnessed by failures like United Airlines and Enron. Broad-based ownership plans should be, among other precepts, integrated into a management approach that treats people as owners in the day-to-day workplace. Companies should also work toward creating "ownership cultures," management styles that encourage greater employee involvement. These kinds of companies consistently outperform their peers and even employee ownership companies with more conventional cultures.
The Committee for Effective Employee Ownership produced 10 principles on what makes employee ownership effective for companies and shareholders. The committee is a joint project of the National Center for Employee Ownership, the Beyster Institute for Entrepreneurial Employee Ownership and the Global Equity Organization. The committee hopes institutional investors will use the principles as guidelines to formulate policies that look beyond equity as simply an issue for a few top executives. The principles include:
• Effective equity compensation strategy is driven as much as possible by empirical data on what works, rather than on theory, assumptions and doing what other companies do.
• Effective equity compensation allocates equity among executive, management and non-management employees fairly and in a broad-based manner.
• Broad-based equity plans should generally provide equity to a majority of full-time employees.
• Executive ownership in public companies should be determined by an independent committee using rigorous guidelines.
• Companies should provide for diversified retirement opportunities as well as company equity ownership, such as a 401(k) plan or adequate diversification within an employee ownership plan.
• Public companies should provide adequate disclosure to investors and employees about equity plans. It is impossible to know from public filings whether a company has a broad-based plan unless it voluntarily discloses it.
• Public companies' plans should be fair to shareholders as well as employees.