Could
an ESOP Save General Motors?
By Louis O. Kelso and Patricia Hetter Kelso
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At the annual shareholders’ meeting last May, General Motors’ Chairman
Roger B. Smith said that not even great technology and the magic
of robots can overcome the competitive disadvantage of high American labor
costs: at GM hourly workers earn $8.00 an hour more than their Japanese
counterparts. Smith suggested that perhaps some wages or benefits be replaced
with a “profit sharing plan.” Ford Motor Company Chairman Phillip
Caldwell recommended the same to Ford employees.
This poses a provocative question: Is any form of profit sharing a suitable
trade-off for wage reductions from the standpoint of the employees, the
company, or the union? Is there some alternative that would better serve
the interests of all parties in restoring the American automobile industry’s
worldwide manufacturing preeminence?
We think there is. If a Kelso ESOP1 is
used as a trade-off for a wage cut, the dollars invested by GM in its industrialization
will go at least three times as far, to the economic benefit of the company,
GM employees, and the public.
Let’s first acknowledge that a mere deferral of pay following the
example of Chrysler, which continues to post record losses, will not make
Detroit competitive with Japan. It is elementary that neither GM nor Ford
can become competitive by postponing costs. Winning requires cost
reduction.
Suppose GM did establish a qualified profit sharing plan with a variable
contribution formula. If profits do not rise, the contribution would be
nominal in relation to employees’ pay reductions. Alternatively,
the larger the profits, the larger the contributions to the plan.
If the GM-UAW negotiations took that route, let us suppose that as a trade-off
for a $1 billion annual wage reduction for five years, out of an annual
payroll of nearly $18 billion, GM agrees to contribute twice that amount
annually to the profit sharing plan. The plan would then invest these funds
in a diversified portfolio of carefully selected presently outstanding
securities. But in doing this, General Motors is merely investing, on behalf
of GM employees, in the outstanding securities of other corporations. This
investment is only marginally profitable (six percent or about half the
rate of inflation). Nor is there anything the employees of GM can do in
their role of workers or managers to affect the profit performance of a
company whose secondhand securities are held in the profit sharing plan.
Nor can GM employees influence the mood swings of the general stock market.
Employees can only affect the profitability of the company they themselves
work for — in this case, GM.
Now let us consider an alternative scenario. Suppose, in response to Chairman
Smith’s request, GM and the UAW agreed that all GM employees — non-union
as well as union, salaried as well as hourly — would take pro-rata
an aggregate $1 billion per year wage reduction and not ask for an increase
until GM is again the world’s most profitable automobile manufacturer. In
return for this critical concession GM and the UAW would agree to replan
their financial future with a Kelso ESOP. Let us further assume that GM’s
estimated capital budget for the next five years is $40 billion,2 and
that a banking consortium agrees to lend the ESOP $20 billion (half the
five-year projected capital budget) at an interest rate that would fluctuate
with prime. GM would guarantee the loan. The loan agreement would
further provide for the loan to be repaid over five years in annual increments
of $4 billion. The ESOP would give its note or notes to the lenders. It
should be remembered that repayments of this loan, both principal and interest,
are deductible from corporate income taxes. Assuming that GM, for combined
state and federal purposes, is in a 50 percent tax bracket, the ESOP financing
plan is twice as efficient as conventional finance in retiring the debt
principal. The ESOP would invest the borrowed funds, as received, in equal
amounts of newly-issued GM stock at market value or at appraised value
if the stock is of a class not in the market.
The ESOP’s allocation formula or financial plan for GM employees
would provide that as periodic repayments on the loan are made by GM through
the ESOP to the lenders, a block of the previously purchased GM stock,
corresponding in value to the amount of the repayment, would be allocated
among employees in proportion to their relative compensation. Employees
would have no personal liability on the ESOP’s note. If it could
be shown that the stock sale would cause material dilution of existing
GM shareholders, a class of preferred stock not designed for public trading,
convertible and redeemable in common stock, suitably priced, could be used
for the purpose.
However, the idea of “dilution” would have to be carefully
examined. Dilution is of two kinds: political and economic. Political dilution
occurs where voting control is shifted to a new power center. Economic
dilution occurs where an event causes a reduction in true earnings per
share. Neither kind of dilution would take place with a Kelso ESOP; economic
dilution cannot occur unless it exceeds asset enrichment. Asset
enrichment occurs when new stock is sold at full value to the ESOP in such
way that each dollar of proceeds has the financing efficiency of three
or more dollars of corporate income used conventionally to finance growth.3
Possible dilution must also be offset against the wage-containment tendencies
and employee motivational power of the ESOP.
As the GM-UAW Kelso ESOP draws down on the loan from time to time to buy
newly-issued GM stock, GM would use the proceeds of the stock sale to "reindustrialize” itself.
Every corporate investment that meets the test of proper financial planning
is actually two transactions in one. The corporation acquires new productive
assets. At the same time, stockholders' equity is increased. This is true
because the corporation is a juristic person, but not a real person.
In reality, the corporation is a financial planning device that connects
people with capital assets and with other people in specifically planned
ways. In economic reality, only human beings count; there are people who
produce through their labor, people who produce through their capital,
and consumers. Every producer is a consumer, and every consumer should
be a producer, although in a badly planned economy there are unfortunately
also parasites that consume but do not produce, although they may appear
to do so.
When a pension or profit sharing plan invests in spent (i.e., already
outstanding) stocks, the employees get a beneficial interest in those spent
stocks. In terms of productive capital assets, the employer gets nothing.
This is not two financing transactions in one; it is simply inept planning.
The yield of the spent stocks will be about six percent, perhaps half of
current inflation. The purchasing power of those stocks for purposes of
the employees’ retirement security begins to shrink on purchase.
When an ESOP is used to plan corporate growth, its effect must be compared
with the dominant method used today — financing from cash flow, which
accounts for 95 percent of all new capital formation in U.S. corporations.
Thus ESOP financing cannot be compared with investing in pensions and
profit sharing plans because these are not financial planning tools at
all; they finance nothing. They buy spent stocks.
In addition, GM and GM’s employees would each save approximately
$300 million in Social Security taxes that would have been collected if
the $5 billion in wages had not been ceded. The total $600 million saved
could, to the extent agreed upon in collective bargaining, be converted
by the ESOP financial plan into employee-owned GM stock.
Conservatively estimating that GM employees would on average be subject
to the 25 percent personal income tax rate, the employees would save $250
million per year, or $1.25 billion over five years, in personal income
taxes.4 The ESOP,
again to the extent agreed upon in collective bargaining, would convert
that savings into employee investment in GM stock.
A $20 billion employee purchase of GM stock would create an average employee
portfolio, at cost, for each of GM’s 517,000 employees, of $38,684.
If the financing plan were renewed, this amount could grow to $77,369 in
ten years and to $166,152 in fifteen years. The employee-investors, however,
would not be passive investors, but stockholders in a position to make
their investment, along with that of all other GM stockholders, grow in
market value over a sustained period. The value of the stock should appreciate
substantially during the five-year period and thereafter as GM regains
its economic health through lower cost products and happier, more secure,
and more highly motivated employees.
GM employees would also acquire a second source of income. Kelso ESOPs
normally pass dividends through the trust currently on already amortized
shares. The trust can be planned to make dividends to the employee-stockholders
payable in pre-tax dollars — double the financing efficiency of conventional
dividends.
The UAW and GM should launch an extensive study of the desirability of
achieving yet another major cost savings through a Kelso ESOP. Fixed benefit
pension plans now cost GM nearly $2 billion per year. But GM's employee
retirement pensions, like pensions from any retirement funds invested in
secondhand securities, are in most cases grossly inadequate. Their use
is the essence of bad financial planning. No employee investments in secondhand
securities, sluiced back and forth day after day in the marketplace to
support the investment community, can compare with a direct investment
in General Motors. Pensions connect employees with a low-yielding retail
investment — perhaps six percent per year or about half the current
rate of inflation. A Kelso ESOP financial plan connects employees
with the 20 to 30 percent average pre-tax return on capital in GM. This
is the range of pre-tax earnings in most major U.S. corporations.
One of the principal reasons U.S. industries have become uncompetitive
as a result of cost inflation is the growing tendency of both management
and labor to seek retirement security through qualified pension and profit
sharing plans. Through these devices brokers sell American workers the
worst "investment bargain" conceivable: already outstanding securities.
This is financial planning gone mad. Kelso ESOPs make credit available
to employees to buy newly-issued equity stock on terms where part of the
pre-tax yield of the assets represented by that stock pays for it.5 At
the same time, as we have seen, it finances the employer corporation's
capital requirements in a way that gets three dollars' or more use out
of every dollar of capital cost when compared to conventional internal
cash flow financing, the source of financing for 95 percent of all U.S.
corporate growth!
Secondhand securities purchased by pension and profit sharing trusts can
never pay for themselves. This is why retirement provisions in American
enterprise are uniformly inadequate and rampantly inflationary. An ESOP
financial plan should be used instead. Diversification can be effected
after the ESOP has accomplished its three-fold task of growth financing
for the employer, estate-building for the employees, and tax saving for
both the employer corporation and its public shareholders. The financial
community’s talents could be better used to diversify in this way
without crippling business with bad financial planning, irrecoverable costs,
and barren investments.
Of course, the U.S. Internal Revenue Code should be amended to clarify
the right of ESOPs to be diversified by exchanging in the securities markets,
if deemed desirable, some of the securities of the sponsor-corporation
for other appropriate investments. Senator Russell Long, the distinguished
former chairman of the Senate Finance Committee and now its ranking minority
member, who first introduced ESOP financial planning to Congress in 1973,
has an answer for this kind of problem. "If the law needs changing
so that it will make sense, you've come to the right place. That is what
we do here in Congress.”
The UAW and GM, through collective bargaining, would divide the
measurable economic advantage of ESOP financing between GM, its public
stockholders, its customers, and its employees. The UAW can at last champion
the constitutional rights of its members to access to capital credit —the
ability to buy capital and pay for it out of what that capital produces,
thus raising employees' incomes without raising the employer’s labor
costs. This is the financial planning tool foreign competitors hoped we
would never discover; the tool we had better learn to use before they exploit
it first.
With the establishment of a second source of current income for GM employees — dividends — the
necessity for demanding progressively more pay for the same or diminished
work input is greatly reduced. As Kelso ESOP financial planning becomes
general in the economy, we will reach the maximum levels of employment
achievable. The U.S. economy is replete with unsatisfied needs and wants
for physical goods and services. What we need now is consumers with incomes
from non-inflationary sources6 to make
potential consumer demand effective. This means that what consumers cannot
buy out of their labor incomes they must be able to buy out of their capital-produced
incomes. We may well then achieve true full employment for a decade or
two. The unemployment that will eventually follow in the wake of technological
advance would be different in kind. Superseded employees, secure in their
capital incomes, could afford to enjoy their leisure. Unemployment is not
so bad when you can afford it.
We should all be aware by now that technological change makes capital,
not labor, more productive, and that the euphemism "rising productivity
of labor" is simply a way of shifting to consumers the costs of paying
for the increasing needs of workers. Unfortunately, solving labor's income
distribution problems in that way forces consumers to pay higher prices
for the same or even lower quality goods and fewer services. The name of
this phenomenon is "inflation." Since employees are also consumers,
and the same technologically-initiated forces are at work throughout the
economy, the dependence of employees upon their decreasingly productive
labor rather than upon increasingly productive capital assures perpetual
inflation. Kelso ESOP financial planning eliminates this hopeless spiral
at its source.
The lesson of foreign competition is that much of our labor is overpriced.
At the same time, we know that only a tiny fraction of the wages of capital
are paid to capital owners — the stockholders. After all, state and
federal governments, in a vain attempt to compensate for bad financial
planning which long ago failed to guide the economy into broader capital
ownership, take more than half of capital-produced income, particularly
if the corporate portion of Social Security taxes is included. In order
to finance growth, boards of directors then divert about three-fourths
of the remainder of capital-produced income away from stockholders and
back into financing the corporation. Clearly, a higher payout to stockholders
of the wages of capital, broader ownership of capital, and more efficient
methods of planning and financing economic growth — all elements
of sound financial planning — are what is required to beat foreign
competitors, reduce inflation, and meet our ultimate economic need: higher
capital-produced incomes for all consumers except those who are already
rich.
General Motors would acquire, at negligible
issuance costs, a new body of employee-stockholders equal in number to
half of its present public stockholder base. This would be an enormous
step toward the unification of the interests of management (who would be
participants in the Kelso ESOP), employees, public stockholders, and consumers.
Employees would be powerfully motivated
to make GM ("their company") succeed in international and domestic
competition.
For GM employees, the ESOP would offer
an additional market for their stock at the time they wish to sell it.
Employees would gain a significant voice
in GM affairs at stockholder meetings. There could be no more interested
or knowledgeable stockholders, nor stockholders that could contribute more
to the performance of GM than its own employees.
1. The union could expand its sphere of
service from interest only in wages, hours, and working conditions to interest
in sound financial planning and the acquisition of capital ownership for
all its members. It is capital ownership that removes the cause of
poverty. It is capital ownership that is the chief source of leisure, affluence,
and freedom from toil, and ultimately the only way for employees to acquire
sufficient capital-produced income to provide secure retirement.
2. The union would acquire the most powerful
recruiting tool in the history of the union movement: the power to assist
members in planning a sound economic future through a combination of labor
and capital earnings. White collar employees have always been reluctant
to demand more pay for the same work. Employee resistance to unionism will
change to interest in and reliance upon it. After all, the problems of
employee stockholders differ in many ways from those of public, non-employee
stockholders.
3. The UAW would take an interest in financial
planning and would exert an influence on the design of the GM-UAW Kelso
ESOP towards ends deemed reasonable and advantageous to the employees,
to GM, its stockholders, and its consumers.
4. The UAW would seek the services of financial
planners for its members as stockholders in GM, and would enlarge its consulting
staff appropriately. It would participate in negotiations as to what part
of the economic growth of GM should be financed in such a way that UAW
members would become the owners of the stock representing that growth,
and the extent to which the wages of capital would be paid currently to
stockholders.
5. Finally, the UAW could become the spearhead
for obtaining equal protection for its members of their constitutional
rights to credit finance their capital acquisition in the process of providing
General Motors — and other employers for whom its members work — highly
efficient, low-cost capital to power their growth and competitiveness.
What sound financial planning can do for GM, it can accomplish for enterprises
and individuals throughout the economy. The other financial planning tools
referred to in a footnote above are constructed on the logic of the ESOP.
-- Originally published in The Financial Planner, Vol. 10, No.
11, November, 1981.
Related Article - Yes,
an ESOP Can Still Save General Motors by John Menke
- The
Kelso ESOP (Employee Stock Ownership Plan) is a financial planning device
intended to advance the mutual economic interests of the employees, the
employer, and the public. There are many ESOPs that are not Kelso ESOPs.
- “How
General Motors Stays Ahead,” Fortune, March 19, 1981,
p. 49. GM’s
ten-year capital investment plan is estimated at “an almost inconceivable
sum — approaching $80 billion . . . .”
- The three-to-one advantage
of ESOP financial planning in this case consists of: $20 billion of equity
opportunity — the opportunity to prudently use equity when without
the ESOP General Motors would not issue common stock to finance growth;
$20 billion of tax savings from repaying the loan principal in pre-tax
dollars, and $20 billion of capital ownership generated in GM employees
in the five year period, a result just as important to sound financial
planning as new capital formation for GM.
- Upon
taking their stock out of the trust on retirement or otherwise, employees
would be subject to a much lower capital gains tax.
- The
Kelso ESOP is but one of eight financing tools designed not only to fulfill
every variety of capital financing need, but also to build viable capital
estates into every type of consumer, whether a corporate employee, a
government employee, a retired person, a technologically superseded worker,
teachers, artists, or the disabled. At the very moment in history when
Americans are beginning to have second thoughts about the soundness of
conventional financial planning that only makes the rich richer while
denying equal protection of credit laws to those who want to own capital
but cannot, these financial planning tools promise to fill the void in
the constitutional rights of the 95 percent of citizens who have been
economically discriminated against.
- Namely,
incomes not dependent either upon taxation-dependent boondoggle or welfare,
both of which are inflationary.
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