Why Don’t Workers Get Paid in Equity Like CEOs Do?

Illustration for article titled Why Don’t Workers Get Paid in Equity Like CEOs Do?
Illustration: Angelica Alzona (Gizmodo)
Giz AsksGiz AsksIn this Gizmodo series, we ask questions about everything and get answers from a variety of experts.

Most workers have no ownership stake in the companies to which they give their labor. This is, if you ask me, not ideal. But I’m not a CEO. If I was a CEO, I’d probably feel this was just as things should be, and would be able to justify this feeling with various statistics, theories, rationalizations, etc. For a better sense of what these might be—a deeper understanding of why, exactly, most workers aren’t paid in equity—for this week’s Giz Asks we reached out to a number of experts in labor law, economics, and employee ownership for their opinions.

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Eliza Forsythe

Assistant Professor, Labor & Employment Relations, University of Illinois at Urbana-Champaign

Some workers are of course paid in equity—if you work for a start-up, are a partner in a law firm, or are a top executive. For most workers, equity pay is a bad idea. You want to diversify your investment portfolio. If you invest in your employer, both your investments and your job are at risk if the business suffers. The logic of equity compensation is to align the interests of the worker and the employer. So if you are in a position to drive company-wide performance, equity pay can encourage you to make decisions that are aligned with the shareholders, since you are also now a shareholder. For workers that are less pivotal to the company’s success, a better option is a profit-sharing bonus. This is a payment the employee receives that they can spend or invest elsewhere. This helps workers feel invested and connected to the company, but does not put their income at risk in the same way.

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Corey Rosen

Founder of the National Center for Employee Ownership

A lot of companies do pay employees at least partly in equity—about 25% of the workforce owns stock in their company through some kind of employee-ownership plan. But the amount of stock a lot of those people own is fairly small.

I think there are a number of reasons why more companies don’t provide equity to their employees. One major problem is that a lot of compensation consultants and boards of directors—and even, I think, the corporate press—assume that the people who matter are the people who are leading the company, and that everybody else is just a replaceable drone.

There is a lot of research that disproves the notion that only the people who can directly influence the stock price should be paid in any form of equity. The research is very clear that companies that share ownership widely with employees perform substantially better than companies that don’t. Especially coming out of this crisis, companies need to think about what they can do to engage employees more fully, to help them think up the ideas and processes that might keep the company going, or even growing, into potential new markets. The notion that the only people that are capable of doing any of that are the handful of people at the top is just offensively and empirically wrong.

Another part of it is that a lot of companies don’t understand what the potential benefits are—there are very significant tax benefits for corporations with some forms of employee ownership.

Take employee stock ownership plans, or ESOPs. These are highly tax-favored plans that are part of US federal retirement plan law, and they’re particularly useful when you’ve got an owner of a company who’s looking at transition. Selling to an ESOP is the most tax-favored way that you can do a business transition. A lot of people think, “well, how could the employees ever buy their own company?” But it doesn’t work that way. ESOPs are funded out of the future pre-tax earnings of the corporation—so they’re funded in much the same way that a private equity firm would fund a leveraged buyout of a company. It borrows money, and then that loan is repaid out of the profits of the company it bought. ESOPs are basically the same mechanism: the company borrows money so it can buy out the shares of the owner. The difference is that those shares go into a trust for employees. The company and the seller get substantial tax benefits by doing this.

Kenneth Glenn Dau-Schmidt

Professor, Labor and Employment Law, Indiana University—Bloomington

Employee participation in equity or profit sharing can make sense for many firms.

Such participation decreases the divergence of interest between labor and capital in the division of the proceeds of production and helps the parties focus on their joint interest in the profitability of the firm. In Japan it is common for companies to give employees annual bonuses based on firm profits to promote this unity of interest between the employees and the firm. Where the employees are knowledgeable about the methods of production, many firms have also found it profitable to have employees participate in the management of the firm through employee committees such as quality circles. Many firms do successfully organize as cooperatives or by including employee ownership or profit sharing and some even include employee participation in management decisions.

Why don’t we see such employee participation in the profits of the firm more in the American economy? First, the nature of capital and labor lend themselves to organization of production by capital. In comparison with labor, capital is easy to concentrate and organize, and very mobile. As a result, it is common for owners of capital to organize and hire labor to undertake production rather than to have workers organize and borrow capital to undertake production. Second, American law and culture do not facilitate or envision employee equity participation, focusing instead on capital’s employment of labor through individual contracts. In the American system of production, workers generally have a right to compensation and benefits only through individual employment contracts. Labor is seen as “flexible” and profits are maintained through market fluctuations by cutting employment and laying-off employees. In recent years even more risk has devolved onto employees in the contract for employment, as employees undertake more and more responsibility for their healthcare and retirement. Although this system of individual contract worked acceptably for American workers during the tight labor markets of the industrial revolution and post-war era, it is less clear that American workers will find it adequate as they struggle to compete with low wage foreign labor in the global economy.

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Ioana Marinescu

Assistant Professor, Social Policy & Practice, University of Pennsylvania, whose research focuses on the labor market, among other things

Regular workers do not get paid in equity because most workers are more risk averse than entrepreneurs and shareholders. Because of this difference in risk aversion, the standard employment relationship is one where firm owners assume the risk taking and workers get a fixed compensation, the wage. A stable wage works best for risk averse workers. Because entrepreneurs and shareholders typically have higher income, they can afford to risk losing some of their income in exchange for higher expected returns. Therefore, equity makes more sense for entrepreneurs and shareholders.

CEOs and high level management are somewhere in between typical employees and shareholders/owners. They are employees, but they have high incomes and their decisions typically greatly affect the profitability of the company. Therefore, giving CEOs part of their compensation in stock or stock options makes sense for two reasons. First, CEOs are typically able and willing to bear the risk because of their higher income. Second, the equity provides additional incentives for CEOs to do a good job: if the company’s profitability increases, the CEOs directly benefit through their equity.

While these arrangements are explainable by economics, they are not without their limits and downsides. First, while workers get a stable wage, they are still at risk of losing their jobs, especially during a recession like today, so they are not completely insulated from risk. This is why other systems like unemployment insurance are useful to create additional income security for risk averse workers. Second, giving equity to CEOs does not always insure the long-term growth of the firm. Indeed, CEOs do not have full control of the outcomes and sometimes they benefit from increases in profitability that have nothing to do with their efforts, e.g. increases in profitability due to higher oil prices. Furthermore, workers have usually little say in the decisions of the firm relative to CEOs and shareholders, and there is some evidence that workers representatives on the board can increase firm investment.

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Lawrence J. White

Professor, Economics, New York University

If workers are paid in equity, they become partial owners of their company. That means that they would share in the downside risk in the company’s fortunes as well as the upside. Many workers would not want to take on that risk.

Also, by working at a company, a worker is already heavily “invested” in the company: If the company prospers, the worker is likely to continue to be employed and perhaps receive promotions and raises. If the company falters, the worker could be laid off. Why would a worker want to exacerbate those risks? This would be the opposite of diversifying one’s portfolio.

At the same time, by paying workers in equity, the existing owners are diluting their ownership position. Many owners would not want to do that. In addition, if the company is not publicly traded, then being paid in equity means that the worker is being paid with an extremely illiquid asset. And if a worker really did want to acquire equity in the (publicly traded) company for which he/she worked, the worker can always use a portion of his/her salary to buy those shares through normal stock brokerage transactions.

Of course, there are young Silicon Valley companies that pay their (largely young) employees partially in (illiquid) equity. Why do these companies do this? Partly, the companies may be cash-starved, so payment in equity allows them to economize on cash. Partly the workers are young and mobile, so they can afford to deal with the downside risk that the company goes bust while hoping for the up-side bonanza.

But these companies—and their workers—are the exception, not the rule.

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Nicolas Aubert

Professor of Finance at Aix-Marseille University and a Fellow at The Institute for the Study of Employee Ownership and Profit Sharing at Rutgers University

The S&P 500 Index fell sharply in the midst of the covid-19 crisis but is rising again. Nevertheless, some companies will not recover. As after the 2008 crisis, public money will surely have to be spent at some point to prevent bankruptcies or to help companies with cash flow problems recover from the crisis. Indeed, the European Federation of Employee Share Ownership calls for a public aid plan to develop employee share ownership. So, to ease pressure on short-term cash flow, why don’t more companies offer stock options to their employees as part of overall income? According to the National Center for Employee Ownership, employees can buy stock directly, receive it in the form of a bonus, receive stock options, or obtain stock through a profit-sharing plan.

The answer depends on the payment conditions agreed between the workers and the company.

From the employees’ viewpoint, the appeal of gaining a share of equity as part of overall income depends primarily on the company’s financial health and prospects. For workers in companies that do recover from the crisis, receiving a share of equity as part of overall income means, by definition, that they will receive lower wages. Employee interest in exchanging a proportion of their wages for equity then depends on individual liquidity constraints—the option may suit the highest-paid workers but not the lowest-paid. Paying workers with equity may also have an effect on individuals’ overall wealth, and the level of risk involved will be determined by external events among other things.

For employers, paying workers a share of equity or stock options as part of their income would help to improve short-term liquidity; instead of cash going out in the form of salaries, companies would issue new stocks to employees.

However, in the short term, one important disadvantage of increasing the number of stocks is the dilution of earnings per share, that is, when company profits are divided among more shares of its common stock. But, in the longer term, most disadvantages of new share issues can be mitigated by the positive outcomes of employee stock ownership: increased workforce motivation leads to improved corporate performance, which increases the value of shares. Extensive academic research of the Institute for the study of employee ownership and profit sharing at Rutgers University shows that companies can expect better performance by developing and implementing employee stock ownership programs.

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Kate L. Bronfenbrenner

Senior Lecturer and Director of Labor Education Research at Cornell University

The main reason that employers don’t pay with equity is that employers do not want workers to have a say in the decision-making of their companies. This goes back to 1946, when the auto workers and other industrial workers were on strike, asking for more than just better wages and hours and working conditions. They wanted to have some say in the bigger decisions—how things were made—because they felt that they knew a lot about production. And the companies responded: we don’t want that, we want to have sole control over what happens, we do not want to give workers control. In the end, the workers were basically bought out with overtime and big pay packages. This helped bring industrial workers into the middle-class. At the same time, they gave up on having seats on the board, and equity, and a say in the decision-making.

Under the National Labors Relations Act, workers can bargain only over the terms and conditions of employment. Other subjects such as whether to close the plant, or what kind of equipment to purchase are permissive subjects of bargaining, with no requirement for the employer to negotiate. Employers drew that line, and unions made the choice not to push it. And workers have not taken that fight further, in part because every time they thought about doing it, employers have [threatened to have company unions?]used the opportunity to impose company unions

The only workers that have ever really been offered equity are highly paid professionals—primarily in high tech—who have been offered stock options as an alternative to pay. No company has ever considered paying low wage workers in equity, because there are too many of them, and if an employer were to pay those workers in equity, the employer would lose control of their companies. The only times corporations consider paying in equity are when they have small numbers of employees and there is no risk of their losing control.

The fastest growing occupations in this country are nurse aids, physical therapy aids, fast food workers, janitors, and security guards. Job growth is among low-wage women of color. Employers are not considering paying these workers in equity. The workers are trying to get paid $15 an hour, they’re trying to get health insurance, they’re trying to get masks and gloves, because these are the people working in the pandemic. So they’re not thinking about equity—they’re thinking about staying alive.

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DISCUSSION

How many factory workers would take 40K cash and 20K stock over just 60k cash? Most of them would take the cash. Stocks don’t put food on the table.