An employee stock ownership plan (ESOP) is a qualified defined-contribution employee benefit (ERISA) plan designed to invest primarily in the stock of the sponsoring employer. ESOPs are "qualified" in the sense that the ESOP's sponsoring company, the selling shareholder and participants receive various tax benefits. ESOPs are often used as a corporate finance strategy and are also used to align the interests of a company's employees with those of the company's shareholders. BREAKING DOWN 'Employee Stock Ownership Plan - ESOP' Since ESOP shares are part of employees' remuneration for work provided for the company, ESOPs can be used to keep plan participants focused on company performance and share price appreciation. By giving plan participants an interest in seeing that the company's stock performs well, these plans are believed to encourage participants to do what's best for shareholders, since the participants themselves are shareholders. Employees are provided with such ownership often with no upfront costs. The provided shares may be held in a trust for safety and growth until the employee retires or resigns from the company. Once an employee retires or resigns, the shares are given back to the company for further redistribution or are completely voided.
Companies set up a trust fund for employees and contribute either cash to buy company stock, contribute shares directly to the plan, or have the plan borrow money to buy shares. If the plan borrows money, the company makes contributions to the plan to enable it to repay the loan. Contributions to the plan are tax-deductible. Employees pay no tax on the contributions until they receive the stock when they leave or retire. They then either sell it on the market or back to the company. Provided that an ESOP owns 30% or more of company stock and the company is a C corporation, owners of a private firm selling to an ESOP can defer taxation on their gains by reinvesting in securities of other companies. S corporations can have ESOPs as well. Earnings attributable to the ESOP's ownership share in S corporations are not taxable.
The first ESOP was created in 1957, but the idea did not attract much attention until 1974, when plan details were laid out in the Employee Retirement Income Security Act (ERISA). The number of businesses sponsoring ESOPs expanded steadily during the 1980s, as changes in the tax code made them more attractive for business owners. Though the popularity of ESOPs declined during the recession of the early 1990s, it has rebounded since then. According to the National Center for Employee Ownership, the number of companies with ESOPs grew from 9,000 in 1990 to 10,000 in 1997, but 60 percent of that increase took place in 1996 alone, causing many observers to predict the beginning of a steep upward trend. The growth stems not only from the strength of the economy, but also from business owners' recognition that ESOPs can provide them with a competitive advantage in terms of increased loyalty and productivity.