ESOPs and Profit Sharing

ESOPs and Profit Sharing

The leveraged employee stock ownership plan (ESOP) has been in existence formally since 1974 when the U.S. Congress codified ERISA. ESOPs are considered to be one of the fastest growing and most visible forms of employee benefit plans in the United States. ESOPs can be traced to the concepts of Louis Kelso, who observed during the Great Depression that there were significant failures of system design that had created a situation in which large-scale productive capacity in the form of idle factories was positioned alongside consumers desperately wanting the goods those idle factories were physically capable of producing and workers equally desperate in their need for income-producing jobs.

Kelso ultimately developed a strategy for income redistribution that would help to maintain widespread purchasing power in the economy. Kelso’s argument was that the effort at income redistribution should be directed upstream rather than downstream. In other words, policymakers should emphasize not only the widespread employment of labor resources, but the widespread ownership of capital resources.

The first true ESOP was designed by Kelso in 1956 and involved the Peninsula Newspapers Incorporated ownership, whose principal shareholders owned 72 percent of the company’s stock and wanted to sell their stock to the employees who did not have the funds with which to make the purchase. Kelso found a 1953 Internal Revenue Service ruling suggesting that a defined contribution employee benefit plan could possibly be utilized to apply what would become the ESOP financing technique.

Kelso designed the fist ESOP by amending seven company-sponsored profit sharing plans to act as an ESOP-type financing vehicle. Owners of Peninsula Newspapers Incorporated accepted 20-year notes from the profit-sharing plans for the acquisition of their 72 percent stake in the company. Principal and interest payments were to be paid from annual tax deducti…

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