One thing that bothers me is that whenever I think my portfolio has reached a steady state, some sort of new information pops up and sows the seeds of doubt. Recently, I ran across a new and useful stock selection criterion that I added to my due diligence checklist: employee stock ownership. I had summarized the potential benefits of employee stock ownership to shareholders in the article Shared Capitalism: A Love Story. Although it was not my intention to change any of my positions, I could not resist going on a fact-finding mission to review my stocks in the light of this criterion. The stock allocation of my portfolio consists currently of the following holdings:
European Large Caps
European Small Caps
For the purpose of the review I put together a simple test consisting of three checks set out below:
Depth of employee ownership (how many employees have access to share-based compensation?)
Stock ownership plans can be limited to only a few employees, mostly executives and senior management, or offered to a larger group. There are two different philosophies behind these approaches: In the former case stock ownership follows individual performance and in the latter case individual performance follows stock ownership. The latter is a plus in the ranking.
Level of employee ownership (how many shares are held by employees?)
In accordance with the threshold that is applied in the stock selection for the UK Employee Ownership Index, I looked for a number north of 3% not including shares held by main board directors. It did not seem ideal to apply the same hurdle to all companies as the more labor-intensive and service-oriented industries may offer a greater scope for employee participation, but I had to start somewhere and was prepared to be flexible in my judgment.
Link between stock ownership and operational decision-making (does the company recognize this link as being key to improved performance?)
Academic research suggests that employee stock ownership needs a matching participatory corporate culture in order to improve the organization's performance. Here I hoped to find some form of policy or statement that confirms recognition of that fact, which would be another plus. Alternatively, I sought evidence for that the company cultivates an entrepreneurial approach to work on all organizational levels.
As information sources I used mostly the companies' annual reports, but I also carried out a quick survey by contacting the IR departments which in turn became an interesting test of the companies' responsiveness.
For each criterion I awarded one of the following symbols:
|(+)||company is moving in the right direction|
For the overall rating I added all (bracketed) pluses, so that the companies could earn up to three pluses in total, which proved to be rather difficult to achieve as we will see. Companies with no pluses at all would get the overall rating "fail." Here is the (somewhat subjective) ranking in ascending order with the winner at the bottom.
(17) HCP ○
Depth of employee ownership: HCP offers its executives and senior management a performance incentive compensation plan, but there is no broader initiative to promote employee stock ownership. ○
Level of employee ownership: Certainly below the 3% hurdle when the shares held by directors are not included. ○
Interaction between stock ownership and operational decision-making: Official documents give little insight into the involvement of employees in the decision-making process. ○
(16) Coloplast ○
Depth of employee ownership: A stock option scheme applies to executives on and above Vice President level. ○
Level of employee ownership: Coloplast advises employees would own only a "small fraction" of the common stock. ○
Interaction between stock ownership and operational decision-making: I could not find any evidence for that participative management is a priority at Coloplast. ○
Further to the stock selection process for my portfolio, I concluded: By All Criteria That Matter To Me, Coloplast Is the Ideal Stock. Well, I still consider Coloplast a great company, but here is a criterion by which they clearly fail to impress.
(15) Chr. Hansen ○
Depth of employee ownership: Although Chr. Hansen explicitly states that the improvement of employee commitment would be a priority, this ambition has not brought employee stock ownership onto their agenda. Approximately 100 senior managers participate in a stock option plan. ○
Level of employee ownership: Unknown, but given the limited scope of the stock option plan it is safe to assume that the 3% threshold is not exceeded. ○
Interaction between stock ownership and operational decision-making: No indications in public statements that participative management would be part of the corporate culture. ○
(14) Schaltbau Holding (+)
Depth of employee ownership: No initiatives to promote employee stock ownership. ○
Level of employee ownership: It is safe to assume that there is no relevant degree of employee stock ownership. ○
Interaction between stock ownership and operational decision-making: The group states in its Code of Conduct that they place as much responsibility as possible on the single employee and give maximum degrees of freedom in return. Thus, Schaltbau Holding is an example where stock ownership would match the corporate culture, but the company does not see the opportunity. (+)
(13) PSP Swiss Property (+)
Depth of employee ownership: The idea of employee stock ownership is not unheard of at PSP as the statutes allow the issue of new shares to create some sort of equity compensation for employees. However, no equity compensation plan exists below main board level. ○
Level of employee ownership: Unknown, but unlikely to be relevant. ○
Interaction between stock ownership and operational decision-making: PSP Swiss Property says its corporate culture is characterized by openness and de-central responsibilities. In combination with the lack of ambition with regard to employee stock ownership this is, again, only a bracketed plus. (+)
(12) Hoya (+)
Depth of employee ownership: There is a stock option plan covering main board directors, directors of subsidiaries as well as certain key employees. The number of employees covered by the plan is about 100, which is not too impressive for a company with 36,569 employees in total. ○
Level of employee ownership: Unknown, but the 3% hurdle is most likely out of reach. ○
Interaction between stock ownership and operational decision-making: Hoya is one of the few companies with publicly outspoken views on decision-making. The process is characterized by thorough but quick discussions that involve many employees. The seeming contradiction between quickness and involvement is explained by a strong relationship of trust between senior managers and their staff. (+)
(11) Energiekontor (+)
Depth of employee ownership: The IR department advises there was a one-off stock option plan available to employees and managers right after the company's IPO in 2000, but there is currently no employee equity compensation scheme in place. The company does not seem to aim at employee stock ownership on a larger scale. ○
Level of employee ownership: Unknown, but employee stock ownership is unlikely to be above 3%. ○
Interaction between stock ownership and operational decision-making: The company emphasizes that its employees would be highly self-motivated and involved in many decision processes, but in the absence of any broader promotion of employee stock ownership I can award only a bracketed plus. (+)
(10) The Swatch Group (+)
Depth of employee ownership: The Swatch Group awards stock options to senior staff and employees to reward outperformance at work. In 2013 they awarded 244,095 stock options as part of this scheme. The number of recipients is between 220 and 230 employees equivalent to less than 0.1% of the workforce. ○
Level of employee ownership: Unknown. Per 31 December 2013 The Swatch Group held a total of 1,396,771 shares reserved for the stock option plan equivalent to 0.5% of the market cap. A level of 3% employee-ownership seems to be unlikely. ○
Interaction between stock ownership and operational decision-making: The Swatch Group aims at creating an environment where each employee can act entrepreneurial. In combination with an ESOP this would be a plus, but in the absence of more ambitious initiative to promote employee stock ownership, I can again only award a bracketed plus. (+)
(9) SAP +
Depth of employee ownership: All SAP employees worldwide are subject to the Employee Participation Plan, which is a performance-related compensation linked to virtual shares. Further, SAP is offering its employees a Share Matching Plan (NYSE:SMP) that gives the option to convert a part of the salary into shares that can be bought at a 40% discount. After a holding period of three years three invested shares are matched by one additional share. +
Level of employee ownership: Unknown. As part of the SMP, employees bought 1,559,000 shares in 2013 and received 573,000 matching shares in total equivalent to 0.2% of all issued shares. A level of 3% employee-ownership seems to be unlikely. ○
Interaction between stock ownership and operational decision-making: If is participative management is part of the corporate culture SAP could make this more clear. ○
(8) SunOpta +
Depth of employee ownership: Basically, all employees of SunOpta is offered to participate in an Employee Stock Purchase Plan (ESPP) and contribute between 1 and 10% of the salary. +
Level of employee ownership: In 2013 SunOpta's employees purchased 80,215 shares under the ESPP equivalent to 0.1% of the common stock. The total number of shares still to be granted under the ESPP was 1,363,771 per 31 December 2013 equivalent to 2% of the common stock. ○
Interaction between stock ownership and operational decision-making: According the company's CSR report SunOpta is still in progress of improving the employee's involvement in the day-to-day business. It is their goal to become better at listening to their employees, which can be a plus next time if accomplished. ○
(7) Kyocera +(+)
Depth of employee ownership: Kyocera is offering all of its employees to participate in a Stock Purchase Plan. +
Level of employee ownership: The Stock Purchase Plan owns 1.42% of the common stock and is Kyocera's ninth largest shareholder. ○
Interaction between stock ownership and operational decision-making: On my question if Kyocera sees any link between the two, their IR officer answered with a plain and simple "no". He was apparently not in marketing mode and company documents speak a slightly different language describing a corporate culture "where perspectives [between management and labor] are shared on the same level." (+)
(6) Canadian National Railway ++
Depth of employee ownership: CNI offers basically all employees to participate in the Employee Share Investment Plan (ESIP). The employees can contribute up to 10% of their gross pay to the plan and the company contributes 35 cents for every dollar invested by the employee. The purchased shares become immediately available to the employee. Some 75% of CNI's employees participate in this scheme. +
Level of employee ownership: In 2013 CNI purchased 2,300,000 ESIP shares on behalf of its employees equivalent to 0.3% of the company's common stock. CNI estimates that between 1 and 2% of the shares outstanding are held by employees including senior management but excluding main board directors. ○
Interaction between stock ownership and operational decision-making: CNI wants its employees to take ownership for what they do and work as if they were running their own business. +
(5) Novartis ++
Depth of employee ownership: Novartis calls its employees "associates" for a reason. Novartis is offering its 13,341 Swiss associates to convert their annual bonuses wholly or in part into shares as part of an Employee Stock Ownership Plan (ESOP). The company's 2,600 associates in the UK can convert up to 5% of their monthly pay as well as their annual bonus into shares. In both, Switzerland and the UK, two invested shares are matched by one additional share after a holding period of three years. In 2013 6,321 Swiss and 1,404 UK associates have chosen to participate in these schemes which is some 5% of the total workforce. It is notable that a bigger number of some 12,400 associates worldwide (9% of the total workforce) received shares as part of an equity compensation plan. The schemes follow the clear intention to promote stock ownership on a large scale. +
Level of employee ownership: The Novartis Foundation for Employee Participation is the company's single largest shareholder holding 3% of the shares. +
Interaction between stock ownership and operational decision-making: The Novartis IR department pointed out that obviously the shares given to the associates come with voting rights, but this does not give any clues about the decision-making on the operational level. Therefore, I could not award another plus here. ○
(4) The GPT Group ++
Depth of employee ownership: All employees are subject to the company's Short Term Incentives (NYSE:STI), which is a variable component of their remuneration that is linked to financial and non-financial performance. As part of the General Employee Security Ownership Plan (GESOP) the participating employees receive an extra 10% of their STI paid in securities that have to be held for a minimum of one year. +
Level of employee ownership: Unknown. Under the plan, 294 GPT employees received 124,492 securities (less than 0.01% of common stock) in 2013 - As the real-estate business is pretty capital-intensive, I believe that it is rather difficult for GPT to meet the 3% requirement. The high level of participation in the GESOP (GPT has 429 employees in total) would at least allow the award of a bracketed plus, if the plan had a bit more punch. 124,492 times ~3,30 USD per security divided by 294 employees translates into some 1,400 USD of value per employee which must be well below a month's salary. ○
Interaction between stock ownership and operational decision-making: GPT has the outspoken goal to build a culture where ownership and accountability are two sides of the same coin. They clearly understand the opportunity for both, employees and shareholders, in this set up. For delivering exactly on target, I award a plus to GPT. +
(3) Ecolab +(+)(+)
Depth of employee ownership: Basically all employees can participate in the company's ESOP by choosing to reduce their compensation in order to make contributions to the plan. Employee contributions of up to 3% of eligible compensation are matched 100% by the company and employee contributions over 3% and up to 5% of eligible compensation are matched 50% by the company. +
Level of employee ownership: Per 31 December 2013 the ESOP trust held Ecolab shares worth $850 million equivalent to 2.7% of the company's market cap. With a little bit of goodwill this is good enough for a bracketed plus. (+)
Interaction between stock ownership and operational decision-making: Ecolab prides itself of an entrepreneurial spirit, but does not explicitly confirm recognition of the link to employee ownership. (+)
(2) Sims Metal Management (+)++
Depth of employee ownership: Sims Metal Management is holding its employees in high regard with all their names being written on the first two pages of the 2010 annual report. At most companies long term incentive plans (LTIP) are solely offered to executives and senior management. Sims' LTIP, however, covers according to VP IR Todd Scott "a meaningful number of the global workforce at both, the management and operational levels". The plan includes a share-based compensation that is linked to performance. I award a bracketed plus here, since it remains unclear which percentage of all company employees is represented by the "meaningful number". (+)
Level of employee ownership: Todd Scott estimates this number to be no greater than 10%. Well, even the actual number is half the estimated maximum it should be above the 3% hurdle. +
Interaction between stock ownership and operational decision-making: Sims Metal Management prides itself of an entrepreneurial spirit, which is why they have consciously extended the LTIP to the operational level. +
(1) IAR Systems (+)++
Depth of employee ownership: In 2011 IAR Systems offered a share-based incentive scheme to all of its employees. The scheme gave the employees the opportunity to acquire subscription warrants free of charge. Each warrant gave the holder the right to subscribe for a one new share in the company for a price equivalent to 150% of the average share price between 7 and 17 June 2011. The warrant had to be exercised by June 2014. +
Level of employee ownership: As part of the share-based incentive scheme 67 employees subscribed for 707,000 warrants (in 2011 the company had 137 employees). Assuming that all these warrants were exercised and the subsequently issued shares kept by the employees, this would translate into the employees holding more than 5% of the common stock. Although this is a theoretical calculation, it is good enough for another plus to IAR. +
Interaction between stock ownership and operational decision-making: I could not find any explicit statement confirming that IAR would link employee stock ownership to an entrepreneurial corporate culture. Their CFO outright denied there would be a link at all, but as in the case of Kyocera this looks a bit like an understatement as the corporate culture does not seem to be in favor of micromanagement which is sufficient for a bracketed plus. (+)
I chose to exclude Hannon Armstrong from the ranking as they employ only 22 people, which means that the business is not quite comparable to the others. After the company's IPO in April 2013 8.2% of its common stock was owned by senior management and employees. Further to the recent capital increase in April this year the number might be around 7%. +
In my previous article I had cited researchers who pointed out that employee stock ownership would not have a positive effect on performance, if it is not combined with a participative corporate culture. What I found in my review more often, however, was the opposite case: companies that pride themselves of an entrepreneurial spirit on all levels without having employee stock ownership on their agendas at all. The issue here is that deeds are more convincing than words, even though I admit that some of these essays about corporate culture are well written (Hoya comes to mind). I do not think that companies can expect its staff to live up to the ideal of entrepreneurship without recognizing that real-world entrepreneurs are to a large extent driven by meaningful ownership in their business. I am sure that by addressing this disconnect shareholder value could be unlocked.
About half of the holdings are in my comfort zone in terms of employee involvement. I would draw the line between the ranks 10 and 9, i.e., Swatch and SAP with SAP's offer to all employees worldwide making the difference.
I consider the existence of an ESOP or the like as best practice. The benefit of these schemes is that they make employee ownership visible as the employee shares are held in a separate trust. By contrast, most of the companies that I contacted have no idea how many of their stocks are held by employees, which is a relevant shortcoming. Even if a company recognizes the link between employee ownership and performance and takes action to promote the former, the effect may be very limited if it cannot be measured.
Still, I am not keen to replace any of my holdings. Of course, I have picked the stocks based on a number of criteria as briefly described in the article on Coloplast. Also, a low rank on the list above does not make a company automatically a sub-par employer. Other things being equal, I would prefer an ESOP company to a non-ESOP company at any time, though.
PS In terms of responsiveness, the ranking does look slightly different: Here the Swiss and Nordic companies take a clear lead followed by the German and Asian/Pacific companies. Lagging behind are the North American companies. Are IR departments becoming more complacent, the more investors just happen to become shareholders because of the index they choose to track?
This article was updated on 5 July 2014 further to new information provided by Sims Metal Management.
Disclosure: The author is long NVS, SAP, SWGNF, CLPBF, CHHYY, IARSF, CNI, ECL, STKL, KYO, HOCPF, SMUPF, HCP, HASI, GPTGF, PSPSF. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I am long Schaltbau Holding and Energiekontor as well (no U.S. listings).
Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.