We all know the fundamental building blocks of the Great Game:
- Know and teach the rules
- Follow the action and keep score
- Provide a stake in the outcome
When it comes to that third step – providing a stake in the outcome – what’s the best way to do that? There are really just two choices: cash bonuses; or equity sharing.
Many owners – especially those new to the Game – are skittish about sharing equity with employees. They can’t always put their finger on why, but it makes them nervous. In fact, however, using equity interests as your way of providing a stake in the outcome is likely to be the superior option. Here’s why:
1. First, profit-sharing bonuses consume your cash. I haven’t met many businesses that have more cash than they need. It’s always a limited resource that has to be managed carefully. Paying out cash bonuses on a regular basis consumes cash that might otherwise be available to use on marketing efforts, or new product development, or capital investments to support growth. This can limit your future. True, when you award equity to employees, you may eventually have to spend money to redeem those interests, unless new employees step up to buy or your company is sold. But even in the case of equity redemption, you have deferred the cash payout for many years, with your cash available to invest in growth in the interim. So it’s much superior from a cash management perspective.
2. Second, the interests of your employees will now be fully aligned with yours. Make no mistake: the interests of someone who shares in annual profits is not the same as the interests of someone who holds a long-term equity interest. Equity holders want to build value for the long term; profit sharers want to avoid investing for growth, favoring immediate cash distribution.
Is there real evidence of the effectiveness of equity sharing? Does it change how employees think about their company and, in turn, how they go about their jobs? This is actually a subject that has been studied extensively by business school academics. In fact, more than 30 studies over the past 20 years have addressed the question of how employee ownership affects firm performance. So, what does the research show?
The jury is in: companies that establish employee stock programs experience a boost in business performance. A 1997 study from Rutgers University, for example, found that, as compared with companies that did not, companies that had awarded equity to employees saw sales grow 2.4% faster per year. Likewise, annual productivity growth increased 2.3% faster.
A 2004 study found that companies that established employee stock plans saw an average increase in their return on assets of 5.5%, an increase in their net profit margin of 10.3%, and an increase in their return on equity of 5.6%. Looking at the data from all of these studies combined, the average estimated productivity difference between companies that share equity and those that don’t was 6.2%.
So how does SRC provide a stake in the outcome? You guessed it: stock is distributed to all the employees of the company. As Jack Stack says, “Companies that don’t share equity are making a mistake.”
Martin Staubus is the executive director of the Beyster Institute (part of the Rady School of Management at UC San Diego) where he advises companies on the use of ESOPs and other stock plans. The Institute was established by entrepreneur Bob Beyster, who grew his start-up venture into a Fortune 500 company. http://www.rady.ucsd.edu/beyster/