Chapter 3 The Impact of Employee Stock Ownership on Firms’ Investments and Market Value

Abstract

Although employee stock ownership may result in increased cash flows due to enhanced organizational productivity or improved governance, this benefit is counterbalanced by the increased risk premium due to a higher correlation between the returns to the firm and the returns to human capital in general. For corporations that employ people with commonplace skills, employee stock ownership results in increased systematic risk, so the optimal level of employee stock ownership is small. When skills are unique, however (so the returns have low correlation with the returns to human capital in general), the optimal level of employee stock ownership is high, with strong incentives for outsourcing – not just the routine easily repeatable tasks but also research, product development, and other highly specialized tasks requiring knowledge not present within the firm. These conclusions hold even without conflicts of interest between owners and employees, but are strengthened in the presence of such conflicts. Incentives for greater employee ownership are further strengthened by the higher costs of becoming or remaining a public corporation that have been imposed by the Sarbanes–Oxley Act of 2002. This analysis provides a framework for optimizing employee incentives from stock ownership.