ESOP vs. Profit Sharing – Which Has the Edge?

“An incentive is a bullet, a key; an often tiny object with astonishing power to change a situation.” – Steven Levitt

It’s far more efficient to retain employees than hire and train new ones. Most estimates put upfront costs of onboarding a new worker at one-third to one-half the salary of the person being replaced.

With labor in short supply in a plethora of major U.S. industries, employee retention takes on even greater importance. If someone leaves, finding their fill-in could take a while. Better to do everything possible to keep good workers from getting itchy feet!

With so many organizations running thin, many are hyper-focused on maximizing workforce productivity, too. The question: How? Especially if a dramatic pay scale increase just isn’t doable?

Enter a larger notion of “incentive”: if the organization does well as a whole, workers are rewarded. The rising tide lifts all employees’ boats.

Our last post explored two potential avenues for this incentive structure: profit sharing and employee stock ownership plans (ESOPs). One (profit sharing) is typically tied to annual bottom lines. The other (ESOPs) give workers shares of company ownership via stock grants.

Profit sharing has been used far wider than ESOPs. Fewer than 7,000 ESOP companies operate in the U.S. While the popularity of ESOPs is growing, confusion still exists over their implementation, operation and benefits.

So which provides the greater incentive for employees to stay and work harder?

Analyzing the Options

Our last post pointed out how, despite profit sharing being a more easily understood concept, it has built-in conundrums. Some seem to work against incentivizing employees. Its dependence on company profitability makes its annual benefit prone to forces outside workers’ control, as well.

Acting as an employee benefit, company shares held by employees through an ESOP don’t suffer this fluctuation.

ESOP vs Profit Sharing

Two main points that drive home the productivity incentive of an ESOP:

  1. In an ESOP, employee benefits and employee productivity are directly linked. The value of shares, which are under employees’ complete control, depend on the organization performing well as a whole.
  2. Despite the hype from financial sectors, Wall Street remains a scary place for many employees.  They don’t want to invest in the stock market. Their employer, with which they’re well acquainted and play a direct role in, is different. Owning stock in their own company can be far more appealing and far less risky.

Simply put, an ESOP provides a strong employee incentive through the concept of “skin in the game,” i.e. ownership. It offers an immediate investment result. Employers can still offer a 401(k) or other traditional retirement plans for workers to invest in the market.

So which will you choose? This is a decision with long-reaching (and potentially costly) consequences. If you’re wondering if an ESOP would fit your organization, contact Excel Legacy Group for a free consultation.

There’s no one-size-fits-all solution to workforce challenges that are seemingly everywhere. The only answer, as more employers are finding, is that they have to do something.