Why Your Equity Plan Should Be Broad-Based

By Corey Rosen. We hear a lot these days about “the war for talent.”  “Talent” is never defined, nor is it ever explained why labor markets are so much more competitive now than they used to be (the “war” existed, it was said, even when unemployment was very high), but we all know that what is meant is mostly top-level  managers and maybe software engineers. These are the people, it is said, who should get most or all of the incentives, including equity.

There are a number of explanations for this that seem to make sense but that research shows are just not true. In fact, the research is definitive—broad-based equity plans work better than narrowly focused ones.  For instance, in a study of the 780 firms that applied for Best 100 Companies to Work for in America list, Joseph Blasi and Douglas Kruse of Rutgers and Richard Freeman of Harvard found that

  • 18% had employee stock ownership plans (ESOPs); 16% made individual equity awards to at least 50% of workforce.
  • Companies with ESOPs and employee engagement in decision-making had 3.9% per year great returns on equity.

Using a “shared capitalism” index that gave points for an ESOP, profit sharing, providing options to 25% or 50% of workforce, and gainsharing, shows that one standard deviation from the norm (that is, about 33% more likely than the median firm) produces a 12% increase in ROI.

LectureThe largest study ever done on broad-based options showed that as the number of eligible employees and amount of options they get goes up, so does return on assets, but companies with narrowly focused awards showed a negative return on assets holding other factors constant.  (Yael V. Hochberg and Laura Lindsey, “Incentives, Targeting and Firm Performance: An Analysis of Non-Executive Stock Options“). Companies that grant equity broadly also produce significantly more patents (“Non-Executive Employee Stock Options and Corporate Innovation,” by Xin Chang, Kankang Fu, Angie Low, and Wenrui Zhang).

By contrast, numerous studies show that concentrating ownership at the top results in lower returns and greater risk taking.

So why the (to some) counter-intuitive results? Shouldn’t awards be focused on the 20% who, as everyone knows (because it is a rule) produce 80% of the results? Shouldn’t people who don’t have a direct line of sight not be motivated by incentives?  And wouldn’t the great unwashed masses just be free riders on the efforts of others?

The “80-20” rule, it turns out, was created by Italian economist Wilfredo Pareto to describe early 20th century land ownership in Italy. In the 1930’s, Joseph Juran, an organizational consultant in the UK, decided this must apply to organizations as well. He wrote of the “vital few and trivial many,” arguing we should focus on the former. But as Alan Robinson and Dean Schroeder show in the seminal book Ideas Are Free, the best performing companies are those that regularly get lots of ideas from people at all levels of the company. Imagine that most of the employees in your company came up with a few good ideas each year to improve performance. The additive effect would be, and is, enormous.

Then there are the twin demons, the free rider effect and the line of sight problem. These assume economan and econowoman works for you. Econopeople make all their decisions based on a rational economic calculation of whether x is worth y. But we know from vast bodies of research that econopeople are constructs that do not exist in nature—or at your company.  Motivation and behavior at work are much more complex, driven largely by corporate culture. In Daniel Pink’s felicitous phrase, what we all want is autonomy, purpose, and challenge.  So if you want engaged employees, let them make more decisions about more things and give them the information they need to do that. In other words, treat them like owners.

So why actually make them owners? Why not just a sense of ownership? Imagine you get to go to a nice restaurant with your boss, where at lunch you can discuss some of your great ideas while smelling the aroma, soaking up the atmosphere, and feeling flattered you are being listened to. But no lunch for you—just a sense of lunch should suffice. If you want people to think and act like owners, make them owners.

coren rosenCorey Rosen is the founder of the National Center for Employee Ownership, a nonprofit membership and research organization, and coauthor and editor of The Decision-Makers Guide to Equity Compensation.