Do not disturb the profit sharing revolution

Back in the late 1950s a lawyer called Louis Kelso co-authored a book called The Capitalist Manifesto.* In it, he posited that democracy suffered when money was confined to the hands of the wealthy. Workers should have a chance to participate in capital, not just in some nominal fashion but as true shareholders.

The essence of property, as Kelso wrote, "is the right to receive its product". Workers needed equity assets and, crucially, the freedom to manage them. After this radical change America would stabilise and would no longer suffer periods like that of Kelso's own youth, the Great Depression.

Working with the late Senator Russell Long, Kelso created a device to mount his revolution: the employee stock ownership plan, or Esop. A Kelsonian spirit also infused the subsequent development of the now widespread employee pension plan, the 401(k).

The 401(k) gives companies the option - it is important to note this is voluntary - to deposit company shares or cash into accounts of individual employees. Tax incentives then encourage workers to match the company contribution made in their name with their own cash savings. There are also confiscatory penalties for those who do not wait until retirement to claim the proceeds.

All this comes to mind when we consider the fate of Enron employees who lost their 401(k) shirts when the Enron stock they held evaporated. One could argue - from the left - that the Enron case shows that worker stock ownership is inherently dangerous. But the truth is that Enron's pension crisis occurred because 401(k)s are not Kelsonian enough.

Consider the nature of 401(k)s. While workers have nominal title to their pensions while they are employed, both the government and company sponsors place all sorts of constraints on their ownership. In 401(k) plans, worker investments are routinely limited to an array of mutual funds, chosen by the company, and to company shares.

They may not invest their 401(k) money in assets that are not on the prescribed menu, such as individual properties. They are, as mentioned, subject to rules that punish any withdrawals before retirement. What is more, pension law encourages employers to play the murky role of principal investment "educator" to employees.

Many of these rules were written in the name of protecting the workers. But the net result is that, during the working years, the rights of ownership of 401(k) plans do not reside with the worker alone. Instead, they are shared between him and his employer.

Worker ownership has generated enormous good, just as Kelso foresaw. The existence of Esops and 401(k)s in the 1980s and 1990s meant that workers could participate in great economic expansions. The fact that companies could offer their own stock to workers meant that they shared out far more than they might otherwise have done.

The second benefit of employee stock ownership was that it did indeed give workers a personal stake in their companies. Companies figured out that worker-owners would be less likely to shirk. This is one reason why US productivity growth stands out internationally.

But Enron illustrates the disadvantages of the half-ownership arrangement. First is the problematic rule that drives employers to play the role of investment educator. This creates a form of pension paternalism that in turn generates a false sense of security. If Enron employees had been talking to an independent financial planner instead of their go-go bosses, that planner would have told them that it was crazy to have 98 per cent of their pension in Enron stock.

The adviser would also have told them that their Enron pension plans were insufficient. He or she would have said it was unwise for middle-aged workers to be taking the same risks as 20-year-olds at internet start-ups.

The second problem was a rule that gave Enron - and other such firms - the discretion to enforce a "black-out" period when workers are not allowed to alter their investments. Just such a black-out was in effect when Enron stock price was plummeting. This denied workers the right of the true owners to, as Kelso put it, receive their capital's product. If they had been able to do so, they could have sold the shares in a timely manner.

The third problem rule is one that gave Enron the discretion to block sales by workers until they reached a certain age. Had workers truly controlled their capital, they would have been free to act more quickly.

The logical next step therefore is to unmuddy the pension law and make clear what ownership is and what it is not. If employees are to have 401(k) investments - and they should - their ownership should be something closer to outright. The law should encourage them to seek independent advisers and to cast a sceptical eye on their employers' enthusiasms. The worst thing would be to heap on new constraints and "protections", as legislation proposed by senators Barbara Boxer and Jon Corzine would do. This would stop companies from contributing to these voluntary plans altogether.

Most important to recall, at this dire moment, is that the profit-sharing ideal did achieve its lofty aim. For the tens of thousands of Enron workers in trouble, there are millions more who have seen benefits. It would do more damage than a dozen Enrons to disturb the progress of Louis Kelso's revolution.

* The Capitalist Revolution: a revolutionary plan for a capitalistic distribution of wealth to preserve our free society; Louis Kelso and Mortimer Adler; Random House.

© Copyright 2002 Financial Times

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