United's ESOP fable

Did employee stock ownership drive the airline into bankruptcy?

Published December 12, 2002 8:30PM (EST)

In 1994, when United Airlines was on the brink of a financial crisis, the company's executives and its employees embarked on a grand experiment in corporate governance. In a marked departure from years of tension between labor and management, the parties came together to save the airline. Employees agreed to forgo billions of dollars in wages in order to keep down the airline's operational costs, so that United could more easily compete with low-cost airlines such as Southwest. In return, the airline would hand over half of the company to the workers, who would have a say in the direction of the airline and would supposedly directly benefit from its future success.

The deal, which created one of the biggest employee-owned companies in America, was seen as a new model for the airline industry, which has always been fraught with fractious labor relations. "Inevitably, other companies will stand up and take notice," Robert Reich, Bill Clinton's first labor secretary and a key supporter of the United plan, told the New York Times at the time. "From here on in, it will be impossible for a board of directors to not consider employee ownership as one potential business strategy." In an effort to show the public that everyone at United was now on the same page, the company changed its slogan from "Come fly the friendly skies" to "Come fly our friendly skies."

On Monday, United Airlines' corporate parent, UAL, filed for bankruptcy. While there's no end to possible reasons for United's failure -- the sour economy, the Sept. 11 attacks, competition from Southwest Airlines and its no-frills ilk -- the company's troubles have prompted some conservative pundits to decry the notion that employee ownership can steer a company to success. The syndicated columnist Bruce Bartlett, for instance, took the United bankruptcy as a sign that employee-ownership programs represent a "left-wing," essentially Marxist idea that "works a lot better in theory than practice." Bartlett wrote in a recent column that employees who have an ownership stake in companies often use their power to "block productivity-enhancing changes" rather than improve the bottom line, and he concluded that what happened at United proves that "employee ownership may still make sense as a way of privatizing government assets, but it is clearly no ticket to higher profits and productivity."

Bartlett's analysis is too simplistic by half. Advocates of employee stock ownership plans, or ESOPs, point out that United's plan was not typical of most employee-ownership situations and was probably doomed from the start. It was a strategy of convenience for United's management and its various labor groups, each of which had a different idea about what "employee ownership" meant. Indeed, a majority of the company's workers -- its flight attendants and its nonunion employees -- were never even part of the plan. As a result, say champions of ESOPs, employees at United never quite acted like owners, and management didn't run the company as if the employees had a say.

It's senseless to conclude anything about all ESOPs based on what happened at United, says Corey Rosen, who directs the nonprofit National Center for Employee Ownership. "I have yet to see a story that says investor ownership failed US Airways" -- which declared bankruptcy in August. "You could make a good argument based on that situation that investor ownership was a bad model at the airlines. But it would be a really silly point to draw from the experiences of one airline."

Still, after United's failure -- not to mention the problems at Enron, WorldCom and all the dot-coms, where employees saw the retirement and stock-option fortunes they'd invested in their companies melt away -- Americans may now be leerier than ever of the prospect of owning their bosses' companies. Should they be? Does it make sense to have workers telling companies how to behave?

It does make sense if the plan is right. If you study what was wrong with United, and what's right with successful companies in which employees have equity, one thing is consistent: When firms make employees feel as though they have a say in what a company does, and when employees feel as though they're working alongside managers rather than against them, companies work better. That might seem like a Pollyannaish notion. Owners and workers are bound to be at odds, goes traditional thinking -- that's basic capitalism.

But that's not true. Contrary to what some conservatives say, employee ownership can increase productivity, decrease production costs, and reduce the waste that comes with a bad labor-management environment. It can do a lot more, too. If the corporate world embraced employee ownership, we might see companies that were more accountable to their workers and to the world. We wouldn't see CEOs making 500 times as much as the average worker, we wouldn't see unions making obviously untenable demands of their companies, and -- with all the new wealth flowing to workers -- we could reduce the gap between the country's rich and poor. And we could still call it capitalism.

Critics of employee ownership have argued that the idea has a fundamental flaw: You're putting workers in charge of their own paychecks. "Somebody's crazy. It can't work," Lee Iacocca, the former Chrysler chairman, reportedly said about United's deal in 1994. "What do you think will happen when it's a choice between employee benefits and capital investment?"

Even though workers in an employee-owned company are also technically "owners," critics like Iacocca suggest that they won't act like owners. Employees will favor immediate pay increases over investments that will, in the long term, pay off even more. The critics aren't wrong; some of Iacocca's worries do seem to have played out at United. But the key to making sure that doesn't happen at other employee-owned firms, and the key to having ESOPs transform society, experts say, is changing the "culture" of an employee-owned company: disabusing workers of the notion they're "wage slaves" and persuading them to value the company.

In November, when it still looked possible for United to avoid bankruptcy, the company asked its employees to take deep wage cuts in order to save the firm. Most of the workers complied, but the company's 13,000 mechanics balked at their proposed share of the pay cuts -- about $700 million over five years. The mechanics said that they couldn't agree to the wage cuts because they were concerned with what they called "work-life" issues at the company -- for example, they were upset about United's refusal to let them choose which vacation days they were required to take unpaid.

Some mechanics seemed untroubled by the idea that United might end up bankrupt. "The general feeling among mechanics is, 'If we can't have it, then greedy executives can't have it either,'" wrote Jennifer Salazar Biddle, a United mechanic, in an Op-Ed on the Socialist Worker's Web site. "Everyone I know is saying, 'Full Pay to the Last Day!'"

Considering that a typical mechanic had paid about $80,000 in wages to buy a slice of United, the mechanics -- who eventually backed down, though not in time to save the company -- could be accused of acting irrationally. Their desire to stick it to "greedy executives" was so consuming that they seemed to forget that, in pushing for bankruptcy, they were also sticking it to themselves.

That sort of irrationality has been a hallmark of United's ESOP, and it hasn't always been confined to the employee side of the bargaining table, experts say. United's management has continually blamed workers for the airline's high cost-structure, and its dealings with workers have always been frosty. "Folks who are more toward the left like to point the finger at management and say they screwed up," says J. Michael Keeling, president of the ESOP Association. "Then people whose values are more to the right, they blame labor and they blame the unions and what the pilots did with that stupid flight slowdown in the summer of 2000.

But you can't blame either the management or the workers, says Keeling. Each side was simply playing its part in the adversarial game that has always characterized the relationship between workers at a company and the owners, especially at large, heavily unionized companies like United.

"If you really want people to behave like owners," says Charles O'Reilly, a professor of human resources and organizational behavior at Stanford's Graduate School of Business, "you have to make sure they have psychological ownership, not just financial ownership." What O'Reilly means by "psychological ownership" is straightforward: People have to care about the fate of the company. What's surprising is that research has shown that psychological ownership doesn't necessarily coincide with one's financial stake -- you can own a lot of stock in a company, but you might still hate everything about the place and try to enrich yourself in the short term even if hurts the company, and you, in the long term.

While it's easy for firms to design ways to hand over financial ownership to employees, there isn't a standard recipe for giving workers psychological ownership. But some things can help predict how well workers will take to their new role, experts say. One is the size of the company: Workers in a small company tend to have an easier time feeling as if they own the place than those in a large company. Most employee-owned companies are not publicly traded, says Rosen, and that helps as well. When workers feel as if the management is more responsive to labor than to a horde of anonymous shareholders, they're bound to feel more loyalty to the firm.

But perhaps the most important factor is the historic relationship between labor and management at the firm. "I remember when I heard of the United plan," says Rosen. "I said, Oh God, why do we have to have United as the company that everyone thinks of when they think of an employee-owned company?" That's because United had a dismal record of labor relations. "We knew that the best environment for employee ownership is one in which -- like Southwest -- the company says employees come first, customers second, and shareholders third," Rosen says.

Rosen adds: "Every company in America says that 'people are our most important asset,' but the tragedy that United illustrates is that that's not true. What we've seen is that when you treat your employees with dignity and respect, you get thousands of people in a big company sharing ideas and information about how you can do things better. And there are only a handful of companies who realize that the people who work for you are the most important asset."

The early thinker most associated with the idea that employees should have an ownership stake in firms was Louis Kelso, a lawyer, economist and philosopher who in 1973 persuaded Russell Long, the powerful Democratic senator from Louisiana, to support legislation legalizing ESOPs.

Kelso is something of a controversial figure in economics; his ideas -- outlined in his 1958 tome "The Capitalist Manifesto" -- represented, to some, an unholy mix of Marxism and capitalism, and he has never really been accepted by academics. But there remains a small band of Kelso devotees, including some in business and policy circles, who believe that Kelso's idea that workers ought to trade their labor in return for capital was nothing short of revolutionary. If we followed Kelso, they say, and pushed more owners to give equity to workers, we would have a more "just" society.

When economists talk about the ingredients required to produce an item, they outline two categories -- which can be broadly described as the workers and the machines, or, more formally, labor and capital. It's always troubled some people -- most notably Karl Marx -- that machines are always getting better and better, meaning that workers are always becoming relatively less and less valuable in comparison and are bound to eventually become, some fear, put out on the street. The communist solution to this was to give governments control of everything, an idea that hasn't fared well. Kelso's solution is more elegant: Let workers get paid for their work in capital.

"The gap between the rich and the non-rich was getting wider," says Norman Kurland, who runs a nonprofit called the Center for Economic and Social Justice and who helped Kelso lobby for ESOPs in the 1970s. "Kelso's idea was that there was a problem in the way we finance new capital. There are barriers to ownership -- it's very difficult to become an owner. If you want to buy a house or a car, you can go out and get credit. But it's much harder to finance capital" -- the infrastructure necessary to start a business.

To be sure, there are always some people who manage to get financing to start businesses. "There are always some geniuses who can break the barriers," Kurland says. "But you can't run an enterprise system as if everyone's a genius." And employee ownership was conceived as a way of transferring capital -- and the wealth that comes with it -- to the vast majority of us who aren't geniuses.

"Americans," Kelso told "60 Minutes" in 1975, "are a nation of industrial sharecroppers who work for somebody else and have no other source of income. If a man owns something that will produce a second income, says Kelso, he'll be a better customer for the things that American industry produces. But the problem is how to get the working man that second income."

For people who don't like the inequality in capitalist systems but who've nevertheless resigned themselves to capitalism, Kelso's idea can be charming. It softens capitalism without adulterating it, especially if it can be shown that companies that adopt employee ownership are, in the long run, more successful.

During the almost 30 years since ESOPs were introduced, they have become popular financial instruments, and champions of employee ownership say that United's failure will probably not do much to stem the employee-ownership tide sweeping over the American workplace. According to the ESOP Association, more than 11,000 companies in America, covering 8 percent of all employees, have ESOPs. In more than half of those firms, employees own enough equity to be a "major factor in the corporation's strategy and culture," the group says.

But what United's failure shows, Kurland says, is that workers have not yet adapted to their true calling, which is as owners. Americans too often measure their worth by the size of their biweekly paychecks, not by the wealth they're accumulating in capital. For this, he blames labor unions, who get their power from wages, and he blames management, who often think of their workers as being as dispensable as machines. He also blames academics -- economists mainly -- who have not yet pushed Kelso's ideas.

Louis Kelso died in 1991, without much fanfare. But Kurland says he's optimistic that Kelso's ideas will be adopted by mainstream business and academia, and he's not worried that what happened at United will give employee ownership a bad name. "When you have Enron situations, you see you need this," he says. "If every worker knew Ken Lay was taking money out of their pockets, he wouldn't be going to get away with it. This effort is a global effort. It must be done right."

By Farhad Manjoo

Farhad Manjoo is a Salon staff writer and the author of True Enough: Learning to Live in a Post-Fact Society.

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