The Untapped Opportunity of Broad-Based Ownership
A bedrock principle of American capitalism is aligning senior business leaders with the financial interests of their shareholders. Embedded in the compensation model of virtually every publicly traded U.S. company is the concept of paying the CEO and senior business leaders in equity rather than cash alone. These equity incentives may take many forms, including stock options, restricted stock grants, profit interests and other forms directly or indirectly linked to the value of a company’s equity. Shareholders view these equity incentives as an “investment” in senior management since they may initially dilute shareholder ownership; however, this investment commonly provides a compelling long-term return for shareholders by motivating business leaders to reach for aspirational growth and profitability targets, thereby driving an increase in shareholder value in which management participates.
These thoughtfully constructed equity incentive programs, which align senior management teams with the financial interest of shareholders, promote an “ownership culture” that unfortunately dissipates below the C-suite level because most American workers lack any form of equity incentives. According to a 2018 National Center for Employee Ownership (NCEO) survey, only 22% of employees at for-profit companies report owning stock in their company directly or via some type of stock or retirement plan. While there are clear benefits to linking compensation to shareholder value, the practice of doing so selectively for senior leadership exacerbates wealth inequality in the U.S. by excluding a majority of the workforce. A recent study by the Economic Policy Institute found that CEOs were paid 351 times as much as a typical worker in 2020; this is a staggering figure, but when you consider that the market capitalization of U.S. stocks increased by nearly $7 trillion in 2020 (or a stock market appreciation of 43.6%, 16.3% and 7.2%, respectively, for the NASDAQ, S&P and Dow Jones indices), it’s evident that the chasm in compensation levels is largely explained by senior leadership having equity incentives while the typical worker does not.
Another way of illustrating this gap is to examine the labor share of economic output, which reached a 65-year low in 2012 before recovering modestly:
As hedge fund leader Ray Dalio put it directly during a recent interview “capitalism basically is not working for the majority of people.”
Compensation practices in the private equity (PE) industry broadly follow the public company playbook with equity incentives heavily concentrated among the senior leadership group. In a typical private equity deal, an equity incentive plan is put in place at the time of investment representing the equity profits on 10-15% of invested capital, with most of this incentive pool granted to the top 10 or 15 executives. This model is a time-proven and highly effective vehicle for aligning the interest of investors and senior leadership. However, like their public market counterparts, PE programs very rarely extend real wealth creation potential beyond the executive ranks. While hard data for the PE industry is elusive given limited disclosure, as a PE practitioner for the past 25 years, I can offer that, among the hundreds of companies that crossed my desk, I’ve only seen perhaps a dozen where equity incentive programs provided meaningful wealth creation potential for the bottom half of the workforce.
Equity incentive programs historically, for both public and private companies, have not been implemented in a manner that would move the needle for a non-executive employee in a median American family with $59 thousand dollars of pre-tax income and net worth of $121 thousand. This is a missed opportunity for shareholders and the workforce generally. Equity incentives create an equity culture that has proven highly effective over time, so couldn’t extending this financial alignment beyond senior leadership unlock a second wave of unrealized shareholder benefits? And on the labor side of the ledger, shouldn’t there be an opportunity to extend the wealth creation benefits of equity ownership to a broader cross-section of the workforce along with the heightened engagement, job satisfaction, and retention that comes with it? There seems to be the possibility at least for a huge win-win here by creating “broad-based ownership” programs that extend beyond the current best practices.
Ownership Works
During my Harvard ALI fellowship in 2021, I began to explore whether there might be a way to extend the powerful benefits of corporate equity ownership more broadly for the benefit of all stakeholders. Eliciting the help of my longtime friend and colleague, Dennis Liberson, we researched where we could have the most impact. The U.S. private equity industry is tiny, employing fewer than 75,000 people, however the portfolio companies owned by private equity firms employed 11.7 million workers as of 2020. Having private equity firms systematically implement broad-based ownership programs has the potential to create a significant multiplier effect across their portfolio companies. Through discussion and iteration, we developed a framework for private equity firms, navigating a tricky set of questions including:
How should the program be structured?
What are the right metrics to measure the effectiveness and financial and non-financial returns of a broad-based ownership program?
Will our portfolio CEOs embrace this concept?
How do you structure an equity program for employees who don’t meet accredited investor requirements?
And finally, in the ruthless, performance-driven PE world where a few percentage points of relative return performance vs. one’s peer group can mean the difference between a pension fund investing $100 million in your fund or kicking you to the curb, is it suicidal to take this execution risk?
While researching and debating the answers to these questions, Dennis and I met Pete Stavros, a senior partner at KKR, one of the largest PE firms, son of a blue-collar worker, and evangelist of the benefits of broad-based ownership. Pete was an early adopter of broad-based ownership practices, first applying and tinkering with these principles within his own investments, and the practice later spread broadly across KKR with some truly exceptional results. While speaking with Pete, it became clear that his ambition, like ours, was a broad industry movement with a systematic approach to driving adoption of broad-based ownership practices. We also discovered that KKR and our firm were not the only firms who saw the tremendous potential, and we joined forces with over 60 partners, including a dozen other blue chip PE firms, and a larger group of financial services firms, pension funds, labor advocates, foundations and others, as founding investors to create a new non-profit organization called Ownership Works.
Ownership Works’ mission is to increase prosperity through shared ownership at work. The vision of the organization is to unlock new levels of success for companies and in turn generate meaningful wealth-building opportunities for all workers. The organization operates as an advocate for employee ownership, offering hands-on guidance for market participants, along with data-driven research and analysis to evaluate results.
The foundation of the Ownership Works model is supporting the adoption of “broad-based and holistic employee ownership programs” that provide every employee with the opportunity to become an owner. Incentive equity grants to employees must be meaningful — equivalent to at least 6 months of an employee’s annual earnings — and offered at no cost to employees earning under $100,000 per year. At a high level, these goals are achieved via the creation of a broad-based equity pool (stock options, RSUs, profits interests or similar) that provides ownership incentives like those received by senior leaders, but only non-executive employees are eligible to participate. Importantly, shared ownership programs should also not be used to replace or as a trade-off for wages or other benefits. Rather, when paired with fair wages and benefits, it presents an opportunity for workers to participate in the multiplier effect of equity and build the wealth that underpins economic resiliency and upward mobility.
As part of a framework for holistic success, the programs must also contain employee engagement to help foster a culture of ownership and financial inclusion elements, including access to financial education and financial services. These features, combined with an unwavering commitment from management teams, creates a comprehensive culture change to align both the company and its workers.
Ownership Works is an ambitious initiative with a goal of creating at least $20 billion of wealth through shared ownership programs for lower-income workers and people of color over the next 10 years. Beyond wealth creation alone, the rationale is to increase economic resilience, improve racial equity, enhance financial literacy, and strengthen employee engagement. It will take time to assess impact. To both help build this movement and measure impact, among the requests Ownership Works makes of participating sponsors, portfolio companies with broad-based equity programs are asked to periodically submit data related to employee attrition, engagement, and satisfaction. This data-driven approach, taken together with investment returns data, will allow our organizations to test, measure and refine our approach over a generation of investments and together refine our best practices.
Our aspiration is to demonstrate that broad-based ownership is not just a tool for greater social equity and higher employee satisfaction, but also an investment by shareholders, akin to the well-established practice of sharing equity with senior leadership, that can be shown to drive incremental shareholder returns above and beyond what is attainable today via programs for senior leadership alone. The stakes are high: if Ownership Works data confirms that broad-based ownership programs generate incremental returns to shareholders as well as significant societal benefits, the practice may one day become the new U.S. best practice, and a powerful tool to reverse the downward trend in labor share of economic output. As we at Capitol Meridian Partners build our investment portfolio, we look forward to working with Ownership Works and the extended team of partners, instituting equity programs for all our portfolio company employees, measuring and benefiting from the positive impact of this initiative on our companies, employees, and investors alike.
About the Authors:
Brooke Coburn is Co-Founder and Partner at Capitol Meridian Partners, a middle market private equity firm based in Washington, DC focused on investing at the nexus of government and commercial markets. He previously spent 25 years with The Carlyle Group in a range of senior leadership and investing roles. He is a 2021 Harvard Advanced Leadership Initiative Fellow.
Dennis Liberson is Operating Partner at Capitol Meridian Partners focused on human capital strategy. He was previously Executive Vice President of Human Resources for Capital One where he led Capital One’s human resource strategy and programs, including recruitment, selection, and competency-based performance management, compensation and employee development.