Plans to share profits and incentives to employees

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Employee profit sharing programs are incentive schemes created to let staff members take part in the distribution of profits within an organization. These initiatives are strategies used by businesses to inspire their workforce. The enterprise's financial performance is one factor that the corporation considers while making such strategies. To disperse profits to employees, businesses take a variety of techniques. Direct and indirect payments are two broad categories for the methods. In addition to the usual compensation, direct payments also include supplementary income. Indirect payments include retirement benefits and the purchase of on behalf of the employees, retirement plans, among others (Poole & Jenkins, 2013). This paper explores different employee profit sharing plans and demonstrates their role to a company.

2.0 Background and history of the topic

Employee profit sharing tools are often lauded as a viable tool for wealth distribution. In the past, executive bonuses were the most commonly used program for companies to reward executive leadership for good performance of the enterprise. Executive bonuses entail top executives such as Chief Executive Officers and Managing Directors of companies receiving huge bonuses and rewards when their companies perform well. This often creates a huge gap between executive salaries and the salaries of other employees. This disparity creates disharmony in an organization which negatively affects profitability. In addition to this, executive bonuses often project a negative image of a company towards the public (Fang, Nofsinger, & Quan, 2015).

As a measure to mitigate the negative publicity and the feelings of discontent by employees that emanates from executive bonuses, several companies have now embraced employee profit-sharing plans. These plans often make employees feel that they are part of the team as they share a piece of the pie; that was previously enjoyed by executive leadership exclusively. Such plans also portray the company in a good light with respect to public relations. Good publicity impacts positively on the success of an organization by attracting more business.

A study conducted by the International Monetary Fund (IMF) in the year 2014 illustrates that extreme disparity between the pay of executives and other employees is usually counterproductive (Ostry, Berg, & Tsangarides, 2014). It often diminishes the morale and productivity of employees. The feeling of discontent reduces the productivity of workers which impacts negatively on the company's profitability. This situation justifies that organizations ought to practice more of employee profit sharing rather than exclusive executive bonuses and rewards.

Employee profit sharing plans in the USA majorly grew in the 1920s. The main aim for this was to unite employees and reduce cases of industrial action. Most of the plans were however discontinued in the 1930s on the onset of the great depression. The plans were then reintroduced after World War II when there was rapid industrialization. The plans at the time mainly constituted of deferred compensation in the form of retirement funds. Companies implemented these plans to avoid excessive taxation on their income. Employee profit sharing plans have since grown in acceptability and approaches. The focus has also expanded from employee incentive compensation initially to employee benefit plans (Arando, Gago, Jones, & Kato, 2015).

Research shows that there exists a huge income disparity in many societies around the globe. The gap in wealth between business owners and workers is quite huge and continues to widen with time. This has created a socio-economic challenge that has left several governments with a puzzling quest. This inequality has resulted in several governments and economists progressively embrace the concept of profit sharing with employees. Some governments have even gone to the extent of offering tax incentives to companies that have implemented such measures. More and more companies need to embrace this concept to build a better society and enhance economic growth (Ostry, Berg, & Tsangarides, 2014).

2.1 Literature Review

The topic of employee profit sharing plans as an incentive has been extensively researched. Major studies have often touched on its conceptualization, application, various approaches used by organizations, pros, and cons. Several scholars are of the view that employee profit sharing plans have more pros than cons. They increase a firm’s performance and improve shareholder value. However, a section of scholars disagree. The dissenting views often cite the increased complexity of implementing the plans, especially in a global organization. Also, some view that too much employee ownership of a company erodes shareholder value.

Poole and Jenkins (2013) identify the major forms of profit sharing that exists in businesses around the world. These are the direct and indirect approaches. The direct approach of profit sharing entails direct cash payments. The indirect approach, on the other hand, is much broader and it encompasses employee share schemes. Cash payments are usually more immediate and tend to improve the competitiveness of the firm. On the other hand, share schemes are more long-term, and they increase employee participation in the company (Poole & Jenkins, 2013).

Poole and Jenkins (2013) look at how employee profit sharing is connected with a company's performance. To begin with, they acknowledge that profit-sharing plans for employees help to eradicate the longstanding antagonism between labor and capital. Secondly, they inculcate a more participatory work environment for employees and enhance organizational democracy. Such conditions present an ideal working environment which is a good breeding ground for creative ideas which are beneficial to the organization (Poole & Jenkins, 2013).

Various scholars have interrogated the performance of companies where employees participate in the ownership, vis-à-vis other companies. According to Arando, Gago, Jones, and Kato (2015), companies, where employees are also shareholders, tend to perform better than the other companies. They view Employee Stock Ownership Plan (ESOP) as an incentive for employees to perform at their best. The good performance is derived from more workers involvement, training and the economic incentives that come with it. Employee ownership of a business makes them go out of their way to ensure the firm’s success. (Arando, Gago, Jones, & Kato, 2015).

Blasi, Freeman, and Kruse (2016) acknowledge the existence of a wide gap between the wealth of owners and the wealth of workers. In the USA, federal government policies have for long supported employee profit sharing plans to address the social challenge of monumental income disparities. ESOPs are identified as an effective tool to fight against inequality. They also encourage greater effort and innovativeness on the part of workers. This is by inculcating the entrepreneurial spirit in the employees. The goal of shareholder wealth maximization becomes a shared concept by employees, management, and external shareholders.

Blasi, Freeman, and Kruse (2016) also note that companies that have broad-based incentive pay for their workers cultivate more positive and long-lasting relationships with their employees. This creates a beneficial effect on the gains of the company. Employees are more trusting to management, more participatory in decision-making, have a positive attitude towards organizational culture. Most importantly, workers tend to stick with the company longer. This creates a harmonious environment in the workplace and the business is able to retain the best skills due to low turnover rate (Blasi, Freeman & Kruse, 2016).

Blasi, Freeman, and Kruse (2016) go ahead to present a dissenting view that ESOPs have an effect of diluting shareholder value for the original stockholders. From the perspective of the stock market, the value of the company’s shares is eroded to some extent when employees take up some of the profits. If ESOPs had not been considered, the market value of the shares would be higher. They are however of the view that the positive gains derived from ESOPs by far outweigh any erosion of share value (Blasi, Freeman & Kruse, 2016).

According to Bova, Dou, and Hope (2015), employee profit sharing plans leads to goal alignment between the employees and the management of a firm. When employees are aware that they have a stake in the profits made by a firm, they put their best foot forward to ensure that the company meets its goals and objectives. This results in improved performance and higher shareholder returns. Also, the company experiences increased transparency with respect to shareholders and improved corporate governance (Bova, Dou,& Hope, 2015).

Bova, Kolev, Thomas, and Zhang (2014) notes that employee profit sharing plans have an adverse relationship with corporate risk. When employees have a stake in shareholding and profit distribution, they are more incentivized to reduce risk. When employees are more attentive to corporate risks, their actions will be meticulous so as not to jeopardize the company. ESOPs encourage good corporate governance practices as well as more compliance (Bova, Kolev, Thomas & Zhang, 2014).

Fang, Nofsinger, and Quan (2015) examine the effect of equity incentives by examining Chinese firms that have implemented them and those that have not. The observation is that the return on equity (ROE) varies depending on whether a company has implemented equity incentives or not. Firms that have employee shareholding are observed to have higher ROE than similar companies that do not have such schemes. During the Global Financial Crisis, the performance of firms that have employee shareholding held up, whereas the performance of those that did not have such plans deteriorated (Fang, Nofsinger, & Quan, 2015).

3.0 Application to the business world

Companies use profit sharing plans to achieve various desirable effects. The key reason for implementing this strategy is usually to incentivize employees. As observed in the various pieces of literature, the plans motivate employees and bring about goal alignment between them, the management and shareholders. Furthermore, such plans reinforce the sense of shared responsibility in the employees. They feel that they are part of the company and its growth and profitability directly affects them. This feeling inspires them to be more innovative to improve the company's bottom-line (Poole & Jenkins, 2013). Technology companies such as Google often use profit sharing plans to inspire their workers to be creative and innovative. This strategy has created a competitive edge in Google and has helped it to grow even further.

Employee stock ownership plan (ESOP) is one of the programs used to distribute a share of profits to employees. In this case, the company allocates a portion of its profits and uses it to purchase shares for its employees in the company. The company determines the formula to use when distributing the shares to its various employees. For instance, the formula may be based on the current salary level or the performance of each worker. ESOPs provide several tangible benefits to an organization. Research shows that employees who have an ownership stake in a company tend to be more productive. This is beneficial for a company’s growth. These plans also motivate employees. Modern management theories often point out the motivation of employees as the most fundamental aspect of enhancing their productivity (Kessler, 2017).

Huawei which is a Chinese telecommunications company is a good example of successful implementation of ESOP. The private company is fully owned by its employees. The company was established in the year 1987 by Ren Zhengfei. At the time, Zhengfei introduced ESOPs which allowed the company employees take the ownership stake in the company. This was a relatively new concept in China at the time. There was also a negative perception towards capitalism in the country at the time due to their cultural background. This perception is what pushed Zhengfei to implement ESOP in Huawei at the time.

Huawei's structure of profit sharing encompasses the principles of both equality and equity. The vision of the Zhengfei when initiating ESOP in Huawei was to minimize the wealth gaps that exist in many organizations. Several organizations usually have monumental gaps between executive pay and ordinary employee salaries. Huawei's structure ensures that such disparities are mitigated as much as possible. In this way, the principle of equality is entrenched. The principle of equity applies in earning according to performance. Employees are therefore rewarded in accordance to their skills that are beneficial to the company (Sundararajan, 2016).

Profit sharing plans may also be structured as retirement plans. Such plans are classified under deferred profit sharing trust. In this scenario, the share of profits for each employee is put in a retirement fund. The company is in charge of managing such a retirement fund to ensure there is sustained growth in value which will be beneficial to employees when they retire. The objective of such retirement plans is usually to provide a framework that provides alternative income to employment income upon retirement (Baddon, Hunter, Hyman, Leopold, & Ramsay, 2017).

Profit sharing retirement plans for employees are often at the discretion of the company. They usually supplement other existing retirement plans such as the 401(k) plan whose contributions come from salary payments. The Coca-Cola Company is an excellent example of profit sharing retirement plan. The company has a defined contribution benefits fully funded by the corporation on behalf of its employees; which supplements the 401(k) plan that already exists (Blasi, Freeman & Kruse, 2016). Key to note is that the defined contribution plan for this company is discretionary, while the 401(k) plan is mandatory and enforceable by the Internal Revenue Service (IRS).

A firm that implements profit sharing plans with workers is able to attract and retain talent in an organization. When such plans are executed in an organization, employees feel that they are appreciated and part of the team. This inspires them to develop themselves and put an extra effort when working for the company. Employee satisfaction is enhanced, and thus such a company experiences low labor turnover. A company that is able to retain competent human resource is able to prosper due to the high level of skills. Operating costs are also lower since there is no need to constantly train new staff (Augustine, Chen, Elkind, Fanelli, Gravin, & Shiryaev, 2015).

Companies that use profit sharing plans have also been found to have a higher return on equity. When employees know that they have a stake in the profitability, they feel obliged to put their best effort to ensure that the business' profitability levels have sustained growth. This can be done through creativity and innovativeness, a rigorous sales and marketing campaign, operational cost control, among others. All these factors lead to high-profit levels which also interpreted as high return on equity (Sundararajan, 2016).

Finally, companies that implement profit sharing plans experience a low corporate risk. Having a stake in the company’s ownership or profits obliges employees to exercise a high standard of care in their work. They are incentivized to reduce the risks that may lead to losses in the company. The company, therefore, incorporates effective risk management practices that are fully supported by its workers. Sound risk management increases the value of a company’s shares (Bova, Kolev, Thomas & Zhang, 2014). This is perfectly in line with the shared value of shareholder wealth maximization.

4.0 Conclusion

Profit sharing plans for employees have proven quite beneficial for organizations that have adopted them. After comparing the pros and cons presented by various researchers, it is safe to conclude that the benefits derived by far outweigh the repercussions. The benefits attained include higher working morale and performance by employees, improved corporate governance due to shared goals and objectives (Blasi, Freeman & Kruse, 2016). Besides the economic benefits that accrue to the employees, profit sharing plans play a critical role in reducing the wealth gap between business owners, executives and other employees. Huge income disparities have been a major challenge in many societies. Profit sharing plans with employees is a practical tool that may be used to mitigate the huge wealth gaps.

Several economists are urging companies to embrace the concept of profit sharing with employees. Many believe that such measures will boost the growth of the companies and the ripple effect will be growth in the entire economy. Such plans have proven to be a useful tool of harmonizing manager, employee and shareholder goals. The plans also cultivate creativity and innovativeness in an organization (Poole & Jenkins, 2013).

5.0 References

Arando, S., Gago, M., Jones, D. C., & Kato, T. (2015). Efficiency in employee-owned enterprises: An econometric case study of Mondragon. ILR Review, 68(2), 398-425.

Augustine, J., Chen, N., Elkind, E., Fanelli, A., Gravin, N., & Shiryaev, D. (2015). Dynamics of profit-sharing games. Internet Mathematics, 11(1), 1-22.

Baddon, L., Hunter, L., Hyman, J., Leopold, J., & Ramsay, H. (2017). People's capitalism?: a critical analysis of profit-sharing and employee share ownership (Vol. 1). Routledge.

Blasi, J., Freeman, R., & Kruse, D. (2016). Do Broad‐based Employee Ownership, Profit Sharing and Stock Options Help the Best Firms Do Even Better?. British Journal of Industrial Relations, 54(1), 55-82.

Bova, F., Kolev, K., Thomas, J. K., & Zhang, X. F. (2014). Non-executive employee ownership and corporate risk. The Accounting Review, 90(1), 115-145.

Bova, F., Dou, Y., & Hope, O. K. (2015). Employee ownership and firm disclosure. Contemporary Accounting Research, 32(2), 639-673.

Fang, H., Nofsinger, J. R., & Quan, J. (2015). The effects of employee stock option plans on operating performance in Chinese firms. Journal of Banking & Finance, 54, 141-159.

Kessler, E. H. (2017). Why Do Management Theories Say What They Do? Toward a Management M-Theory. Group & Organization Management, 1059601117730573.

Ostry, M. J. D., Berg, M. A., & Tsangarides, M. C. G. (2014). Redistribution, inequality, and growth. International Monetary Fund.

Poole, M., & Jenkins, G. (2013). The impact of economic democracy: Profit-sharing and employee-shareholding schemes. Routledge.

Sundararajan, A. (2016). The sharing economy: The end of employment and the rise of crowd-based capitalism. Mit Press.

February 01, 2023

Business Life Economics

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