How Can Good Governance Keep ESOP Companies Independent?

In a healthy economy, one of the many challenges a successful ESOP can face is   an unexpected or unsolicited purchase offer. With shareholders having voting rights for the sale of the company, an ESOP operates under unique conditions, which are often much different than those of a publicly held company in a similar situation. While unsolicited offers are not uncommon, understanding the role that human dynamics plays in directing the ensuing decision processes is rarely covered—a point that illustrated by the current offers made for the Wall Street Journal (WSJ) and its parent company, Dow Jones & Co.(DJC),  by Rupert Murdoch’s News Corp.

In May, 2007  the WSJ received an offer for an extraordinary premium of over 60% of the present value of stock.  One could call this a “strategic buy” for News Corp.  For the WSJ shareholders, the majority of voting stock is held in various Trusts, particularly belonging to the Bancroft family, requiring trustees to vote on the matter.  An initial reply from the trustee of the stock on behalf of the family’s beneficiaries rebuffed any willingness to discuss sales terms on the grounds that “the family with control over the stock” (The Bancrofts) was not interested in any discussions.  Over the years, I have seen other ESOPs respond this way.  The trustees see management cannot create the stock value an outside buyer can offer.  Yet, as time passed, an undercurrent of conflicts among beneficiaries, directors and trustees surfaced, and the Bancroft family met with Mr. Murdoch to examine the offer more closely. I see many other familiar ESOP issues or stories being written into the WSJ experience.

The June 2-3, 2007 edition of the WSJ had an enlightening write up about the governance issues, decisions and ramifications that all ESOP’s are exposed to.  For example, one Trustee of the family stock is also the family’s attorney, who also sits on DJC’s board.  Many in the family are accusing Mr. Elefante, that Trustee, of having several conflicts of interest.  As Trustee, he said he must protect the interests of ALL family members, or beneficiaries; as Director, his focus and decisions should be based on ALL shareholders; and as the family’s attorney, he should be independent in advice and counsel.  While holding all three positions, is Mr. Elefante without conflict?  If you are an employee of an ESOP company, and are a trustee and director, are you in the same condition as Mr. Elefante?  What would you do if you were him?  His reply was “the interests of his various constituencies… are almost always in alignment and (I) take pains to avoid any conflicts.”  Have you heard this before?  When things aren’t going well, the appearance of conflict adds unneeded vibrations to what can already be a difficult situation.

Looking deeper into the organizational and family dynamics, there are also parallels for ESOPs to learn from.  The Bancroft family has held control over DJC for over 100 years and has been viewed by many as the protector of independent journalism for the WSJ.  Over the years, this proud family grew accustom to receiving huge dividend checks. Yet as the later generations increased in size, the once sizeable checks were decreasing in amount.  Doesn’t this happen with ESOP distributions over time?  Are you finding the new employees are less connected with the ESOP and just want more money?  Is it getting more difficult to deal with employees who are not granted the sizable stock shares longer term employees have?  Is there ‘generational’ jealousy regarding long term employees and newer employees?

The youngest generations of the original Bancroft family, now with different last names, are fighting their elders over money and the perceived opportunity News Corp’s purchase offer affords them.  The story sadly describes fathers and sons, mothers and daughters in conflict over their portion of the trust.  Murdoch’s offer created HUGE rifts in and among the various branches and generations of the Bancroft family, as the younger generations did not feel as strongly about independent journalism as they did about the value of their shares.  Isn’t this a common condition when an offer to buy an ESOP occurs?   Aren’t there legacies from the founder that continue today? Is it in an inevitable issue of principle and values versus profit?

The most obvious reason for the DJC’s breakdown is the focus on dividend distribution--not reinvesting profits for the continuation and competitiveness of the company.  How is this different from the Repurchase obligations many older ESOPs are facing?  How about the debate for recycling versus acquiring stock?  Aren’t these board and trustee issues?

So, how do you develop loyal shareholders to remain an independent ESOP company?

<!--[if !supportLists]-->1)      <!--[endif]-->When the grantor of the ESOP trust, which is usually called ‘the founder’, creates the first tranche, I suggest they write an intention letter, describing the values and intentions he or she desired by not selling to an outsider or other family members.  That way, the board and trustee have another value guide beyond just stock value.  Themes should be established as guiding principles, and can include independence, growth, values, ownership, and a dream.

<!--[if !supportLists]-->2)      <!--[endif]-->While there is an emerging debate over the value of the ownership culture by some CEO’s, it is the engagement of employees to perform better that provides the foundation for continuing as an independent company for several generations.  By continually engaging the shareholders with values, or guiding principles, the younger generation will develop the strong connections their more seasoned shareholders have with the company.  In my eyes, this is a board function: to engage the shareholders and develop a shared sense of purpose.

<!--[if !supportLists]-->3)      <!--[endif]-->Focusing on distributions, and not the business, will eventually create the mess the Bancroft family is experiencing.  DJC was under-investing in future opportunities and risk, for the sake of keeping the shareholders happy with continued large dividends, and found itself in this awkward scenario.  Again, another board function and responsibility should be to balance the desires for continued large dividends with the opportunity cost of not investing in the future.

<!--[if !supportLists]-->4)      <!--[endif]-->When Trustees and Directors have conflicting roles, it will only cause more harm as conditions become less favorable.  Is the director’s primary purpose to increase shareholder value at the expense of independence?  If a buyer offers you a strategic premium, have you done your job to reach that value first?

<!--[if !supportLists]-->5)      <!--[endif]-->Executive and Mid-level management must engage with the ESOP culture, as well as take risks on future opportunities, as these efforts will increase the value of the stock to a competitive level, effectively creating value that an outside strategic buyer will not be able to offer.  As a board member, how is your management team improving the value drivers to sustain the company’s independence?

As the WSJ and DJC story unfolds, there may be more lessons for ESOP fiduciaries to learn from.