If the company can afford to pay me with stock, why can't it just give me cash instead?
If you're an employee-owned company, you've probably heard that question before. The truth is, a lot of employees would happily trade a few dollars in cash for several dollars in stock. However, there are a number of reasons why companies either have to or prefer to pay in stock.
An ESOP Is Buying Out an Owner If your company has an employee stock ownership plan (ESOP), there is a good chance it was set up to buy out one or more of the company's owners. The company puts cash into the ESOP, which the ESOP then uses to buy the owners' stock. Alternatively, the ESOP can borrow money to buy shares, with the company repaying the loan by putting enough cash into the ESOP to make the loan payments. If the company simply gave that cash to the employees, then the cash wouldn't be available to buy the owners' shares.
Well, you might say, that's not my concern. But let's assume that company did pay people cash instead. What would the owners do then? They'd try to sell to someone else. The most likely buyer is another company. That company might or might not want to keep all the employees of the company itbuys, not to mention the cash you're getting instead ofthe ESOP. So getting cash instead of stock might not work out very well for the employees.
Moreover, most ESOPs add to total employee benefits, and very few result in a reduction in wages. Companies that sponsor ESOPs are willing to provide this extra benefit because it offers a tax-favored way for them to buy out an owner. If they were not buying out an owner, they would probably keep the cash spent on the ESOP and reinvest it inthe business or pay the owners a larger salary.
The "Pay Me Later, Not Now" Argument Companies need two things to be successful: profitsand cash. Profit is what is left over from sales afterall costs have been paid. Costs, however, includedepreciation, the wear and tear on assets. If acompany buys a piece of machinery, for instance, itfigures the annual cost of the machine based on aformula that projects how long the machine will last.So it might pay $100,000 for the machine in 2001,but the annual cost it figures in its profit and lossstatement might be only $20,000. What this means isthat the company would spend $100,000 in cash in2001, but have "spent" only $20,000 in profits. Thatmeans a company can run out of cash and still beprofitable. So conserving cash is important if acompany wants to have money to invest to keepgrowing and competing.
One way it can do that is to pay its employees outof the future income of the company -- the income thatwill come on stream after all these investments havepaid off. A good way to do this is to give peoplestock. Stock, essentially, is a claim on the company'sfuture income, either through dividends or throughthe sale of the stock to someone else. If the companybuys back the shares, as in most ESOPs and somestock option plans, this sale will cost the companyfuture cash. But in many cases, employees will gettheir shares and sell them to other shareholders, ineffect passing on the cash cost of the plan to thecompany's other owners. Then the company hassaved the cash and can use it to keep growing.
Keeping Motivated Although buying out an owner or saving current cashmotivates many employee ownership plans, many (perhaps even most) are simply an expression of the company's desire to get people to think and act like owners. Profit sharing -- giving people cash at the end of the year instead of stock or options -- can have a very different motivational impact. Assume, for instance, that every year the company gives you a cash payment equal to a percentage of its pretaxprofits. In a typical company, that might give you a bonus of 5% to 20% of pay, depending on how the company does. That's a nice addition, but it will always be a minor part of your pay.
Now assume instead the company gives you the same amount in stock each year. After several years, you will have accumulated an amount equal to perhaps one year's pay. That's an attention getter that can keep you very focused on the company's growth. Of course, many companies provide both profit sharing and stock, but if your benefit is limited to stock, it's important to understand why this may be happening.