EMPLOYEE SHARE OWNERSHIP AND FIRM PERFORMANCE: EVIDENCE FROM A SAMPLE OF CAMEROONIAN FIRMS

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1 EMPLOYEE SHARE OWNERSHIP AND FIRM PERFORMANCE: EVIDENCE FROM A SAMPLE OF CAMEROONIAN FIRMS Marcel T. Ngambi 1, Frederic Oloume2 University of Yaounde 2, Cameroon and Madonna University, Okija, Nigeria 1 Univertsity of Yaounde 2, Cameroon 2 ABSTRACT: This paper examines the link between employee share ownership and performance using a sample of firms in the republic of Cameroon. The data are collected from the National Institute of Statistics. The variables used to measure performance and employee ownership are the return on equity and return on assets on one hand, and percentage of capital held by employees on the other. A group of firms using ESO is compared with a group of firms not using ESO and correlation analyses and non-parametric tests of wilcoxon are performed to test the hypothesis on differences of performance between the two groups. Our results show a positive relationship between ESO and economic performance measured by the return on assets. However, there is no evidence of the impact of ESO on financial performance as measured by the return on equity. Keyword: employee stock ownership, firm performance; 1. INTRODUCTION Although technically in existence since 1952, the concept of Employee Stock Ownership Plans (ESOP) has been used since 1921 in some advanced countries in the form of Stock Bonus Plans. Stock Bonus Plans, like Employee Stock Ownership Plans, are tax-exempt trusts which are designed to enable employees to own shares of the company for which they work without an outlay of funds. The distinguishing feature of an ESOP is that unlike a Stock Bonus Plan, ESOP may engage in leveraged purchases of a company stock and therefore allowing borrowing funds in order to purchase company stocks. In that sense, ESOPs are a technique of corporate finance, and its purpose of benefiting both employees and the Company has been clearly highlighted in the finance literature. The origin of ESOP goes back to the idea of the Industrial Homestead Act in America. Like the original Homestead Act, it was designed to broaden the ownership of capital by employees. The Homestead Act had tremendous impact on economic growth in America: during the first half of the twentieth century in America, land represented the major source of wealth and a poorly developed source of capital resource because it could not be combined with appropriate levels and quality of labor and capital to be sufficiently productive. The Homestead Act provided that any person who took possession of land and made it productive for a certain period could acquire full ownership of that land at the end of the period. As a result of the Act, thousand of people were able to acquire land and thus capital to become financially independent. However, as the structure of the economy shifted from an agricultural nature to an industrial economy, the source of wealth shifted from ownership of land to ownership of capital stock. ESOP, like the Homestead Act, was designed to enable employees to benefit from the ownership of capital through the investment of their talent and energy. The second goal of ESOPs was to create a source of revenue for employees which can be used to supplement retirement income. Third, one goal of ESOPs was to encourage and reward increased employee productivity and efficiency. Increased employee productivity and efficiency have an impact on firm s overall profitability. The goal of an ESOP therefore is to create a direct link between employee productivity and employee compensation. 48

2 In Cameroon, the use of ESOP basically originates in the nineties from the mismanagement of public enterprises and their inability to achieve their economic and financial objectives and thus forcing the government to pour public funds by subsidizing their activities. Structural adjustment programs that were implemented by the Bretton Woods institutions in the nineties lead to the wave of privatizations and re-structuring of parastatals, given their miserable performance. Consequently, public funds (at least a good part of it) had to be withdrawn from public enterprises and be replaced by private money in the form of stock ownership by foreign investors, national investors, and ownership of stocks by employees of the company. The legal framework surrounding the use of ESOPs rests on three articles of law: the ordinance 90/004 of June 22, 1990 relative to the privatization of public enterprises and parastatals; the decree 90/1257 of August 30, 1990 implementing Ordinance 90/004 of June 22, 1990; and the Uniform Act pertaining to Commercial Law and the Grouping of Economic Interests. Those laws organize the repartition of private ownership among foreign investors, national investors, and employee ownership as follows: 20-30% of stocks for national investors, up to 5% for employees, about 10% for the State, and the residual going to foreign investors which should hold the majority of the stocks. Many public companies went private in Cameroon like Sonel ( electricity), Camrail (transportation), Intelcam (telecommunications), Hevecam (rubber), Socapalm (palm oil), Camsuco (sugar), Camship (cargo shipping), Camair (airlines transportation), Cimencam (cement) to name just a few. The purpose of this study is to examine the link between employee share ownership and firm performance in Cameroon. Employee share ownership may impact firm in many ways: (1) by improving firm productivity because employees become more motivated as they invest their human capital and their savings in the company and thereby assuming a double risk and (2) in participating in the decision process as shareholders, they may have better control on opportunist behaviors from managers since they are likely to suffer the consequences of poor management decisions. There is a body of studies that examine the relationship between ESOP and firms performance. There is no definite answer as to the direction of the relationship (positive or negative) if any, between ESOP and performance (economic or financial). Therefore this study will add to the economic literature by investigating the matter using a sample of Cameroonian firms. In the next section, we survey the empirical literature on the impact of ESOP and performance and disclose the major results of previous studies. We then present the methodology and the data. We next analyze our results, and finally we present our concluding remarks. 2. SURVEY OF LITERATURE Many studies on ESOP find a positive link between ESOPs and performance. In a study conducted for 78 firms with ESOP (Conte and Tannenbaum, 1978) firms with ESOP were found to be 1.5 times more profitable than the conventional firms. Similar studies found that firms with ESOP tend to have faster annual growth than those without ESOP (Marsh and Mc Allister, 1981) and ESOPs have positive effect on value added (Conte and Svejnar, 1987). Studies also show that ESOP have positive impact on financial markets because investors perceive the announcement of ESOP as good news and expect firms to perform better in the future. Indeed a study from Beatty using a sample of 145 annoucements of ESOP finds a positive effect of ESOP on performance (Beatty, 1995). A similar study conducted using 232 announcements of ESOP collected between 1979 and 1989 find that there is a positive impact on performance if there is significant external shareholding (Park and Song, 1995). Mehran measures the impact of ESOPs on firm performance in the stock market and find using 382 announcements of ESOP recorded between 1971 and 1995 that firms with ESOP realize a cumulated stock exchange performance of 7% higher than those without ESOP (Mehran, 1999). Another wave of studies has found that firms using ESOP have a capacity of survival more important than that of firms without ESOP (Blair and Ali, 2000; Park and Ali, 2004). The impact of ESOP on productivity and on financial and economic performance is controversial as some studies find positive effects and others find negative effects. Indeed, 49

3 while a study of 221 French firms with ESOP testify of larger return on assets and return on equity and stronger growth rates (Trebucq and d Arcimoles, 2002), another study from a sample of 102 firms (51 with ESOP and 51 without ESOP) has resulted in firms with ESOP realizing a lower profitability than those without ESOP (Livingston and Henry, 1980) There is also controversy on the impact of ESOP on firms productivity. Sesil and Ali (2001) find a positive effect on productivity while a negative effect on productivity is found on a more recent study (Faleye and Ali, 2006). Numerous studies also found no conclusive evidence of the impact of ESOP on either productivity or financial or economic performance. The above studies were conducted in a different economic context where firms operate in more mature business environments and where financial markets are present and function well. In our study, we deal in a more scanty financial system dominated by scarcity of funds available for investments. Therefore, this study examines the effect of ESOP on economic and financial performance from this different perspective. 3. DATA AND METHODOLOGY The data for this study were obtained from the National Institute of Statistics (NIS) of Cameroon. We selected information from 24 firms operating in the industrial sector among which 12 firms having ESOP plans and 12 firms not having ESOP plans. In the group with ESOP, the average percentage of capital held by employees was 4.6, which is consistent with the ordinance 90/004 of June 22, 1990 imposing a maximum on the percentage of capital that can be held by employees. The average duration of presence of ESOP in the sample selected was 9 years at the time of the study. Accounting information for the four-year period 2005 to 2008 was collected. Based on those accounting data, we constructed our variables of interest namely the Return on Assets (ROA) and the Return on Equity (ROE). Those two variables were used to measure the firm s performance. The Return on Assets is a measure of profit per monetary unit of assets. It is the ratio of Net Income over Total assets. ROA can also be obtained by multiplying the profit margin by the asset turnover. That formula developed by Dupont causes the analyst to examine the sources of a firm s profitability. A high return on asset can be obtained by either a high profit margin or a high turnover of assets. A high profit margin indicates good cost control while a high turnover of asset demonstrates efficient use of assets. Efficient use of assets indicates that the firm is operating efficiently. Therefore, ROA can be considered as a good measure of economic performance. The return on Equity is a measure of how the stockholders of the firm fared during the year. Since benefiting shareholders is our goal, ROE is, in accounting sense, the true bottom-line measure of performance. It is measured by the ratio of net income over total equity and is a good measure of the financial performance of a firm. As indicated earlier, we created two groups of firms: those using ESOP and hence included in the group denominated PESO (presence of ESO); and those not using ESO. The variable PESO therefore takes the value 1 or 0 depending on whether a particular firm uses or does not use employee stock ownership. The percentage of capital owned by the employees (PKE) and the duration of the presence of ESO in a firm (DESO) were also selected as exogenous variables. The control variable retained in the analysis is sales revenues. We conducted tests of correlation of Pearson, Spearman, and Kendall to examine the correlation existing between the different variables constructed. Then, we performed nonparametric tests of Wilcoxox to compare the means of ROA and ROE in the two groups over the period from 2005 to In the Wilcoxon procedure, we test the hypothesis that there is no difference between the average ROA and ROE of the firms with ESO and the firms without ESO against the alternative that there is a difference between the average ROA and ROE between the two groups. Those tests are conducted at the 1%, 5%, and 10% levels of significance. 4. THE RESULTS Table 1 below shows the descriptive statistics of the variables PKE, DESO, ROA, ROE over the 4-year period covering the study. The table indicates that the number of observations under 50

4 study is 96. We indeed selected 24 firms in the sample and obtained data over a 4-year period, which totals 96 observations. Data from table 1 also indicate that the minima and maxima for ROA and ROE are respectively (-0.765; 2.158) and ( ; ); while the mean for ROA is and the mean of ROE stands at Standards deviations of the means are also available. Also note in the table that PESO takes values 0 or 1 and DESO which describes the duration the firm has been using employee stock ownership plans is between 0 and 10 years. The variable PKE representing the percentage of stock owned by employees in the firm is between a minimum of 0 and a maximum of 13. Even though privatizations laws, for the most part held the percentage of stocks that could be held by employees to about 5%, there were a few exceptions to that rule. The State allowed employees of the late CAMSHIP to hold 13% of the new privatized company. Tables 2, Table 3, and Table 4 show the intercorrelations among all different variables under study. The correlations between ROA and the percentage of capital held by employees appear strong and significant. It is also strong and positive when the firm is using ESOP plans and with the duration of ESOPs. Strikingly, the correlations of ROE with PKE, DESO and PESO respectively, are weak and not significant, suggesting that the relationship between those variables is quite weak. Pearson, Spearman and Kendall correlation coefficients are all consistent and confirm the strength of the relationship between ESOP and economic performance and the weakness of the relationship between ESOP and financial performance. Table 5 and 6 show the results of non-parametric test of Wilcoxox and add credence to the findings displayed in the correlations tables. The test compares the mean ROA and ROE of the two groups (with or without employee share ownership plans). Table 5 clearly indicates that the means ROA of the two groups differ. The differences in the ROAs are highly significant: differences in ROAs are highly significant at 1% in 2005, 2006, and for the entire period taken as a whole. Difference in ROAs is significant at 5% level in 2008 and significant in 2007 at 10% significance level. These results show conclusive evidence of the impact of ESOP on economic performance as measured by the return on assets. Table 6 displays the results for model 2 which compares the mean of ROE of group1 and group 2 (Group1 being PESO = 0 and group 2 being PESO = 1). The test indicates that there is no difference in the return on equity for the two groups. This suggests that whether a firm utilizes ESOP or not does not impact on its financial performance. Our results are in line with the trend in the empirical literature in which there is no convincing and definite answer as to whether ESOPs impact financial performance positively or negatively, or has any impact at all whatsoever. 4. CONCLUDING REMARKS The chief contribution of this paper is that it adds to the literature by providing new empirical evidence in support of the view that ESOPs applied to firms improve economic performance. The empirical results support the prediction that employee ownership positively will improve the return on assets. The findings add credence to the belief that as employees become part owner of the firm they become more productive and are willing to contribute more to the value of the firm. However, we find no convincing evidence that ESOP is associated with improvement in financial performance as measured by the return on equity. If any, the correlation is rather negative implying that ESOPs could have a negative effect on financial performance and hence reduce the return on equity instead. This finding is consistent with a number of studies such as those from Faleye and Alii (2006), Livingstone and Henry (1980). Nonetheless, the findings of this paper raise new questions that need be addressed. For instance, why would ESOP improve economic performance and not financial performance in this case? Are economic performance not linked to financial performance? The answer to those questions could be found by re-examining the data at a later date thus giving more time to firms to digest heavy investments made at an early stage of the firm life-cycle and allow them to obtain better financial returns on their investments. Another explanation to the disassociation between economic performance and financial performance could rest on the 51

5 leverage effect of how ESOPs are financed (debt or equity). Table 1: Descriptive statistics for variables: ROA, ROE, PKE, PESO, DESO, PKE, SALES Variable Mean Std Dev. Min Max Observations ROA Overall N= 96 Between n = 24 Within T = 4 ROE Overall N =96 Between n= 24 Within T = 4 PESO Overall N = 96 Between n=24 Within T =4 DESO Overall N =96 Between n=24 Within T = 4 PKE Overall N =96 Between n=24 Within T =4 SALES Overall exp exp exp11 N = 96 exp10 Between 5.07exp exp exp11 n=24 within 7.02exp exp exp10 T =4 TABLE 2: Pearson Correlation Coefficients Correlation coefficients of Pearson, N = 96 Prob. > r under Ho : Rho = 0 ROA ROE PESO DESO PKE SALES ROA ROE PESO * DESO * * PKE * * * SALES * * * *

6 Table 3: Coefficient of correlation of Spearman Correlation coefficients of Spearman, N = 96 Prob. > r under Ho : Rho = 0 ROA ROE PESO DESO PKE SALES ROA ROE PESO * DESO * * PKE * * * SALES * * * * Table 4: Kendall Correlation Coefficients Correlation coefficients of tau b of Kendall, N = 96 Prob. > tau under Ho : tau = 0 ROA ROE PESO DESO PKE SALES ROA ROE PESO * DESO * * PKE * * * SALES * * * *

7 Table 5: Test of comparison of means Model 1 using ROA Firms WILCOXON non-parametric bilateral (approx. student) Year Average mean for Average mean for Difference Stat. P-value Significance group 1 group 2 PESO =0 PESO = *** *** * ** Whole period( ) *** * = significant at the threshold of 10%. ** = significant at the threshold of 5%. *** = significant at the threshold of 1% Table 6: Test of comparison of means Model 2 using ROE. Firms WILCOXON non-parametric bilateral (approx. student) year Average mean for Average mean for Difference Stat. P-value Significance group 1 group 2 PESO =0 PESO = ns ns ns ns Whole period( ) ns ns= not significant 54

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