Employee Stock Ownership Plan (ESOP) business definition
A qualified retirement plan in which employees receive shares of the common stock of the company for which they work and the company receives an investment tax credit. The purpose of this type of plan is to give employees a vested interest in the company, thereby providing them with an additional incentive toward greater productivity. See also leveraged ESOP
An ESOP allows the owners of a small company to gain a tax benefit and diversify their personal investment portfolio while the firm's employees become owners. ESOPs were first offered in the 1950s on the theory that employees who become part owners will work harder, thereby creating a more productive and profitable company. The owners of the business who initiate an ESOP receive tax benefits at the same time they gain more loyal and productive employees. Depending on the size of the business, the firm might borrow several million dollars that it then lends to the ESOP. The ESOP uses the borrowed money to purchase shares from the owners (or the company). Special tax breaks applicable to ESOPs allow the company to deduct both interest and principal payments on the loan. The disadvantage to the employees is the lack of diversification of their retirement plan, which is subject to many of the same risks as their current employment. If the firm encounters financial difficulties, the employees are subject to losing both their jobs and their retirement nest eggs.
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