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The Sunday Paper – The Impact of Employee Stock Ownership Plans on Stock Price Crash Risk

I’d have put the conclusion from this work another way. One with more resonance for regular investors than researchers Xiyuan Jing and Mangfei Liu of the Victoria University of Wellington and the Shaanxi Normal University have chosen to.

Their summary notes a negative correlation between Employee Stock Ownership Schemes (ESOPs) and stock price crash risk i.e. the likelihood a stock will fall out of bed with little warning. I’d have said what they’re more usefully pointing out is fairer valuations as a result of ESOPs.

Stock price crash risk has been extensively studied and it’s generally agreed the problem (but not the causes) are sort of the same every time. A build up of bad news occurs behind a dam of silence that eventually breaks and, crash!

Investors don’t like this and previous studies have focused on strength of internal controls, management educational attainment, controlling shareholder stock pledging etcetera. This study is the first to look at how ESOPs may also be employed as a useful check for investors seeking to avoid the risk of sudden, and often permanent, capital destruction.

The paper is short and I’d urge the closer look for those facing this risk here Impact of Employee Stock Ownership Plans on Stock Price Crash Risk.

For the time-poor though here are the main points:

  1. The presence of an ESOP reduces stock price crash risk; because..
  2. They reduce internal/external informational inefficiency
  3. They contribute to enhanced firm productivity
  4. The effect is stronger in firms with high levels of external interest, and..
  5. They’re effective where significant minorities are present
  6. They’re more effective in non SOEs and firms located in the East (of China)
  7. The wider the employee participation, the more effective they are
  8. Shares sourced from the secondary market have a better effect than those of the privately placed variety

Given how effective ESOPs seem to be in promoting good Corporate Governance companies without such schemes should be challenged by investors as to why they’re not yet operating them?

Happy Sunday.

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