The ESOP Model and Drucker’s Management as a Social Function and Liberal Art

Peter Drucker, a political scientist with a doctorate in international law, often called the “Father of Modern Management,” spent his entire career developing principles of management that reflected his passion for people, their organizations, and society. A major by-product of his efforts resulted in the concept of Management as a Liberal Art or MLA, the practice of which “not only [involves] the ability to apply knowledge in the material world, but also [serves as] a constant reference to higher sources of moral reference” (Pearce et al., 2009, p. 9). This practice was most notably tied to the field of business; however, over time, Drucker refined and expanded the principles to apply to all organizations, depicting management as a social function in a functioning society.

Louis Kelso, an economist-attorney, had a similar passion for people and spent most of his adult life trying to correct what he believed was a gross inequity in western society’s capitalist system. He saw an increasing divide between the wealthy owners of capital and the creators of that capital, the average worker. Though programs for building capital wealth, such as 401(k), pensions, stock purchase plans, and so on, had existed for years, they all generally required a portion of the worker’s pay as a necessary building block. For the average laborer, too often, their pay levels were not sufficient enough for them to make significant contributions to such plans. Combining that with the possibilities of their organizations’ outsourcings, downsizings, divestitures, and/or merges, all of which were beyond the workers’ control, they were vulnerable to situations that could not only cut short their wealth-building plans but their means of earning a living.

Kelso saw an opportunity for at least partial reparation of improving the balance by expanding their opportunity to build capital wealth beyond the cadre of programs offered at that time. He sought to design a wealth-building mechanism that was not only feasible for the average laborer regardless of pay but would also add a level of security and control to their efforts to earn a living. Given Congress’ endorsement, his goal was finally realized with the forging of the Employee Stock Ownership Plan or ESOP, which was legislated as part of the Employment Retirement Income Security Act (ERISA) of 1974.

Although both men occupied the same economic era and had similar passions, to this writer’s knowledge, they never worked together. Yet, if one was to examine many of the characteristics and outcomes of Kelso’s ESOP model in light of some of the tenets Drucker ascribed to management as a liberal art, management as a social function, and a functioning society, one would find the former is a reasonable example and application of those principles. Table 1 contains a chronological list of management and organizational concepts discussed in this paper and is obtained from empirical research, using key management principles as espoused by students and scholars of Drucker and highlighting essential outcomes of the ESOP model documented over the last 40+ years, along with this writer’s personal experience as a former employee-owner.

Peter Drucker, the Social Ecologist

Despite being known as the “Father of Modern Management,” Peter Drucker’s passion was to study people and how they interacted with one another in society through its organizations (Choudhary, 2018; Veiga, 2005). The results of his work initially informed the discipline of business with a focus on the management of for-profit organizations, and what emerged was the concept of Management as a Liberal Art or MLA. According to Drucker (2008): “Management is thus what tradition used to call a liberal art: ‘liberal’ because it deals with the fundamentals of knowledge, self-knowledge, wisdom, and leadership; ‘art’ because it is practice and application. Managers draw on all the knowledge and insights of the humanities and the social sciences—on psychology and philosophy, on economics and history, on ethics as well as on the physical sciences…” (p. 24). His ideas of management were framed in concepts that addressed the sanctity of human dignity, freedom with accountability, and citizenship. They included leadership and stakeholdership with responsibility, along with the notion that “we are all in this together” and have an obligation greater than ourselves to fulfill.

This viewpoint was not enthusiastically received by most of Drucker’s contemporaries who embraced the largely accepted practice of “management as a science,” which was not constrained by the wisdom of the social sciences, nor did it possess any moral frame of reference. Nevertheless, Drucker’s heart for people required no alternative, and his name became synonymous with the term “Management as a Liberal Art.” Furthermore, he advanced the concept of MLA by positing that management was the key through which cultural diversity would serve the common purposes of humanity. Drucker (1974) stated: “Management…has to make productive the values, aspirations, and traditions of individuals, community, and society for a common productive purpose. If management does not succeed in putting to work the specific cultural heritage of a country and of a people, social and economic development is unlikely to take place” (p. 29).

Secondly, what emerged from Drucker’s efforts was the realization that since his youth, he had an “interest in, and concern for, community, society, and polity” (Drucker, 2003, p. vii). It was this realization that helped lead him to an understanding of the essential role his principles of management played in a functioning society which, in turn, led him to refer to management as a social function. In fact, Drucker (2008) makes a very clear argument that “management is not [just] business management, it is the governing organ of all institutions of modern society” (p. 572). By this, he meant government and non-government agencies, hospitals and clinics, colleges and universities, churches, organizations of the arts, and community services. This concept was expanded to that of a functioning society, which culminated in a book of the same title in 2003. Drucker’s book, A Functioning Society, reflects his persona not as a management guru but as a social ecologist, one who was “concerned with man’s manmade environment the way the natural ecologist studies the biological environment” (Drucker, 1993b, p. 441).

It is in this work that Drucker defines the individual’s need for status and function, that special purpose in the society in which he or she exists and without which society could not exist. He also highlights the role of the modern organization as a necessary destabilizer to the traditional conserving institutions of family, community, and society. It is in this work that he identifies the role of the knowledge worker and argues for increasing knowledge worker productivity, which he believed would contribute to social stability and help minimize inequality. Many other concepts, principles, and practices are discussed throughout the text, but a common theme prevails: his concern for people and their welfare and his persistent expression of a morally guided interdependence between individuals and their organizations for the sustained function and growth of society.

Louis Kelso, the Modern Capitalist

Louis Kelso, an economist-attorney, also had a passion for people and, for much of his adult life, worked at resolving what he believed was a gross inequity in modern capitalist society. Kelso argued that in today’s capitalist system, business enterprise ownership was increasingly comprised of pension funds, private equity firms, and other “outsider” interests to the exclusion of the sustenance worker, the one whose work activities in the business enterprise for a contracted wage or salary were committed to the toil of producing the necessities, comforts, and conveniences of life. He disapproved of this owner-worker system that essentially locked each into their respective roles, serving as the impetus for maintaining the inequality, a system that afforded the capital owner the benefits – through financial returns – of the growth and prosperity of the sources of production (business enterprises), while limiting that same opportunity to those whose unremitting toil made it possible (Kelso & Adler, 1958).

A staunch capitalist, Kelso acknowledged the evolution of our capitalist society and the investor-based model of ownership. Nevertheless, he also maintained that those who created the most value and bore the most risk should be aptly rewarded. This system worked well when the pre-industrial capitalists were usually involved from the beginning in developing an idea, amassing the capital to launch it, hiring the workers needed, and managing the operation for its long-term growth and competitiveness.

However, most current owner-capitalists are external to the enterprises they own and are more concerned about maximizing the short-term returns on their capital rather than the long-term success of the enterprise. The negative impact of an unacceptable downtick in share price could easily be avoided by simply selling the shares and moving on to something “better.” Yet the answer for the sustenance worker is not as simple; years of productive activity, training and skill development, building a family, and settling into a community did not allow for such an easy escape. So, in today’s capitalist society, though the value created and inherent risk has shifted from the entrepreneurial owner-capitalist to the company’s employee, the sustenance worker, the distribution of their returns has shifted into the hands of the external owner-capitalist.

Kelso felt that true capitalism was one that fulfilled the ideals of economic democracy where “all its members would be economically free and equal” (Kelso & Adler, 1958, p. 46). He recognized that ownership was a form of wealth and had the ability to transform people’s lives and, in most cases, provide a level of security and control the average worker was not likely to attain. Therefore, he used his background and experience in law and investment banking to reform the capitalist economy, focusing on how to extend ownership of industrial capital to the masses on the premise that “no one should have to live on labor income alone” (Rosen & Case, 2022, p. 98.), since he believed the wage of the average worker would never be enough to afford any substantial acquiring of stock. Consequently, starting in the early 1950s, he began working persistently to perfect a means by which his dream of economic reparation would be possible.

However, it wasn’t until 1973, at a dinner with Senator Russell Long, that his idea gained traction. At the time, the Senator was Chairman of the Senate Finance Committee to develop ways of addressing the economic inequality that plagued the nation. With a mandate from the Joint Economic Committee, Long and Kelso studied a variety of ways to expand capital ownership among U.S. citizens, which they felt was the key to mitigating the inequality that everyone agreed existed (Rosen & Case, 2022).

Finally, with industrial capital as their target, in 1974, they introduced the Employee Stock Ownership Plan (ESOP) as part of the landmark Employee Retirement Security Act (ERISA). It was introduced as a low-risk means of addressing the inequality problem. That is, the ESOP became the sole vehicle to provide workers with the opportunity to own stock in their companies that did not depend on their savings, nor was it based on their ability to purchase shares, as with a broker (Freeman et al., 2013).

Drucker’s Principles and the ESOP Model

So how does the ESOP embody the principles of Peter Drucker? We have seen that as a social ecologist, Drucker’s passion for people, community, and society led to the development of principles and practices for responsibly managing the organizations of society. Drucker (1993a) stated: “…all institutions, including business, will have to hold themselves accountable for the ‘quality of life’ and will have to make fulfillment of basic social values, beliefs, and purposes a major objective of their continuing normal activities.” He further argued: “This will apply increasingly to fulfillment of the individual. It is the organization which is today our most visible social environment…The ‘community’ is increasingly in the organization, and especially in the one in which the individual finds his livelihood and through which he gains access to function, achievement, and social status” (p. 145).

Addressing what Kelso felt was a growing inequality gap in the present capitalist system, his ESOP model specifically targets the average worker in the community of organizations, whose livelihood depends on such organizations, and without whose commitment those organizations could not exist, and it raises their status and function with the opportunity to share in the capital they create, an opportunity that might not otherwise be possible through wages and income alone. This writer maintains that Kelso’s ESOP, in many ways, was a significant improvement of the individual worker’s quality of life and the “glue” that helped cement the organizational community to which they, through capital ownership, were able to gain or at least increase their access to the function, achievement, and social status spoken of by Drucker. As a former employee-owner, this writer can attest that status change substantially alters one’s perspective for the better with regard to the organization, the work environment, and those with whom one works.

In terms of sheer numbers of those directly benefiting from the ESOP, according to Rosen and Case (2022), there are “6,500 [employee stock ownership] plans covering over 14 million employees” (p. 81), representing nearly $1.5 billion in capital assets. This may not seem like much in the grand scheme of things, but it means that since the inception of the ESOP, 14 million workers were transformed from being just “employees” to becoming “employee owners,” giving them a new special status in the organization and society as owners of capital wealth. As a result, there is robust evidence that employee-owners have

• 92% higher median household wealth,

• 33% higher income from wages, and

• 53% longer median job tenure

relative to their non-employee-owner counterparts (Wiefek, 2017, p. 1), demonstrating a significant relationship between ESOP participants and enhanced economic outcomes that persist over time, including in times of crisis (Wiefek & Nicholson, 2021). Wiefek (2017) also notes that the great majority of those who experienced these benefits were among the marginal subgroups analyzed: parents raising small children, non-college graduates, workers of color, and single parents. These and similar stats reveal an enhanced quality of life for which Drucker held the organizations accountable.

But what about the performance of businesses with ESOPs? Drucker (1993a) stated that successful organizational performance and results are based on the objective of maximizing the organization’s capacity to produce wealth. Furthermore, he argued that this is the objective on which all constituencies depend for the satisfaction of their expectations and objectives, whether employees, shareholders, or customers. Lastly, Drucker outlined the operational dimensions of business performance by which the maximization objective may be accomplished: market standing, innovation, productivity, and people and their development.

Validating the precise market positions of ESOP companies is virtually impossible since roughly 90% or 5900 of them are privately held and do not normally share that metric with the public. However, the strength of their relative market position may be inferred by selecting a recognized list of companies characterized by superior performance above their peers and identifying the number of ESOP companies on the list. While there exists a large volume of such lists, Rajendra Sisodia’s Firms of Endearment, or FoEs (Sisodia et al., 2007), reflect those companies that Drucker (1993a) referred to when he said businesses must" hold themselves accountable for the “quality of life” and will have to make the fulfillment of basic social values, beliefs, and purposes a major objective of their continuing normal activities" (p. 145); in the words of Sisodia et al., these companies are “endearing” themselves to their stakeholders (p. 8).

According to Sisodia et al. (2007), FoEs “seek to maximize their value to society as a whole, not just to their shareholders. They are the ultimate value creators: They create emotional value, experiential value, social value, and of course, financial value” (p. 4). Drucker (1964) suggests a similar perspective, stating that marketing analysis is much more than “ordinary market research or customer research,” but it starts by looking “at the entire business” (p. 110). Furthermore, these companies bring into strategic alignment the interests of all their stakeholders so that one does not benefit at the expense of any other. Darroch (2009), when discussing Drucker’s ideas on marketing with respect to organizational performance, states that “…it is important that you look at your organization from the perspective of each group of stakeholders…” to understand their wants and needs and the problems they wish the organization to solve. “After all, any successful organization is characterized by its relevance to its stakeholders” (p. 263).

This is no small feat when one considers Sisodia et al. (2007); “stakeholders” comprise five categories: society, partners, investors, customers, and employees. The societal stakeholders include local and broader communities as well as government and non-governmental organizations. Partners include those upstream, horizontal, and downstream, and investors include individual and institutional. Customers include those current, future, and past, and similarly, employees include current, future, and past, as well as their families.

Moreover, the list was assembled using what the authors describe as an “organic and analog” approach as opposed to one based on statistical analysis (Sisodia et al., 2007). Thousands of survey recipients from all over the world, including business professionals, market professors, MBA students, and consumers, were first asked, “Tell us about some companies you love. Not just like, but love” (p. 13). Then nearly a dozen more probing questions were asked about the recipients’ selections to unearth the “depth of endearment.” Hundreds of candidates, public and private, were put through a screening process that assessed the qualitative and quantitative performance of each.

First, humanistic performance was assessed with respect to each of the stakeholder categories, after which a detailed comparative analysis was performed from the investor perspective. When this process was undertaken over 15 years ago, the first list of firms that made the final cut was comprised of 28 companies. One surprising quantitative finding was that the public FoEs outperformed the S&P 500 by significant margins for 10-, 5-, and 3-year time horizons. That list has since grown to 51 firms, which can be found on the Firms of Endearment website, along with performance results indicating that the FoEs also significantly outperformed the S&P 500 over a 15-year period (Firms of Endearment, n.d.).

Of the 51 U.S. FoE firms, 16% are ESOP companies based on Department of Labor data (N. Weifek, personal communication, March 2, 2023). That statistic is significant when one considers that over the 12-year period from 2007 to 2019, the number of U.S. employers firms average 5.9 million (U.S. Census Bureau, 2022), and the number of ESOP firms among them is less than 1/10 of one percent (NCEO, 2023). Given that such a significant number of ESOPs occupy the impressive list of FoEs when their proportion to the total populace of employer firms is infinitesimal by comparison speaks volumes to the market strength of ESOPs relative to their non-employee-owned counterparts.

As for the remaining metrics outlined by Drucker, ESOP companies’ outcomes regarding their employees, their community, and society are also impactful. This information is obtainable through a combination of Dun & Bradstreet data on privately held firms, the firm websites, and the IRS Form 5500 filings required of all companies offering employee benefit plans, such as 401Ks and ESOPs. Comparisons of performance for pre-ESOP to post-ESOP are made relative to match non-employee-owned companies and represent the latest studies with the largest and most representative samples.

Before presenting the performance findings, however, credence must be given to how ESOP companies are run, which is where their true efficacy lies. It is more common for ESOP companies to seek employee involvement and utilize participatory management than their non-employee-owned counterparts. Both practices are designed to increase employee commitment to an organization’s success through collaborative decision-making. Although Drucker (1974) was explicit in his argument that the power relationship in a company through a system of authority is essential to the organization, he also saw the value of, and even the need for, “participation” as well (p. 192).

The findings from studies of participation-performance yields are mixed (Pendleton & Robinson, 2010; Wagner et al., 1997), but it is clear that with the employees’ added ownership status, the question of “what’s in it for us?” is unequivocally answered. Likewise, along with ownership status, the opportunity for decision-making directly affects them and increases their autonomy and control over their professional lives. These factors combine to induce a level of productive joy in their work and pride in the organization over what is commonly found among workers in companies without employee ownership. As a former employee-owner, though it has been nearly 20 years, this writer seldom remembers a time when going to work was filled with anything less than excited anticipation of the challenges to be overcome with other co-worker-owners in the family-like environment we created and nurtured. This heightened level of employee job satisfaction and the familial work environment, creating a more cooperative culture, are common in ESOP companies and suggest a reinforced organizational community referred to by Drucker.

Moreover, these characteristics also impact the organization’s economy. Companies in which employees have an ownership share and a voice in their governance tend to experience not only more motivated and productive employees but lower turnover and increased potential for creativity and innovation (Postlethwaite et al., 2005). Similarly, most studies report an improvement in productivity for ESOP companies (Blasi et al., 2013; Logue & Greider, 2002; Logue & Yates, 1999). Furthermore, in their longitudinal match pair study (1998-2004), Stretcher et al. (2006) found that operating cash flow to assets “was significantly greater (p = 0.05) for ESOP firms than for non-ESOP firms” (p. 11).

Lastly, studies consistently show that employee-owned companies have greater survival rates compared to their non-employee-owned counterparts (Kurtulus & Kruse, 2016; Park et al., 2004; Robinson & Pérotin, 2009). Greater survival rates are not only linked to their greater employment stability but to their organizational stability, making them less likely to be acquired, taken private, or thrust into bankruptcy. Overall, referring to Table 1 for a summary of the previously discussed ESOP model outcomes with respect to Drucker’s principles, these findings point to more robust organizations positioned to navigate the economic and societal complexities of life that Drucker maintains must be overcome in a functioning society.

Conclusion

Two influential scholars with similar passions for people, their organizations, and society worked separately to achieve what this author believes is a similar result. For Peter Drucker, it was a broad yet comprehensive approach to addressing the challenges and issues of worker-organization interactions and relationships and their impact on society. The resultant principles, models, and practices represented a framework for a) the workings of management: management as a liberal art and management as a social function, and b) a functioning society. These concepts, while operationally sound, also addressed the sanctity of human dignity, freedom with accountability, and citizenship. They included leadership with responsibility and the idea that we have an obligation to fulfill, which is greater than ourselves.

Louis Kelso’s efforts were more task-oriented, focusing on what he believed was a gap in our capitalist system: the increasing deficiency of owners of capital wealth who were the capital builders he called the sustenance workers. He believed that these individuals were not only limited in their ability to attain any significant capital wealth in their respective organizations due to the negotiated levels of pay but were also exposed to the risk of losing their livelihoods altogether, subject to organizational maneuverings beyond their control. Kelso’s objective was to create an opportunity for the average worker to build capital wealth without it having to come out of their pockets and, in the process, provide them with some control over their work environment. His efforts were finally rewarded with the establishment of the Employee Stock Ownership Plan, or ESOP.

Drucker and Kelso shared similar passions for people, especially the workers of our society, with the objective of not only maintaining their dignity but increasing their abilities to create value for not only the organizations of which they were a part but for society in general. Although there is no evidence that Kelso’s design of his Employee Stock Ownership Plan was based on or even influenced by any of Drucker’s principles, the evidence is clear. Kelso’s vision has become a reality, and the ESOP model, with its outcomes at the employee and organizational levels, is an application of Drucker’s management concepts as a social function, making “productive the values, aspirations, and traditions of individuals, community, and society for a common productive purpose” (Drucker, 1974, p. 29).