A Plan Doomed by High Profits   

Too many staffers at Peoria's Journal Star wanted to cash out, scuttling its employee ownership plan.

For eleven years Peoria's Journal Star was the newspaper industry's prime example of how to keep a newspaper locally owned by selling it to employees. In March and April 1993, I wrote columns in AJR describing how it was done and how successful employee ownership could be.

Too successful, it turns out: The newspaper's directors recently put the newspaper up for sale (see Bylines, November), and the Journal Star soon is likely to join the long list of newspapers taken over by chains.

The financial success of employee ownership turned out to be a time bomb that thwarted the original owning family's determination to avoid chain ownership. In effect, many employees became so wealthy on paper that they decided to cash in early rather than wait for retirement, as the ownership plan had envisioned. It became clear that soon the financial burden of redeeming employee stock would become so great that it would break the company.

The Peoria employee-ownership plan was initiated by the patriarch of the newspaper's owning family, Henry Slane, utilizing special tax advantages created by Congress to encourage creation of Employee Stock Ownership Plans (ESOPs). The ESOP legislation makes employee purchases of companies possible by giving banks a 50 percent tax break on interest earned on money lent to an ESOP that owns 50 percent or more of a company's stock. The ESOP thus can borrow money at a favorable rate, which it uses to buy stock from the owners.

The ESOP in effect becomes a stock fund that sells stock to employees, using employee payroll contributions and matching company contributions. Each year the company also pays a stock dividend, which the fund uses to pay down its debt. Since the contributions and dividends are paid into the ESOP, they remain untaxed until an employee quits or retires. The annual value of the company's stock is set by an outside appraisal (for the record, I was the appraiser).

The Journal Star employees enthusiastically embraced the plan. By the end of last year, they owned 91 percent of the company and would soon have bought the rest from the Slane family. In earlier years the newspaper had had its share of fractious dealings with its five unions, but such strife largely vanished with the advent of the ESOP. Employees began to work as if they owned the place, which of course they pretty much did.

Profits were strong despite the fact that the Journal Star's market was losing population and was beset by lengthy strikes and layoffs at Peoria's major employer, Caterpillar. The Journal Star regularly ranked near the top in profitability among media companies surveyed each year by Veronis, Suhler and Associates. Indeed, if the expenses associated with the ESOP – expenses typical newspapers do not have – are removed from the company's profit-and-loss statement, the Journal Star keeps more than 30 cents of every dollar it brings in, an exceptionally high cash-flow margin.

By the end of 1994, the average value of each employee's stock account had reached about $190,000, with many accounts approaching $1 million. Accounts reached these high levels because in recent years they had been increasing 20 percent or more annually, partly because of increases in the appraised value but mostly because high profits swelled contributions and dividends into the ESOP.

These high-value employee accounts became the bombshell that sent the newspaper on the path to chain ownership. Under the plan, employees can retire at age 59-1/2 and immediately draw out their cash, either all at once or over a period of years. Quitting before that age requires a year's wait for the money.

It didn't take long for some employees to figure out that once their stock account's value equaled 15 times their annual salary, they could cash in and earn the equivalent of their annual salary just from the interest on the cash they received. Even if they had to wait a year to get the money, they could save up or take another job until the payoff. If they kept the new job, their incomes would be much bigger than if they had continued to work at the Journal Star.

This scenario became so attractive that each year a growing number of employee shareholders decided to cash in. The growing financial burden on the company has been manageable so far, but management concluded, after gauging the sentiments of employees and performing extensive projections, that in just a few years the company would be unable to keep up with annual financial demands.

Thus the directors, including Henry Slane, reluctantly concluded that the only solution was to sell the company. It had been a noble effort that kept the newspaper locally owned for more than 11 years. But in the end too much financial success killed it. l