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The Money with Katie Show
This Private Equity Exec Wants to 5x Your Wages with Employee Ownership
00:56:54
Discussing the power of ESOPs, with an unlikely advocate.
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- [00:01]
Hannah
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- [00:49]
Pete Stavros
We talk about it as the right thing to do. That also happens to be good business. And the reason we order it that way gets back to that example of, hey, there's two companies, same industry, very similar businesses. We give ownership programs and the same tools to both. And one, great things happen culturally and financially, and the other one, culturally, things kind of go sideways. The one who says, if I turn some dials, how much more productivity can I get? I mean, the world is so lacking in authentic leadership and genuineness. I mean, people will smell that a mile away and it just doesn't work. The leader who starts with that orientation of like, I'm just doing this because I want to lift up my people is the one who changes the culture if it comes from that place in someone's heart and not like, I could grind a little more out of this company. If I do this, then we'd see their engagement scores spike and the quit rates drop. And that's when the culture shifts. Then great things happen.
- [01:49]
Unknown
When I first learned about Pete Stavros, the KKR executive making headlines for employee ownership plans, my guard was up. For one thing, the timing was coincidental. We had just done a deep dive on private equity with a former DOJ prosecutor, and if you've heard that episode, you know the takeaways were not all that favorable to the PE firms. And KKR just so happens to be one of the largest private equity firms in the world. Memorialized by the 1989 book and later 1993 movie Barbarians at the the Fall of RJR Nabisco, about a particularly dramatic KKR leveraged buyout, said he's not going to sit on the sidelines.
- [02:37]
Pete Stavros
He only has to sit there a few more days, he said.
- [02:39]
Unknown
He's the one that gave Ross the idea for the leverage, and Ross decided.
- [02:43]
Pete Stavros
To go with us.
- [02:44]
Unknown
So lbos are his game, Peter. He invented them. And it's clear he doesn't want you playing in his sandbox.
- [02:49]
Pete Stavros
I'll make a note to be scared. Come on, will you? What can he do about it?
- [02:53]
Unknown
Why don't you meet with him and find out?
- [02:55]
Pete Stavros
Why don't I find out and then meet with him? Henry is not a man you stonewall. Not Henry Kravis. Not kkr.
- [03:02]
Unknown
But as you probably know, private equity firms are typically in the business of trimming headcount. So a KKR guy interested in promoting more robust employee benefits packages seems more than a little ironic to me. Regardless, the consensus of his critics and fans alike is that Pete is nothing if not earnest about his interest in making employee ownership plans more common. And as one of the people at the head of a firm with something like $600 billion in their control, he's not a bad guy to have on your of course, Pete's efforts are a lot larger than private equity. He's founded two separate organizations that are also working on rolling this out. But his role at KKR gave him the first path to implementation. Pete started working on building up these sorts of plans at KKR in 2011. He's implemented this model at more than 50 portfolio companies, now impacting around 100,000 employees globally. For a sense of scale, about 12 million people work for companies owned by private equity firms, so it's a good start. But there is still a long way to go. One of the most highly publicized success stories of this approach was that of CHI Overhead Doors, a company with 800 employees in a rural Illinois town. The payouts are a function of tenure and salary. Because Jamison is in her 18th year at Chi, she'll be bringing home 5.5 times her annual salary. Words cannot explain how my mind was going.
- [04:38]
Pete Stavros
It's just in a hundred directions.
- [04:41]
Unknown
Employees received envelopes with their bonus details. On average, hourly workers received $175,000. And when KKR sold, Chi's employees received an average payout of, as you just heard, $175,000 each, with some of the most tenured plant employees receiving as much as $400,000. The median income in Arthur, Illinois is less than $60,000 per year. So this was certainly a life changing event for these people. That's around $140 million distributed to employees. KKR had sold CHI Overhead Doors to a company called Nucor for around $3 billion, which was 10x their original investment. And when Pete finished telling the firm's employees about their payouts, he said, we want this to be the new normal for business, that everyone participates when things go well. This story is in many ways an unalloyed success, especially when compared to how other highly publicized PE deals have gone. But I still feel conflicted about it. $140 million to the business's employees is a ton, but it's still just around 5% of the overall sale price. Private equity firm CEOs regularly make $100 million alone in annual compensation. Still, maybe this represents a step in the right direction after all, even if it's not radical enough to meaningfully address labor's declining share of income, it seems to be pushing employee ownership into the mainstream in a way that lends it more legitimacy beyond just being a nice thing to do. After all, if even the big bad PE firms think it's good for the bottom line, maybe other businesses will follow suit. I want to talk to Pete today about these complexities. I want to ask him what he thinks about these critiques, and I want to know why he became interested in employee ownership as a concept. Because in the US employee stock ownership programs, or ESOPs, are the only significant form of employee ownership that exists today. Formally established in 1974 as part of the Employee Retirement Income Security act, or ERISA, ESOPs were intended to distribute shares of a company to its employees that vest over time according to things like tenure or your salary. It's a way for workers to benefit from the capital appreciation of the business that they are working to make more valuable, rather than from their wages alone. Now, this is different from a worker cooperative where workers buy a share of membership in order to become direct owners with a voice in the firm's decisions. That arrangement is considered the most democratic workplace, and ESOPs do not typically involve that level of direct input or decision making power. It's also important not to confuse ESOPs with ESPPs or employee stock Purchase Plans, which allow employees to purchase company stock at a discounted rate. ESOPs just grant you the shares, no purchase necessary. The challenge is that ESOPs can be complicated and expensive to administer, so most companies simply don't bother. And the ones that do often have to hire third party firms to handle the heavy lifting of administration, record keeping, and the valuations that have to be done. So if you're a business owner who doesn't really have a strong view one way or another about the proper way to structure the ownership of your business, the question likely comes down to whether or not you believe it's going to be worth it to you. Will the boost to morale and retention be worth all the additional cost and complexity? And when you're answering questions about whether ESOPs will be effective in that way, it can be helpful to remember how all investing works. Anyone who invests knows that assets can go up in value, but they can also go down. And in that respect, just as using your wages to invest in an index fund the slow and boring way is an exercise in delayed gratification, so too can the promise of an esop. Which means it's not necessarily as motivating as a higher wage right now, depending on the financial position that you're currently in. One person who was offered an ESOP told the New York Times that it didn't seem to affect the people he managed. Quote, most people understand it, and when they realized there was no way to track or plan it or anything, it didn't change anyone's day to day performance. This isn't altogether surprising. Does the slow creeping balance in your 401k motivate your day to day performance? I mean, probably not, but someday you're certainly going to be glad you have it. And that's why the introduction of a private equity timeline makes this conversation all the more interesting. Because most PE firms are trying to sell between three and seven years. That is a blip compared to most investment horizons. So enjoy this conversation with Pete Stavros right after a quick break. This one is for my investing listeners, both new and seasoned. Public.com is the investing platform with a wide range of tools and asset classes that can help you build the multi asset investment portfolio of your dreams. Like for example, if your allocation goes beyond stocks and bonds to include things like options trading, you can also generate fixed income with a suite of yield accounts like Public's High Yield Cash Account that set an industry leading 4.1% APY. You can also tap into Alpha Public's AI powered investment research Assistant that can answer questions about any stock. Public is a US based company and a member of FINRA with an award winning customer support team that's trusted by millions. Fund your account in five minutes or less and you could earn up to $10,000. Yes, I said $10,000. When you transfer your old investment portfolio, start@public.com MWK that's public.com MWK paid for by Public Investing. Full Disclosures in Podcast Description Pete, thanks for being here. I'm really excited to talk to you today. So you first came to my attention a couple years ago. It was actually my godmother sent me an episode of Kelly Corrigan's podcast, and she was like, you should listen to this. I think you would like this guy. So I want to start with a deep cut to that interview that you did, because in that conversation, you referenced a session of Congress in 1974 where they essentially predicted the situation that we are in now, one in which capital is expanding at a much faster rate than wages are. And so you're seeing this pretty dramatic divergence between the haves and the have nots.
- [11:45]
We'll say Congress predicted it. So if you go back even before 1989, in 1974, as a part of something called the ERISA Act, Congress had a sub part of that law which encouraged worker ownership. It's called an esop. It's one of the more misunderstood terms in American business. People think, oh, yeah, no, every company's got an esop. It's a stock option plan. It's an employee stock ownership plan. It's a defined term in the tax code and in erisa. And basically, I'm way oversimplifying.
- [12:17]
Good. But if we like it that way.
- [12:19]
If you share a meaningful amount of stock ownership with workers in this tax structure, which is complicated, you pay no federal income taxes as a company forever. Tax free company forever.
- [12:32]
So somebody was like, this is going to work. The Pete Stavros plan will work. Somebody said it in 1974 and put it into the tax code.
- [12:40]
And if you read all the congressional testimony, they were predicting everything that's happened, which is workers are barely getting by on their wages, and if they don't have savings, they can't invest in capital. And capital is getting more and more productive with technology. And so this is going to explode. I know we all love to complain about the government, but there were a lot of smart people in 1974 saying, we have to do something. This is not going to be the country we want.
- [13:06]
So I struggled through the archives of the Congressional Library trying to find the actual minutes from this meeting so that I could reference it specifically. But I do want to talk to you about this, because that was the first time they ever heard that ESOPs were introduced with the specific intention of curbing a trend that it seems like they saw coming 50 years ago. And I'm curious if you perceive that in retrospect as an admission that ownership is really the only way to thrive in a modern economy.
- [13:44]
Pete Stavros
I think it is. I think it's incredibly hard to get ahead without owning. You know, in our ownership programs, which are not ESOPs, we're trying to deliver about 100% of someone's annual earnings in stock over a five or so year period of time as a free and incremental benefit. So they're not purchasing the stock, it's free to them, and they're not giving up any other benefits. It's hard to do that in wages. You'd have to give someone a year one right off the bat, 20% wage increase, which I'm sure few companies are willing or able to do. And then with ownership, the equity, the upside's uncapped. So if the company does really well, you may earn 500% of your wages in stock. Now, it's not a guarantee the company has to perform and there's risk to it. It's not a guaranteed payoff. But I do think that without ownership, it's hard to replicate that kind of financial result. And ownership to me is more of an ethos. It's not just about the money, but it's about giving workers a voice, having a different type of culture where people feel included and trusted and respected. So I think that also speaks to thriving in today's economy. It's not just the money, but are you working in a culture where you're respected and you're, as I say, included and trusted and you get access to the financial information, you're really a part of the team. So I think both of those speak to thriving.
- [15:08]
Unknown
I do want to understand a little bit more about the technical vehicle that is being used to accomplish this, because I think that that's something that's relatively easy to pay lip service to if you're a business like, oh, we're a family, you're part of the team, your voice matters. But it's a different thing entirely to be granting equity to people, and even beyond that, for that equity to have decision making influence carried along with it. So in the private equity world, specifically when a PE firm buys a company, the idea is that they would grant some shares of ownership to the employees of that company, and then when that PE firm sells the company later, the employees receive a payout as their shares are sold as well. Am I mostly getting that right?
- [16:04]
Pete Stavros
That's right. Now, if we were to take the company public as opposed to selling it, so if we were to relist it on an exchange like the New York Stock Exchange or the nasdaq, then workers would get tradable shares. So that's what we did, for example, with Ingersoll Rand, by the time we exited, I think we had 18,000 workers around the world with tradable stock. So it's not always that we sell the stock and they get cash. We also might take the company public, but you mostly got it right.
- [16:29]
Unknown
How often does that happen versus a private sale?
- [16:32]
Pete Stavros
It's much more common to sell a company than to take it public.
- [16:37]
Unknown
Okay, I figured. And are ESOPs actually the vehicle that is being used to accomplish this? It sounds like they were more so the inspiration for a different mechanism that's being used because it sounds like ESOPs are pretty complicated to administer.
- [16:51]
Pete Stavros
That's right. That's right. And ESOPs are really fundamentally a tax structure. So there's a tax incentive that comes with giving workers ownership. And so our model, we avoid all the complexity. As you note, it's a part of the ERISA Act. There's lots of regulation legislation around it, and it comes with a lot of litigation risk if, God forbid, something goes wrong. Our model sits outside of all that, but does not come with a tax incentive. So for us, we really need to prove out the business case without a tax incentive.
- [17:24]
Unknown
When you are pitching this to businesses, because I know you founded an organization called ownership works in 2021 and then you launched a group called expanding ESOPs, I think in 2024, which is a nonprofit that teaches executives how to deploy this model. When you're pitching this to businesses, how much of the challenge then has been just knowledge sharing around like, hey, this is a thing you can do and here's how you implement it versus actually having to convince these businesses that this is a good idea, that they should be doing this?
- [17:59]
Pete Stavros
I would say it's both. It is contrary to conventional wisdom that you're going to share stock ownership with all employees. And I'd say there's a pretty deep seated belief that workers will never understand ownership. If they don't understand it, they won't value it. If they don't value it, then you can't possibly get a return on the investment. Ownership should really be concentrated in the hands of the just the few people at the top of a company who really, quote, unquote, move the needle. There's a whole list of things that are immediate objections. And then, as you note, it's hard to do. Just even administering these programs is difficult enough. But then if you're going to get a return on the investment you're making in frontline workers, you are going to have to do all this culture building when you open up the financials to the workforce Keeping in mind, more than 60% of Americans are deemed to be financially illiterate based on government surveys. There's going to have to be a whole series of educational efforts that go together with these efforts to build an ownership culture. It's not like you just give stock, people are suddenly happy and less likely to quit. All of this work takes years, which is a whole nother set of objections of like, gosh, I'm going to give this stock, do all this work for years. And then the really unfortunate part is it doesn't always work, is sometimes you do it with the best of intentions. I could show you two companies in the same industry. Let's say we own both of them and we give the CEOs the same tools, the same ownership program, and one of them will have a really dramatic shift in the culture, and the other one, nothing will happen. As you can imagine, we're going through a lot of work to understand why that is. It's an investment. It's not a guaranteed payoff.
- [19:38]
Unknown
Do you have any hunches?
- [19:40]
Pete Stavros
We do. Initially, we thought surely it had to do with the size of the company, how many employees there were, and how globally distributed they were. So it's like, much harder to do this. I mentioned Ingersoll Rand. That company operates in 80 countries, hundreds of sites, so time zones, even just legal structures, local tax issues, like if you grant someone in Belgium stock, they get taxed on it even though they don't get the cash. That's this idea of dry income, for sure. We thought it's those kinds of things, technicalities. And in reality, none of that has been true. It hasn't mattered. The industry, the size of the company, how distributed. I'd argue that some of those things make it harder to implement this program. But what we started to notice was because we've done this now 70 times with 70 companies, close to 200,000 frontline folks, that there were categories of CEOs who did a better job of creating these cultures. And the categories were women. Female leaders did a better job with this. People of deep religious belief, immigrants, CEOs who grew up poor. And I was at a conference talking about this, and I mentioned empathy being a common ingredient. So I think the New York Times or someone wrote a little blurb on it. And a professor at Stanford who studies empathy called me named Jamil Zaki. He said, someone forwarded me this story in the Times. Explain to me what you're thinking. And so I said, well, I noticed these categories of people. They seem to be more empathic as a general matter. And maybe empathy is the key ingredient where CEOs, they care so deeply about their people that they'll fight through all the complexity, they'll push through all the hard work, they'll put the years into it and they'll change the culture. And so he said, well, let's assume you're right. What's your strategy? Is your strategy to only hire, like immigrant CEOs? And I said, well, we haven't, we don't even understand this yet. And he said, well, let me measure the empathy of your CEOs, because we can measure empathy. There's a test that you're given where as an example, they put up on the screen different people's faces, but you only see their eyes. And you're asked to assess their emotional state. And a more empathic person can more easily assess whether someone's frightened or fearful or angry or frustrated. And then you answer a series of questions about yourself and your leadership style. There's three different types of empathy. So we'll get scores for each of them. Then we'll get a composite empathy score for all your CEOs. And then if you give me your data on each of the company's engagement scores and quit rates, we'll run a regression analysis and I'll be able to tell you whether or not empathy is a key ingredient. So he came in, did all this work, ran these regressions, and sure enough, it's like a blowout correlation. It's way beyond what the benchmark. The benchmark correlation for this is.02 something. And this was like double that, two and a half times that. So now the question is, can we move the empathy of these leaders and then see a consequential movement in the employee experience? So how do you move empathy? You give people different lived experiences. So CEOs are going into their local communities and they are seeing what it's like to live the life of a frontline worker. So opening up low dollar amount checking and savings accounts, see what that is like, get payday loans, all the things that frontline folks are dealing with. He's also setting up these things called empathy gyms, where he has CEOs come out to Stanford with him and he puts them through the exercises. We're also having our CEOs do frontline work. So if you're in a manufacturing business, you work in the factory floor, all sorts of stuff. This is going to take us years, but that's what we're working on.
- [23:22]
Unknown
Wow, it's so wild to me you could have given me 100 guesses of like what's, what's KKR up to? Empathy gems for CEOs would not have been at the top of that list. But it is interesting because there was a leaked zoom call with Jamie Dimon and I'm thinking about this because you mentioned low dollar value checking accounts. One of our listeners sent it to us and was like, he sounds so angry about the fact that people don't want to be back in the office five days a week. But when you become that wealthy and you have that level of, of access and resources and you have full time staffs that are like managing the rest of your life for you, it is so easy to lose touch with just the average person's experience of keeping the wheels on day to day and the average experience of like what it takes to work a 9 to 5 and have a family and commute and do all these things. And so it's really interesting to think about the fact that there's could be a statistically significant correlation between leaders who understand how to get people to buy in to an ownership culture and see the importance of it, and the ones who don't, even when given the same skills.
- [24:43]
Pete Stavros
Yeah, well, as I say, we got a lot more work to do. But yeah, there's these different components of empathy and we'll also be studying which are the most important. One of them is the ability to take someone else's perspective, which is what you're talking about. But part another one which I've also found to be anecdotally important is someone who just like catches other people's feelings easily. So CEOs who, they just feel it like when one of their people is hurting or if their people are struggling. So in the research we'll get into which of these matter the most and then how we can train for it. But I think the dynamic you're talking about I think is everywhere. In the old days when business was less global and smaller, your employees were in your community. They were your community, you know, so if you were a manufacturer making whatever garage doors, you walked into town and if you fired people or if you treated them poorly, like you had to wear that in town. Now corporate headquarters are in an urban area in some far off land in flyover country, as people refer to it today is like that's where the manufacturing plants are and real, where the real work is done. So I think that lack of connection I think is everywhere.
- [25:55]
Unknown
We'll get right back to it after a quick break. Here's a story my e commerce listeners in particular will appreciate. A company called Lux Weavers started off with just $200 in investments, a three person team and a dream to offer high quality textiles at price point. When they started selling on Walmart Marketplace, a few things happened. They tapped into a new network of customers, gained access to tools for scale, and received comprehensive technical support, all of which helped them grow 45% year over year. Today, Lux Weavers is projected to hit seven figures and is operating out of three warehouses across the country. This company's journey is amazing, but is just one of many success stories from sellers on Walmart Marketplace. Their solutions are clearly designed for growth. So if you've got goods to sell, head over to marketplace.walmart.commwk and see what you can achieve. That's marketplace.walmart.commWk Spring is in full swing and if you're anything like me, you are on a cleaning spree. But while you're organizing your closet and decluttering your kitchen, why not give your finances the same refresh? Chase Private Client connects you with a dedicated banker who helps you tidy up your financial goals and create a personalized roadmap tailored to your needs. Their bankers serve as skilled specialists that can help with tasks from money movement to account servicing, online assistance, and more. Plus, you'll gain access to exclusive events and experiences with financial industry experts. True clarity isn't just about a one time cleanup. It's about having a dedicated banking relationship that keeps everything in order as your life and seasons evolve. Ready to spring clean your finances? Learn more@chase.com Chase PrivateClient JPMorgan Chase bank and a member FDIC it seems like this has been something that's interested you forgot a long time. And maybe it's because you are just an empathetic person, or maybe it's because your upbringing was more average, more normal. But it came to my attention in my research for this episode that you wrote your business school thesis about this. So it's clear that you've been thinking about this for a long time. Why were you concerned about the role that ownership structures played in businesses even back then?
- [28:37]
Pete Stavros
Well, so employee ownership was something my dad actually talked about. So my dad was a construction worker, earned an hourly wage and had a really horrible relationship with his employer. Not just him, but his whole union. So it was just constant conflict and fighting. And in fact my dad, who just turned 86. Wow. And if you believe it or not, there's such a lack of available labor, my dad still occasionally works construction. He Operates a road grader. So every. I know it's crazy, but they can't find people. Which gets into this whole point about this is good for business and good for the economy. Like, if we don't get more people off the sidelines wanting to work, like, the economy's not going to work. So my dad, his complaints about the job were that of course, he couldn't build wealth on an hourly wage. That was a problem. But I would say maybe even more than that was there was no alignment. They were never on the same page. As an hourly worker, you always want more hours, and your employer is always trying to constrain your hours while getting the same amount of productivity. And so my dad, just growing up, would always talk about how screwed up this was. Why do we have half of America earning an hourly wage? Wouldn't it make more sense for people to, if not be salaried, have ownership or profit sharing or some reason to care? Because if you don't, an hourly worker is going to do everything that they can to not have their hours go down because their paycheck's going to go down. So there's like a. There's an incentive to not be productive. That was growing up a lot about this idea at a high level. And then I wandered into investing. I didn't even want to go to Wall Street. It was the only job I got was in an investment bank coming out of college because I was a chemistry major. And then at the last minute, decided I'd spent a lot of time in the lab and didn't like it. I got to go get a business job. And I only got one job offer, which was at a firm called Salomon Brothers, which is not around anymore. And so at Salomon Brothers, when I was all of a year into it, the guy who ran the mergers department where I worked said, hey, you should go work at an investment firm. I know these people. They started a firm in the 80s. They're looking for their first ever analyst class. This was in the mid-90s, and why don't you go interview with them? And I did, and I got a job. And that was kind of how I got into that was a private equity firm. So the two first projects that I worked on, One was an esop. So there was a company in Rochester, New York, called Gleason Corporation that made machine tools. And it was an old esop. And so I had never heard of an esop. And this was before I went back to business school. And this really ignited my interest in ESOPs. Which is why I published that paper almost 25 years ago on this idea. At Gleason Corporation, frontline factory workers, executive assistants had million dollar stock accounts, people who had been there for much of their career. And so I had never seen anything like that. And I was totally fascinated by it. The other early project they had me work on was they were selling a company that made semiconductor equipment. It was a company called Clark Schwebel, and they were selling the business. So when you sell a company, you have to have a young person like me at the time basically oversee all the wire transfers. So like a company gets sold for $500 million, it pays off its remaining obligations, and then whatever's left gets sent out to all the owners. And a bunch of the owners were employees. I was confirming these wire transfers for this sale. And I'll never forget just the dynamic of more senior folks who were making a lot of money, not being that, let's say, emotionally moved by the whole thing. And when you got down to mid level folks. So there was like an assistant treasurer, as I recall, who was getting a fraction of what the CEO was getting, but was so emotionally moved. I mean, he'd literally lost the ability to speak on the phone and had to leave a voicemail afterwards about how much it meant to his life. This meant college for his kids. I mean, it was really, really meaningful. So in that moment, it's like, geez, what if everybody owned? How big of a impact could it have? And then how much could it do for the company? This guy on the phone was like, I never thought I'd work for such a great company. It was just such a big deal. So those were a couple of things along the way before business school that then led me, you know, in business school it's an opportunity to explore your interests. And that was mine. So I grabbed the finance professor I had and asked if I could go spend my second year really studying this. And that's what I did.
- [33:16]
Unknown
It's interesting. Hearing you talk about that and tell that story kind of calls to mind for me. I started my career at Southwest Airlines sort of toward the tail end of Southwest's golden years, I guess you could say. And it's been really, really sad now to watch activist investors get inside that company and change the way that it's run. I think I was very spoiled working there because it was a huge corporation, but the culture was amazing. And part of it was because the founder had so believed in this idea that employees should come first, customers should come second, and your Shareholders should come third. And it really set the tone in that business. There was profit sharing there, there was stuff like that. But it was also just a sense that like, not only are we in this together, but this company is really here for us and really cares about the customers. And there was a level of buy in, I think that in the other large corporations I've worked in the year since, it just, it wasn't there. And so I was kind of surprised then later on that like, oh, everywhere isn't like this. And so I sit back and I think there is a bit of an irony here because a lot of the contradictory or conflicting incentives, these tensions inherent in these arrangements are in many ways typical to capitalism from the standpoint of like, capital and labor are always kind of in tension with one another. And you work for a private equity firm, which is like capital, Right. And I'm sure I'm not telling you anything that you don't know. The American public does not, not like, feel super favorably about, about the industry of private equity at this point. And so I think that there is an interesting question to ask here that fans of what you're doing and fans of this kind of mission that you're on say, like, hey, this is a realistic way to create wealth for rank and file workers that they would not be able to build on their paychecks alone. But then critics look at this and say, well, any positive effects that you can get from doing this and throwing a little equity at these workers is going to pale in comparison to the jobs that are going to be lost as the dynamics of private equity unfold further in our economy. And I'm curious what you make of that critique, if you think that that's fair and how that lands with you.
- [35:47]
Pete Stavros
From the position that you're in with private equity. The opportunity that I see is a PE firm is responsible for so many companies and so many workers that scaling something is much easier with that type of decision making and governance. So in other words, if I can convince a private equity firm to join this effort and do employee ownership, that might be 500,000 workers and it might be one person who can make that decision as opposed to going. And I've done this as well, but going to individual CEOs, when I spent time with Harley Davidson, working with them on worker ownership with their union, that took a lot of time. We might have been at that for a year and it was 4,000 people, which is great. I don't mean to diminish it, but in less time you might be able to impact the half a million people on the PE critiques. I'm sure that there's been some mistakes. I'm sure there's some bad actors. I wouldn't be in the industry if I thought what the New York Times likes to run sometimes were true of like, yeah, these firms just buy a company, strip it to the bones and then sell the pieces. That's not realistic. It just would never work either. Like the idea that you come in and just gut a company, well, then it's not worth anything. Who's going to pay you for it? Really, the only way to build value over time is to make the company better. I'll give you an example that we always get criticized for is Toys R Us. You know, we invested in Toys R Us with a real estate firm and another investment firm and the company went bankrupt. And over the period of time we made the mistake of trying to save it. So Amazon was starting to kill the toy industry. Amazon and Walmart had both decided it was going to be a loss leader for them, the toy category. And basically over the time period that we owned it, every toy company went bankrupt. And if you look at the destruction of retail and you look at Sears and JCPenney and Kmart and Bed Bath and Beyond and Brooks Brothers, there's just like this litany of companies that have gone bankruptcy. But we did it for all the other ones. No one talks about who are the shareholders and like, what happened. It's just, oh well, Amazon killed it. So as I say, there starts to build this narrative that I think is not. I just don't think is true. Not to say there haven't been mistakes made, but I think the broader story is just overdone.
- [38:07]
Unknown
It is probably true that private equity bears what I'll call maybe a disproportionate level of angst when there are other factors in a capitalist economy that are probably just as much to blame. But it does feel like there is something specific about the PE model that enables a firm to through debt financing, through the fees, through these other mechanisms to make money even if the business is not doing well. Do you think that that's an unfair assessment?
- [38:45]
Pete Stavros
I do. I mean, the vast majority of the way a PE firm gets paid is incentive fees based on the profits of the business. So again, aren't like a bunch of saints in the private equity industry? I'm not trying to say that, but if everything was written was true, we wouldn't have. We have like way more demand for our style of investing than we have Room for, like, our. The last two funds we've raised in the US were, like, massively oversubscribed. A huge source of our money is labor pension money. So it's just like state pension boards would not be investing billions of dollars with us. If we were turning around and our whole model was to fire workers. We wouldn't have CEOs lining up to work with us. It's just not reality.
- [39:28]
Unknown
Okay. I do think the pension element is an interesting wrinkle that so many pension funds are invested with PE firms. And there is, again, to me, my whole thing is like, be hard on systems, not people, right? There aren't, like, evil individual actors that are going around trying to make the world worse. But ultimately, incentives structures will, over time, shape outcomes. And I think PE is sometimes an easy one to pick on because I think that there are some very public examples of things going very poorly. But. But it's interesting to get to talk to somebody like you because from everything that I've learned about you, from every interview I've heard you do, the little bit that we've gotten to talk, you strike me as extremely sincere in your belief and in your desire to build worker ownership. And I think when I've heard you talk about things like the Great Risk Shift, for example, by Jacob Hacker, this book that outlines the way in which American corporations used to kind of operate like, their own welfare states. And like, where other countries like, like a Denmark might have an actual Welfare State. The U.S. used to have these, like, big corporations that would really take care of its people, but that over the last generation, there's been this big shift from the broad shoulders of government individuals. You fascinate me because you are a. A private equity guy who's talking to cbs, talking about how the social contract is broken. So I want to understand to you what that means. What does it mean that the social contract is broken? Like, diagnose this for us.
- [41:06]
Pete Stavros
To me, it means that I think the contract was, if you work hard and play by the rules, you can have a good life, meaning you can own a home, you can have a dignified retirement, your kids can get a good education. And all of that's just not the case anymore. So Jacob Packer talks about how we've gone from. And it wasn't always relying on the big shoulders of government. It was. A lot of it was your employer. So your employment was relatively consistent. So there was loyalty. There's another great book called the End of Loyalty. My dad stayed at his job for 45 years, and he Even like his employer. But that was just the way it was. You stayed for your career. You got a defined benefit pension plan, which my dad has. You have gold plated health care, meaning you don't have these crazy high deductible plans where you're out of pocket for thousands of dollars before you get any protection. That's where we are. We've gone from lifetime employment, great healthcare, defined benefit pension plan, to bare bones healthcare plan, if you even have healthcare, defined contribution plan. So you're on your own and you're an at risk employee. You know, we'll see how it goes. So that's what Hacker's talking about. On top of that you have asset prices have exploded while wages have not. So people talk about real wage growth, which has been a problem, but real wage growth relative to asset prices is an even bigger problem. So my parents bought our house, I think was maybe 80 or $90,000. That house has probably gone up fivefold and wages have not done that. College tuition to a great private school used to be like 15,000 a year when I was a kid and now it's 100. So asset price, and look at what's gone to the stock market relative to wages, cost of education. That's what I mean. It's just the whole thing seems broken.
- [42:55]
Unknown
I think a simple way to describe what's happened is that if you are somebody who's earning millions and millions of dollars a year, if you are a very highly paid employee or owner of a business, the tippy top, you can't spend all of that money. You're going to spend a small fraction of it. And what are you going to do with the rest? Well, you're going to use it to buy assets. And so it becomes really, really clear how without intervention, without some sort of backstop or mechanism that can prevent that cycle from continuing, it will only ever get worse. That's not going to correct itself on its own. And when I think about realistic solutions, I think the first thing that I jump to is a wealth tax. I don't know how you implement a wealth tax, but I think that that's necessary. But the second thing is you have to find a way for regular people through their labor to build equity in something. And this seems like an interesting way to do it. And again, it's, anything that makes this more mainstream to me is a good thing. I have a feeling that I have a more radical approach than you do. But I do think that like anything that puts that on the map and gets it in people's heads. I'm like, well, hey, if a guy at KKR really high up, wants to take this on and wants to make this his thing, and if he has all this control and all this power and all this influence, that's a great thing. And I'm curious as you are moving forward, and I can see how this would be something where you're walking a fine line because you're in business. So you have to sell people on the idea that this is going to be good for the bottom line, this is going to be good for business. But for you, is worker ownership more of an ethical question?
- [44:52]
Pete Stavros
We talk about it either internally or at ownership works that nonprofit. We talk about it as the right thing to do. That also happens to be good business. And the reason we order it that way gets back to that example of, hey, there's two companies, same industry, very similar businesses. We give ownership programs and the same tools to both. And one, great things happen culturally and financially, and the other one, culturally, things kind of go sideways. The leader who starts with that orientation of like, I'm just doing this because I want to lift up my people is the one who changes the culture, the one who says, if I turn some dials, how much more productivity can I get? I mean, the world is so lacking in authentic leadership and genuineness. I mean, people will smell that a mile away and it just doesn't work. So if it doesn't come from that genuine intention of I want to help the leader of the company just won't have any success with it. So I don't know if I would say it's an ethical thing because it makes it sound like I think my ethics are higher than someone else's. But. But I do think it's the right thing to do. Everyone should participate. And if it comes from that place in someone's heart and not like, I could grind a little more out of this company if I do this, then they end up getting all the results come their way anyway, even though that's not really their intention. And so we'd see their engagement scores spike and the quit rates drop. And that's when the culture shifts and great things happen.
- [46:18]
Unknown
How are decisions made about how the equity is distributed? Like, how is that decision made of, like, how much are the workers going to get versus the investors versus the how does that happen?
- [46:30]
Pete Stavros
So we do a bottoms up build where we will take a payroll run. So let's say a company has 10,000 people. There'll be a big Excel file with everyone's income and we'll say if we wanted to show folks a path to make 100% of their income over let's say five years, what's that dollar amount? And then we have our projections of what the growth and equity value should be. So it allows us to back into in five years. How much do people need to own to get to that? A hundred percent, if I'm making sense. So it's very much a bottoms up build.
- [47:01]
Unknown
Okay, so it's based on the wages that they're already being paid.
- [47:05]
Pete Stavros
That's right.
- [47:05]
Unknown
That's kind of the original foundation for the equation.
- [47:09]
Pete Stavros
Well, to be honest, we would be looking out five years on what their wages would be in five years. So you can inflate their wages five years forward. And then you'd say how much equity would we need to get people to be able to show them 100% of their income in five years?
- [47:24]
Unknown
It's interesting when you talk about incentives too and the importance of understanding like what this really means, because to your point, I'm sure most people in the moment, particularly if you're not a very highly paid person and like if things are already a little tight for you, you would almost certainly prefer the 20% wage increase up front or the one time cash bonus. But as I was reflecting on how the communication of the value of this over time is so critical to implementation, there's something sort of similar in the personal finance world with helping people understand even just basic compounding and how investing in an index fund for 15 years is like very boring. But at the end of the 15 or 20 years you're like, oh, I'm really happy I did that because now I have a huge amount of money. But it kind of defies intuition. It's not immediately tangible necessarily how valuable that's going to be. But it is interesting in this respect because the PE timelines tend to be a lot more abbreviated than like 20 or 30 year investing timeline. You have a closer in chance of getting a payout. Part of it is just the fact that like our economic system for the average person really forces you to think in bi weekly paycheck increments.
- [48:53]
Pete Stavros
Yeah, expanding ESOPs. What we are trying to do is open up that law from 51 years ago, 1974 and make ESOPs easier to form. The goal would be like every company's got an esop, but we would also like to see workers getting some access to some of the money sooner. So if you're a 25 year old factory floor employee and the company's an ESOP and you can't access any of it till you're 62 years old. It's nice that it's there, but it's not that tangible to your point and you have problems. Now. It would be nice if people could access some of the ESOP money sooner. The other reason to do that is our economy has become so competitive and things are changing so quickly with technology. I'm not sure it's a good idea for an individual to be in an ESOP and to hold onto that stock for 35 years. Like not that many companies are going to survive in 35 year increments. Everything's going to change, as we know over time with AI and there's going to be probably mind blowing technologies in the next 35 years. So allowing people to diversify much earlier I think would be better for esop. So that's. There are other things we're looking to change with the law. That'd be one of them.
- [50:06]
Unknown
In a traditional ESOP is the company 100% employee owned.
- [50:11]
Pete Stavros
So when Congress passed the original law 51 years ago, no, that was not the idea. The idea was that workers would own a piece of, of everything. Like there's no company that couldn't be an ESOP and there'd be a portion that was set aside for workers.
- [50:25]
Unknown
Okay.
- [50:25]
Pete Stavros
In the 90s there was a change to the tax code that allowed for this, this quite complicated 100% model where if a family owns a business, they can convert it to an ESOP that's 100% worker owned. Now one of the questions I often get when I'm explaining this to people is they say, well, how could that be? Because we all know in today's economy workers don't have any money, so how are they buying 100% of the company from the family? And there's a lot of financial engineering that goes into it, but the family gets paid in two ways for their company. One, a loan gets taken out against the company, just like a leverage buyout. Oh, and then for the rest of the purchase price, the family takes an iou, effectively like a note. They will be paid in the future with that note actually often gets attached ownership because again, if the workers are going to own all of it, it's not feasible because they don't have the money to buy it. So the family takes back this seller note that has not only an interest rate attached to it, but some warrants some equity. And so at the outset of the formation of any kind of ESOP, it's really almost never 100% worker ownership. But if the workers can pay off the bank debt and then pay off the seller note over time, 20 years out, they could become 100% owners. That's possible. And that has happened a number of times.
- [51:44]
Unknown
All of these kind of different ways of structuring it. I was reading about worker co ops as well, and that sounded sort of similar from the standpoint of the workers have to buy their shares. It's not just given to them. But my understanding of the way that ESOPs work today is that the shares are just given to employees and almost like vest over time. Is that not true?
- [52:12]
Pete Stavros
In my mind it is true.
- [52:14]
Unknown
Okay.
- [52:14]
Pete Stavros
It's not how the government looks at it. An economist would say that there's no free lunch. So if workers are given ESOP stock, they're giving something.
- [52:24]
Unknown
Oh, they're being paid less.
- [52:25]
Pete Stavros
Being paid less. Less. 401k match. No 401k. Whatever. There's something they're giving up. Yeah. That's not been my experience. I've not seen ESOPs effectively charging workers by taking other things away, in part because it wouldn't work. Back to the point about workers saying, I'm not going to give up wages or benefits for something 35 years from now. But that's not how the government looks at it. So they do look at it, which is why there's been a lot of litigation where the government has come in and said, hey, wait a minute. The price at which workers are being granted stock is unfair. We need to look closely at the valuation because in our mind, it's a part of their overall compensation package. And we need to be sure that when the family's getting the tax benefits associated with converting to an ESOP, that the workers are getting granted shares at a fair value. It's a whole mess. And this is one of the things we're trying to fix. Hmm.
- [53:15]
Unknown
Okay. Interesting. Something that occurred to me throughout this conversation was, and particularly when you mentioned a company that's around today may not be around 35 years from now. You don't want to hit your wagon to. That's like a lot of concentration risk for the average person. And it's why we generally advise people against buying a bunch of company stock even if they have like an ESPP where they can get a discount. We usually say like, well, you want to diversify because you don't want your source of income and your investments to be wrapped up in the same thing in case something happens to it. There's some famous examples, like an enron where people whose entire retirements were an Enron stock lost everything. And that also feels kind of like a challenge for, I'll say, like the average person who may not have a lot of extra money left over from their wages to be investing in other things. Diversifying a portfolio to where, yes, asset ownership brings upside, but it also brings risk and it also brings the chance that if you just own one thing, that that one thing could eventually become worthless. And I don't know what we do about that. I don't know if that's just kind of the nature of the beast, if that's like, you gotta take the bad with the good, or if that's something that you guys have thought about differently.
- [54:48]
Pete Stavros
I think that's why ownership, whether it's in an ESOP or in our model that we do outside of the ESOP construct, it's gotta be free and incremental. So if it's free and they're not trading off wages or benefits or 401k or anything else, they're not worse off. Yes, it's a concentrated bet on their own employer. But then if you also give them diversification rights sooner. So in a private equity context, 5, 6, 7 years, and then with changes we want to make to the ESOP laws, similarly, they would be able to always sell some percentage of their vested equity, so they're not waiting decades. I think if you do those two things, free and incremental, and give people diversification rights much earlier than they have today in an ESOP model, as an example, then I think it's fine and it gives the company the potential to change their culture. Because I've had people say, why don't you guys give stock to employees, but have it be a diversified basket of holdings, like maybe all of your portfolio. Like, if you guys own 200 companies, they get a slice of everything. It removes all of the benefits of the potential culture shift, where you're trying to get people to understand the business, care about the business, understand the financials, understand how they can contribute to the company's goals. Like, you're losing all of that. So, as I say, if it's free and incremental and they can diversify, I think it's fine.
- [56:12]
Unknown
That makes sense. At first I was like, oh, yeah, that's really smart. But you're right, the entire intention of think like an owner, be an owner, have equity. You see, the value of what you get is based on the work that you're doing. That it does dilute that. Well, thank you so much. For joining me.
- [56:28]
Pete Stavros
I appreciate your interest and your enthusiasm for employee ownership.
- [56:38]
Unknown
That is all for this week and we will see you next week right here on the Money with Katie Show. Our show is a production of Morning Brew and is produced by Henna Velez and me, Katy Gaddytasan with audio engineering and sound design from Nick Torres. Devin Emery is president of Morning Brew. Content and additional fact checking comes from Scott Wilson.