ESOPS: Financial performance and federal tax incentives

Previous research has suggested a relationship between the establishment of employee stock ownership plans (ESOPs) and post-adoption improvements in financial performance — presumably as a result of the alignment of employee and stockholder interests. I examine the role of tax incentives on the financial performance of ESOP firms. The results indicate that ESOPs formed prior to the availability of tax incentives provided by the Tax Reform Act of 1986 have experienced significantly greater improvement in financial performance than ESOPs established after passage of the Act. The results are consistent with my hypothesis and suggest that even though ESOPs can be utilized to reduce a firm's federal income tax liability, ESOPs may be more useful to management to reduce agency costs throughout the firm.