Crafting an executive stock purchase program.

• Author: JURGENSEN, W. G.

Why ESP programs are seen as effective and attractive by shareholders, directors, and senior management alike, and what makes a company a good candidate for such a program.

FOR YEARS, Corporate America has tried various approaches designed to give board members, executives, and managers the incentive to perform like owners of the corporation. Unfortunately, the most common approaches -- various forms of issuing stock options -- too often do not result in directors and management teams that consistently meet this objective. And, most of these approaches either require the company to make repeated share repurchases or dilute shareholder interests.

One approach that is finding favor among boards of directors, shareholders, and chief executives is the Executive Stock Purchase (ESP) program. Under an ESP program, the vast majority of a company's management team -- and sometimes the directors -- band together to purchase 1% to 10% of a company's stock at full market price. The entire stock purchase is financed, typically by a third-party lender. The debt is structured so that managers do not need to make out-of-pocket cash payments during the life of the ESP program.

These programs are becoming popular with managers and directors, as evidenced by their very high participation rates. Over 70% of the managers offered a Bank One-structured ESP typically elect to participate.

Managers and directors are willing to participate in a program that allows them to enjoy unlimited upside return, gives them a chance to increase their personal net worth in an outsized proportion to their annual income, and puts them on a team with a very visible common goal. ESPs are also popular with shareholders because managers and directors who participate in ESPs consistently make investor-friendly strategic decisions.

Keys to ESP structure

There are two keys to the ESP program structure. First, the stock is not "gifted" to managers or directors. Managers and directors pay market price for the stock they purchase. Secondly, they personally shoulder the responsibility of repaying the financing. Unlike many management stock purchase programs, ESPs contain no provisions for financing forgiveness: Participants in the ESP program are subject to loss if the stock price falls.

Baxter International Inc. pioneered the ESP concept in 1994 with Banc One Capital Markets' predecessor company, First Chicago Capital Markets Inc. Baxter's board of directors, shareholders, and management...