The mineral resources minister recently gazetted an amended Mining Charter, which generated a good deal of controversy. Although the revised charter retains the principal target of achieving 26% ownership of mining companies by historically disadvantaged South Africans, it adds the requirement of retaining this level continuously. A further amendment stipulates that workers, through the establishment of employee share ownership plans (Esops), are to be allocated a minimum stake of 5% that counts towards the 26% total black economic empowerment (BEE) equity.
This marks a significant departure from previous versions of the charter that imposed no specific obligations on companies to include Esops in BEE transactions. The public narrative has been critical of BEE for disproportionately benefiting a small elite, despite the ostensible shift towards broad-based BEE. The insistence on Esops seems to be a direct response to this concern, and thus represents a step towards more broad-based reforms in conventional empowerment models.
At the core of Esops is the idea that workers ought to own a stake in the company they work for. In theory, the distribution of equity to workers through Esops should align employees’ interests with those of employers and shareholders. By allotting a stake to staff, Esops allow employees to share in the company’s growth by deriving benefits flowing from (share) capital appreciation. This should encourage improved productivity as workers seek to maximise returns on their equity investment.
To date, the most successful example is the Kumba Iron Ore Envision Esop that transferred about 3% of Kumba’s equity to more than 6,000 non-management employees in 2006. Five years later, on the back of increased production and high share prices, the Esop yielded R2.6bn to its beneficiaries, who each received more than R500,000 in pre-tax dividend payouts.
In another instance, more than 9,600 below-management employees of Exxaro each received dividends of R135,000 at the end of the five-year vesting period in 2011.
Unfortunately, the successes of the likes of Kumba, Exxaro and Sasol belie a more discouraging pattern of underperforming Esops. In the context of stagnant and volatile global demand for raw materials, mining companies’ share performance is especially susceptible to fluctuations in commodity prices and political risk perceptions. The problem lies with the debt-based equity-funding model underpinning most Esops. In these transactions, low-interest debt is used to purchase the Esop’s stake in the company. This means the Esop equity structure consists of a combination of unencumbered (free) and encumbered (loan) shares.
Often, the loan shares constitute the largest proportion of equity held in Esop trusts and the loan is expected to be repaid from dividend returns. Although no capital injection is required from beneficiaries, the compromise is that they can derive the full value of share ownership only once the debt tied to encumbered shares is fully repaid. The risk lies in the fact that Esops depend 'on rising commodity prices to result in value-creation for beneficiaries', as the Chamber of Mines concedes.
The majority of Esop deals in the mining industry were structured during the commodity boom of the early 2000s, with companies expecting the value of their shares to appreciate enough for dividend income returns to settle the debt commitments. The best-performing Esops tended to be those whose shares matured during the commodity boom that peaked in 2011, while the subsequent slump in commodity prices eroded the market value of many listed mining companies. This severely undermined Esops’ ability to generate substantive economic value for their beneficiaries as debt on the loan shares was still outstanding. The result, in many cases, was that Esop shareholders did not receive any dividends.
If Esops are to be pursued as a viable model of worker-empowerment, the schemes will need to ensure a sustainable and less risky means of generating monetary benefits for workers. To this end, the incorporation of a profit-sharing component into the Esop’s structure could provide another source of additional income for eligible beneficiaries. It could also be deployed as an instrument of redistribution.
The key difference between a profit-sharing model and a typical Esop is that the former provides a direct stake in the profits, while the latter relies on stock ownership. Whereas beneficiaries of an Esop may earn income only when dividends are declared or through the sale of their shares (depending on capital appreciation), a profit-sharing scheme may distribute profits without having to declare dividends.
The fact that many companies generate profits even during depressed conditions suggests that a stake in profits would secure (potential) income that would be less susceptible to equity market volatility. This would mitigate the pernicious effects of an undiversified Esop portfolio since profits are affected by a wider variety of factors (for instance, the weak rand has boosted revenue for mining firms selling in dollars).
Profit-sharing would not be a novel addition to the mining industry. In 1995, Nicoli Nattrass’s study of the mining crisis in the gold sector revealed the possible advantages and challenges of profit-sharing deals. Her paper evaluated two profit-sharing arrangements struck between the National Union of Mineworkers (NUM) and the chamber in 1992 and 1993. The NUM accepted below-inflation wage increases in return for a share of the profit pool. By workers taking real wage cuts, expenses were limited and job losses minimised. Workers could claim 5c-20c of every rand of profit generated.
However, administering the agreements proved difficult. Profit agreements varied at individual mine level and this proved to be a contentious issue for NUM members.
Although past experiences of Esops and profit-sharing deals may have produced mixed results for workers, with the correct restructuring that is sensitive to market volatility and debt levels, these models could prove effective channels for worker empowerment and enhancing labour relations.
Written by Kwezi Sogoni, a Konrad Adenauer Stiftung visiting scholar with the South African Institute of International Affairs’ resource governance programme. He is completing his MPhil studies at the University of Cape Town. This article was first published in the Business Day.