Samuel Zell, the Chicago Tribune, and the Emergence of the S ESOP: Understanding the Tax Advantages and Disadvantages of S ESOPs

Abstract:     
Samuel Zell's acquisition of the Chicago Tribune Company (the Tribune) in December 2007 using a little-known type of Employee Stock Ownership Plan (ESOP) made headlines. In a complicated transaction, which took nearly a year to complete, the Tribune converted from a subchapter C corporation to a subchapter S corporation, established an ESOP that purchased 100 percent of the company's equity, and sold Zell a call option giving him the right to purchase 40 percent of the company's equity. Press reports claim that Zell's novel structure enabled Zell to outbid other suitors. And financial commentators predict that many acquirers will employ that same structure as soon as acquisition activity picks up. Zell's Tribune transaction also caught the eye of legislators, including Congressman Charles Rangel, who introduced a bill that would increase the tax on indirect claims - such as the one owned by Zell - on the equity of an S corporation held by an ESOP (synthetic equity).

Although ESOPs are more than 30 years old, until 1998, an S corporation could not sponsor an ESOP. Over the last ten years, so-called S ESOPs have grown rapidly, but largely outside of public view. The Tribune transaction has focused a bright light on S ESOPs and there are some who believe that their current tax treatment is too favorable. Yet, there has been little in-depth analysis of the tax treatment of S ESOPs. Accordingly, this paper attempts to fill that gap by presenting a systematic economic evaluation of the tax consequences of using an S ESOP. It seeks to describe both qualitatively and quantitatively the tax advantages and disadvantages of using an S ESOP (with or without synthetic equity) relative to alternative available structures. This paper also estimates by how much the S ESOP structure likely allowed Zell to increase his bid for the Tribune.

Keywords: Employee ownership, Employee stock ownership plans, ESOPs, S corporations, mergers and acquisitions, Samuel Zell, Chicago Tribune, valuation, taxation, synthetic equity, Charles Rangel

JEL Classifications: G34, H25, K22, K34

Working Paper Series