Not All Equity Owners Will Act Like Owners: 3 Pathways To Create Psychological Ownership

When I was a kid in communist Bulgaria, my father had a small plot of land where he grew a tiny vineyard. The plot – one of a dozen such privately owned plots – was on the south side of a hill, mostly occupied by a very large, state-owned vineyard. One summer, torrential rain carved massive gullies through the hill (despite all the terracing) and brought most of the exposed topsoil to the bottom of the slope and against any obstacle such as fences or cars that stood in the way. The damage was so bad that the state-owned winery abandoned the vineyard for several years until finally bulldozers took out all the vines and reshaped the hill.

The private owners of the small plots, using nothing but shovels and buckets (as no equipment was allowed to be privately owned), spent that very same summer weekend after the rain carrying thousands of cubic feet of topsoil back to their plots. One bucket at a time, they literally moved a hill. The private plots were restored within two weeks of the disaster.

There is a special power in ownership. We develop a strong attachment to the things we own. Indeed, they often become part of our identity and an extension of ourselves. Because of this connection, we are willing to devote an extraordinary amount of time and effort when we are owners. To continue the metaphor, we are willing to move mountains. If this were a daunting job or project in which we had less of a vested interest, we would (with good reason!) be more likely to just give up and say, “This is too much!”

So when we talk about how best to distribute ownership in an advisory firm, perhaps the answer is simple. Give everyone some shares and they will all grab a bucket, right? Unfortunately, in my experience, ownership doesn’t work like that. Just telling someone that they are now an owner does not cause them to feel like one. Instead, creating a sense of “psychological ownership” when it comes to advisory firm owners is more complex and comes with some critical preconditions:

1. A history of contributing significant amounts of energy, time, and effort to the firm;
2. A strong sense of identity derived from belonging to the firm and its vision and mission; and
3. A sense of knowledge and control of the firm.

Team members who meet these three preconditions are likely to feel and behave like owners, whether they have any shares or not. Historically, these are also the individuals who are most likely to be offered the opportunity to buy shares in the firm.

Ownership Creates A Special Attachment

The desire to own “things” is very much a part of human nature, and a powerful part at that. Psychologists have discovered that we start claiming ownership of objects as early as the age of two. According to Christian Jarrett of The Psychologist (the official monthly publication of The British Psychological Society), we start experiencing what is known as the “endowment effect” by the age of six, placing greater value on objects we own (or those that we have owned in the past or helped to create), in comparison to the lower value we associate with the same types of objects that we don’t own.

The endowment effect of valuing items that we own more than the same items that we don’t own is well documented and supported by field research. For example, in an experiment conducted by the Nobel Prize-winning psychologist and economist Daniel Kahneman, subjects were divided into two groups: buyers and sellers. Sellers were given a coffee mug and asked to consider either selling it for a negotiated price or keeping it. Buyers were given money and asked to consider either purchasing the mug or keeping the cash. The asking price of the mug owners turned out to be twice as high as buyers were willing to pay.

By the time we become adults, we are not only the owners of many things, but ownership of those things actually becomes part of our sense of identity. In her article, “The Liminal Experience: Loss of Extended Self After the Fire”, author and Professor of Communication Studies Karen Lollar describes her experience losing her home in a fire through this powerful quote:

The house is not merely a possession or a structure of unfeeling walls. It is an extension of my physical body and my sense of self that reflects who I was, am, and want to be.

For Lollar, the trauma of losing the house went beyond mere monetary loss. Instead, it was akin to losing a part of herself. Likewise, for many business owners, their businesses represent much more than an abstract claim to some profits and value. Rather, their business is an integral part of their identity. Which is why those small vineyard owners grabbed the buckets and got to work. The urge to save the land was as natural as the urge to save a part of their own bodies. This is also why founders of firms often have trouble sharing ownership. For them, sharing their business is like sharing a piece of themselves.

The rules of ownership are also interesting. In his article, “The Psychology of Stuff and Things”, Jarrett points out that young children gravitate toward the “finders keepers” rule, where whoever finds an object first gets to own it. Similarly, adults recognize their own set of ownership rules, although perhaps a bit more complex than the one based on the “finders keepers” principle, where a history of possession also comes into play.

Very importantly, we consider creators to be owners, as illustrated in experiments conducted by researchers James Beggan and Ellen Brown, who published their work in 1994 in the Journal of Psychology. In their paper, the authors describe an experiment in which subjects were told a story about a boy who found a stick, left it unattended, and then came back later to find another boy playing with the stick and claiming ownership. When asked to judge who owned the stick, most subjects argued in favor of the second boy who made the claim of ownership. However, when the story changed and the first boy carved a little boat out of the stick before leaving it unattended, the ‘jurors’ came to the opposite conclusion, arguing that the creator of the boat was the rightful owner. In other words, the act of creation implies ownership.

Psychological Ownership Vs Actual Ownership

Ownership is not only a physical and legal reality; there is also a psychological dimension as well. Much has been written in the field of organizational psychology (and marketing research) about psychological versus legal ownership. The notion of ownership is very psychologically appealing and powerful. We often enjoy the sense of having ownership of things such as an organization, idea, brand, or object when certain conditions are in place, even in the absence of legal ownership. Having a sense of ownership can also help us shape our own identities; the things we become attached to can offer us a simple way to define or express who we are.

This is the reason employees may behave like owners even when they don’t own a single share of the business, and why people may feel an ownership-like attachment to a brand. The phenomenon of psychological ownership gives rise to ideas about empowering employees to feel and act like owners – because when someone feels like they actually own a part of the business, they become more vested in taking care of the business and ensuring its success. This is also why many brands seek to create ‘raving fans’ who will act like owners and proselytize their products.

The outdoor gear company REI serves as a good example of both. REI customers are actually co-op owners in the business, and many have an undying love and loyalty to the brand.

Three Pathways That Lead To A Sense Of Psychological Ownership

Finnish management scientist Antti Talonen proposed a three-path framework of psychological ownership in 2018, which presents clear findings about what leads individuals to reach a psychological sense that an object belongs to them.

1. Path One: Controlling something for an extended period. Think about that vacation house you rented for two weeks in the Cape ten years ago. Didn’t it start to feel like ‘yours’ toward the end of your stay? Better yet, think about a situation where you rent the same house every summer. You are likely going to start calling it “our summer house,” even though the deed is not in your name.
2. Path Two: Generating intimate knowledge of something. Let’s say you have a favorite mountain that you have hiked many times. You have become intimately familiar with its secrets while walking its various trails. You recognize specific trees and know all the creeks where you can fill up your water bottle. You have a mental map of where all the best camping spots are tucked away. It is “your mountain.”
3. Path Three: Investing personal resources or effort. There are two trees on my street that my son and I planted during a neighborhood event years ago. I remember very well which trees those are. I feel a special connection to them, even though it took all of one afternoon with a shovel in hand to plant them. (For some reason, a lot of my stories involve a shovel.) Those are “our trees.”

This three-pathway framework can also be directly applied to an advisory firm. If we give our team a sense of control (Path One), if we let them fully immerse themselves in the running of the business and share every detail of it with them (Path Two), or if we let them invest their personal time and effort (Path Three), they will start to feel like owners.

Realistically, we are likely to see a more limited scope of psychological ownership, where team members tend to associate ownership more commonly with only certain aspects of the overall firm. For example, the Salesforce expert in the office may feel psychological ownership over that software system. The person who controls the firm’s social media accounts may feel ownership over those marketing channels. The team member who spent many hours remodeling the lunchroom may feel ownership over that space. Fostering a sense of ownership over the entire firm in each of our team members, though, is a more difficult endeavor and may never materialize.

Why We Fail To Feel Like Owners, Even When We Are

Researcher Antti Talonen, who proposed the three pathways to psychological ownership discussed earlier, has also studied co-op businesses like REI who try to give their customers a sense of ownership in the brand in an effort to create more brand loyalty. He is particularly interested in why, sometimes, despite all the best efforts of the brand, this sense of ownership does not materialize.

In interviews with hundreds of different co-op customers, Talonen attempted to answer the question of why psychological ownership does not always become a reality, despite customers participating in a structure of shared ownership, and identified four primary reasons.

Lack Of Sense Of Control

While customers are technically owners in the co-op, they often fail to develop a sense of psychological ownership because they see no method or forum to express their voices and influence decision-making. Furthermore, they can’t find any record of their voices or similar voices being heard and influencing decision-making.

I often observe this same trend in large partnership groups. Partners can feel that the distance between them and the executives running the firm has grown so large that their voices are no longer heard.

Lack Of Intimate Knowledge

When customers are not very clear on how the co-op runs or how decisions are made, they are less likely to develop the emotional attachment the company desires. Similarly, when team members have little knowledge of the strategy of their advisory firm, they will have a hard time feeling a close connection to it.

Employees who are caught by surprise when they overhear that the firm just made an acquisition or just sold 30 percent of shares to an institution are not going to feel any strong sense of psychological ownership in the firm.

Inability To Identify With The Organization

Not everyone is going to wear the company T-shirt with the same sense of pride and belonging. For some team members, the job is only a job and always will be. It is simply the place they go to generate the income they need to meet the needs of their family and do the things they really enjoy doing.

Indeed, it is unrealistic to expect everyone to have the same passion for the organizational mission. Some advisory firm team members may have spent years studying and passing exams to become advisors and deliberately chose that career path. On the other hand, some team members may not have invested nearly as much time and effort into their career paths and simply joined the company by answering an online ad.

As another example, I met some people in Whistler, British Columbia, who worked as drivers and security guards for the 2010 winter Olympics. When I asked them about the winter games, let’s just say their view of the events differed from those of the athletes who had spent at least the previous four years training to qualify for the elite competition.

Lack Of Investment Of Self Or Disappointing Results In The Investment Of Self

When it comes to cultivating psychological ownership, a big contributing factor is the individual’s own investment of time and/or energy. We feel an emotional attachment to causes in which we devote a significant amount of effort. I feel a special connection to New York City because I ran a marathon through its streets. I don’t feel the same way about San Francisco, despite having taken hundreds of taxi and Uber rides up and down its hills. This is because we must apply ourselves to form a sense of psychological ownership.

Psychological ownership requires more than good intentions. It grows out of a strong commitment to a cause. Professionals who truly devote their energy and effort to the firm and who can point at some part of the firm that they have created are the ones who are most likely to feel like owners. They are also the ones who are usually offered ownership.

Despite an absence of psychological ownership for any number of the reasons described above, some firms still feel that extending ownership broadly among the team is worth the risk. After all, what is there to lose but a few shares or units? In reality, that cost can actually become quite high.

The Cost Of Having Owners

While it may be very tempting to err on the side of inclusivity and broaden ownership in a firm, having more owners does come at a significant cost. It is a bit like the hamster my mother-in-law gifted my daughter for her birthday. Sure, the hamster only cost $20 at the pet shop, but it cost us two years of cleaning a hamster cage and wondering what to do with Shadow when we went on vacation. Some gifts are very expensive to receive, and ownership is like that.

To begin with, there are the administrative complications for new owners. Let’s dig into a few of them:

• New owners need to sign an operating agreement or shareholder agreement and they are advised to have their attorney review the agreement as well. There are always some provisions that may not be acceptable to someone, and this results in negotiations and legal costs. Unfortunately, future owners often sign agreements without fully understanding them and then find themselves in a bad situation without an easy exit.
• Ownership income arrives on a K-1 form and can complicate the new owner’s tax return. Depending on the state and how many states the firm files in, this can result in a significant increase in tax-compliance costs for new owners. When I first became a partner in a firm, I found myself filing taxes in six different states, even though I live in a state with no income tax!
• Ownership income also frequently means having to make quarterly estimated tax payments. This means learning how to set aside income to make those payments. Some help from CPAs is usually needed, resulting in additional costs for new owners.
• Business ownership can also complicate the approval process for a mortgage or other type of loan. It may also require additional work and costs in cases of divorce or other life changes.

Which means that if we were to hypothetically give all stakeholders $5,000 worth of shares in the firm, it could be more accurate to describe the gift as more of a punishment than as a reward. Because chances are that the additional costs and complications they will experience from having those $5,000 of shares will outweigh any dividends they receive. In my experience, income generated by ownership needs to exceed $20,000 for it to be worth it.

Furthermore, when firms extend ownership, the cost of doing so is not limited to the new owners. Indeed, bringing on a new owner does not come free to the firm. And the more owners a business has, the higher the costs to administer ownership. Consider these additional costs and responsibilities for the owners themselves:

• CEOs and other executives are fiduciaries to the shareholders, and they incur additional liability with each new shareholder. Getting sued by minority-interest shareholders is neither a rare nor a minor event for many companies. The same holds true for all governance structures, including the board of directors and its members. The liability of adding new owners is not unsubstantial, and the presence of more shareholders requires more formality in governance.
• Information must be made available to new shareholders, including financial statements and possibly executive compensation.
• Managing cash flow and distributions may become more complicated, as some shareholders need the distributions to pay off loans for purchasing interest in the company or to make estimated tax payments.
• When a shareholder leaves, the company usually prefers (or is even required) to purchase their shares, creating cash outlays and transactions with high administrative burdens.

The Cost Of Discouraging Top Performers

The administrative costs inherent in extending ownership are significant, as not only are new shareholders burdened with potentially unfamiliar administrative demands, but owners, too, have additional responsibilities that come with extending offers of ownership to stakeholders. That being said, the discouraging effect that an overly inclusive ownership structure can have on top performers can be even more costly for the firm.

Team members who work the hardest and invest significant amounts of effort – and emotion! – into the firm will inevitably end out feeling discouraged when others who are not nearly as committed receive the same equity treatment.

Most marathon races offer both full and half-marathon options. I promise you, runners of the full marathon would be beyond upset if they had to share the same finish line, T-shirts, and medals with the half-marathoners. Now, a half-marathon is no joke – it is undoubtedly quite an achievement! Yet still, a runner dragging themselves across the finish line after four hours is not going to be happy to see themselves among a throng of people who only ran half the distance that they just did.

Perhaps full-marathon runners could be more open-minded and learn to accept their half-distance peers as worthy fellow travelers. But don’t even try mixing them up with the 5K crowd. In every firm you will have your equivalent levels of effort: some of your people will run the full marathon, and some will do the 5K. Unfortunately, many will walk a mile and ask for a ride.

The cultural effect of not distinguishing your top performers and rewarding them with prestige is profound and damaging. There are few things more demotivating than your effort and achievement not being recognized and distinguished.

The Synthetic Options

Legal ownership has three main features: 1) a share in the value of the firm, 2) a share in the profits of the firm, and 3) a share in the vote of the firm. We can easily strip (or enhance) one or two of these three components and create a new instrument. If we isolate the income component, we can create ’income partners’, or essentially offer a bonus plan. If we isolate the voting component, we can distinguish between ‘voting’ and ‘non-voting’ shares. To service these new features, we can create phantom stock, stock appreciation rights, options and warrants, and Class Z triple-distilled shares.

But here is the question with all of these synthetic options: Have we really created the powerful psychological connection that ownership brings?

Most of the time, the answer will be “No!”, because synthetic ownership only creates a synthetic emotion, which is neither as authentic nor as strong as the emotions associated with true ownership. Not only are the psychological preconditions of ownership (i.e., contributing resources, identifying with the firm, and developing a sense of knowledge or control of the firm) missing, but it is also clear that someone actually did not want you to be a real owner.

Still, as we already saw with the research quoted so far, if firms allow their people to take control of the organization, if they allow them to participate constructively in decision-making and feel that their voice is heard, if firms allow them to intimately know the way the business runs, they are very likely to create a sense of psychological ownership. And when people feel like owners, perhaps the exact form of legal ownership matters less. The things we value the most, though, are the things we have obtained through effort. The greater the effort, the greater our sense of pride and achievement.

The same holds true when ownership is offered through stock grants (i.e., shares that are paid to employees as compensation, rather than purchased by the employees). If the shares are part of an employee’s compensation, then the company is essentially forcing the employee to purchase stock, which does not seem like the right way to treat mature financial professionals.

If the shares are not really compensation (meaning that the company would not have paid the employee the same amount in cash), then the offer feels like an unnecessary expense that may also be highly ineffective in achieving anything at all. Usually, such shares are also restricted for some years in an attempt to improve employee retention. Although, any ‘reward’ instrument that is described as “handcuffs” does make me wonder.

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Psychological ownership can be achieved through a combination of a significant investment of time and energy, the accumulation of deep knowledge of the firm, and a growing sense of control. Team members who identify most strongly with the mission of the firm, and who dedicate the most emotional and physical energy to helping it fulfill that mission, are the most likely to feel like owners.

They are also the ones most likely to deserve to be owners. The old ways are often still the best ways, and these are the same criteria that advisory firms have been using for the last two decades to identify potential owners. They have been in use by accounting and consulting firms for more than a century.

Ownership is a powerful tool that can create a strong emotional attachment to the firm and motivate team members to devote extraordinary effort, but only when it is not applied indiscriminately. Trying to make owners out of employees who don’t feel like owners is like asking non-runners to visualize completing a marathon. They aren’t likely to see the point, and if you expect them to start hitting the treadmill with a renewed sense of purpose and direction, you are bound to be disappointed.