An employee stock ownership plan is a qualified stock bonus plan, or a combination stock bonus and money purchase pension plan (essentially a defined contribution plan), that is designed to invest primarily in employer stock, and that meets the requirements of the Employee Retirement Income Security Act of 1974 and the Internal Revenue Code of 1986.

ESOPs are established for many reasons, including (1) to provide employees compensation and an ownership stake in the company, (2) as a form of takeover protection, (3) as a financing vehicle, (4) as a means to take a company private, (5) to transition ownership from a single owner or a group of owners (i.e., an exit strategy), or (6) to realize available tax incentives. In addition to the tax advantages provided by other employee benefit plans, ESOPs may enable employers and others to qualify for the following, if specific requirements are met:

An ESOP may purchase the employer's shares from an existing shareholder, the employer’s unissued shares or shares held in treasury, or shares outstanding in the public equity market, or may also purchase the employer's debt securities. Alternatively, new classes of capital stock are frequently created specifically for ESOPs. See SC 11.3.3.

Shares issued to the ESOP are allocated by the ESOP trustee to plan participants in accordance with the plan agreement. Shares are allocated to individual employees even though they may not vest for a period of time and will not be distributed to them until retirement or termination.

Some companies' bylaws prohibit non-employees from owning employer stock, thereby requiring participants to sell their shares back to the ESOP or the company upon termination of employment or retirement. Large publicly-traded companies typically do not require participants to sell their shares upon leaving the company.

At a high level, a typical ESOP is just another way to provide compensation to employees in the form of employer stock. Depending on the specific terms of the ESOP, including when and how shares are allocated to individual participants, the amount and timing of recognition of compensation expense may vary, but the basic principle is that compensation expense will be recognized for the value of the shares awarded to the employee over the requisite service period.