Allocations to company stock are substantially lower in plans that offer more alternatives. The authors cannot reject the hypothesis that investors follow a simple "1/n" investment allocation for company stock, where n is the total number of investment alternatives available.
Currently, about 45 million workers participate in a 401(k)-type plan, and aggregate assets of these plans totaled $1.97 trillion in 2001. The trend toward 401(k)-type plans has forced employees to make decisions about how and how much to save. In addition to traditional investment choices, employees are often given the option to invest their 401(k) contributions in company stock. Company stock is offered as an investment option in 72 percent of retirement plans with more than 5,000 participants. At Enron, for example, 62 percent of 401(k) assets at year-end 2000 were held in company stock. Part of the high concentration reflected the company's match in Enron shares, but Enron employees also were allocating a large fraction of their own, discretionary contributions to company stock. Such a high concentration of retirement assets in company stock is not unique to Enron. Many workers do not have well-diversified retirement plan portfolios. For example, at General Electric, Home Depot, and Pfizer, more than 75 cents of every dollar in defined contribution plan assets is held in company stock.
In Investor Behavior and the Purchase of Company Stock in 401 (k) Plans: The Importance of Plan Design (NBER Working Paper No. 9131), co-authors Nellie Liang and Scott Weisbenner examine the factors that influence investment decisions made by participants in retirement plans. They find that the characteristics of the 401(k) plan strongly influence investment decisions by participants because the employees follow naïve diversification rules and view plan features as implicit investment advice by the firm.
The number of investment alternatives offered by the plan is a significant indicator of the share of contributions in company stock. Allocations to company stock are substantially lower in plans that offer more alternatives. The authors cannot reject the hypothesis that investors follow a simple "1/n" investment allocation for company stock, where n is the total number of investment alternatives available. However, the full reduction in allocations to company stock in response to an increase in investment options takes about 4 to 5 years, probably because of investor inertia.
The authors also find that employees appear to interpret restrictions on asset allocation put forth by the firm as providing implicit investment advice regarding the purchase of company stock. The employees of firms that have a match in company stock put more, not less, of their own contributions in company stock. In addition, a switch from allowing the employee to invest the match without restriction to requiring that the match be all in company stock is not offset by the employee investing less of his own contributions in company stock. An examination of other plan restrictions, such as minimum or maximum limits on company stock purchases, further suggests that workers take investment cues from plan restrictions.
Because the plan features are so important in determining the purchase and holdings of company stock, the authors ask what determines the number of investment options offered and the employer match policy. They find that firms have offered more options in recent years, possibly because the proliferation of mutual funds has made it easier to offer more alternatives. The only significant determinant of the employer match in company stock is whether the firm pays dividends. This link to dividends likely reflects the fact that when the match is in company stock, then the match contributions can be paid into a leveraged ESOP. This is desirable, because then the subsequent dividends paid on the stock will be considered compensation expense and thus will reduce a firm's future taxes.
The authors studied 994 publicly traded companies from 1991 to 2000, where the average share of participants' discretionary 401(k) contributions in company stock was 19 percent.
-- Les Picker