The Role of Company Stock in 401(k) Plans

ABSTRACT The Enron situation has caused the retirement income policy community to focus increased attention on the desirability of current law and practices regarding company stock in 401(k) plans. Several proposals have been advanced to limit the exposure of 401 (k) participants to company stock. I suggest that, contrary to conventional wisdom, the introduction of company stock into 401 (k) plans is not simply more risk for no additional (expected) return. Rather, the introduction of this asset class into the 401(k) participant's portfolio may have beneficial influences via the differential asset allocation. I create a model to simulate the likely financial impact of prospectively eliminating company stock from 401(k) plans and find that average balances are expected to be between 4.0 and 7.8 percent larger if company stock is retained. INTRODUCTION Although the topic of company stock investment in 401(k) plans has recently been the focus of considerable interest, the concept of preferred status for employee ownership has been part of the U.S. tax code for more than 80 years.1 At Enron, 57.73 percent of 401 (k) plan assets were invested in company stock, which fell in value by 98.8 percent during 2001 (IOMA, 2001, p. 1). The decrease in share price and eventual bankruptcy filing of Enron resulted in huge financial losses for many of its 401 (k) participants. This development has prompted several lawsuits as well as congressional and agency investigations into the relative benefits and limitations of the current practice. In addition, the practice of imposing "blackout" periods when the 401 (k) sponsor changes administrators has recently been called into question in light of the Enron situation.2 Certainly, the Enron situation has caused the retirement income policy community to focus increased attention to the desirability of current law and practices regarding company stock in 401 (k) plans, resulting in much debate. Presumably, any recommendations to modify current pension law would attempt to strike a balance between protecting employees and not deterring employers from offering employer matches to 401 (k) plans. Some have argued that if Congress were to regulate 401(k) plans too heavily, plan sponsors might choose to decrease employer contributions or not offer them at all. Previous research has shown that the availability and level of a company match is a primary impetus for at least some employees to make contributions to their 401 (k) accounts (VanDerhei and Copeland, 2001). Others have argued that individuals should have the right to invest their money as they see fit. This article attempts to fill the empirical void in which many of these proposals have been created. The second section analyzes the concentration of company stock in 401(k) plans, and the third section reviews previous research I have coauthored with respect to employee reaction when employers mandate that matching contributions be invested in company stock. The fourth section provides results of the first known attempt to simulate the financial impact of prohibiting company stock in 401(k) plans. A summary and conclusion are provided in the last section. THE CONCENTRATION OF COMPANY STOCK IN 401 (K) PLANS Percentage of 401 (k) Plans and Participants With Company Stock Figure 1 shows that for the 1996 version3 of the Employee Benefit Research Institute/ Investment Company Institute Participant-Directed Retirement Plan Data Collection Project (hereafter, the EBRI/ICI database), only 2.9 percent of the 401(k) plans included company stock (1.4 percent of the plans had company stock but no GICs4, while 1.5 percent of the plans had both company stock and GICs). However, the plans that did have company stock were generally quite large and represented 42 percent of the 401 (k) participants in the database that year (17 percent of the participants had company stock but no GICs, while 25 percent had both options) (see Figure 2). …