RESEARCH Business Government

RETIREMENT SAVINGS
Worker's investments can lead to company stock overexposure

Mark Reutter, Business Editor
(217) 333-0568; mreutter@uiuc.edu

3/1/03

Photo by Bill Wiegand Scott Weisbenner, a finance professor, who has completed the most comprehensive study to date, says employees will likely continue to load up on company stock in retirement accounts, leaving them potentially exposed to heavy losses if the company unravels.

CHAMPAIGN, Ill. — Without government regulations, employees will likely continue to load up on company stock in retirement accounts, leaving them potentially exposed to heavy losses if the company unravels, a study by a researcher at the University of Illinois at Urbana-Champaign suggests.

The collapse of Enron Corp., Global Crossing and WorldCom dramatically illustrate the risks to employees who invest too heavily in company stock in their 401(k) retirement plans. Urged on by company officials, Enron employees held 62 percent of their 401(k) assets in Enron stock; they lost more than $1 billion after the company filed for bankruptcy.

Attempts to pass legislation mandating diversification of 401(k) plans – similar to laws covering traditional defined-benefit pension plans – have run into roadblocks in Congress. Business lobbyists, Republican leaders and some Democrats object to a plan to cap company stock at 20 percent of 401(k) plans, saying it interferes with an employee’s right to make independent investment decisions.

But how do employees decide where to invest their 401(k) savings? In the most comprehensive study to date, Scott Weisbenner, a finance professor at Illinois, and Nellie Liang, an economist for the Federal Reserve Board, examined the data of 994 publicly traded companies with 401(k) defined contribution plans. In all, they made 3,412 observations over 10 years (1991 through 2000).

While diversification is considered the key to sound investment – especially in the volatile stock market – employees went in the opposite direction, purchasing more, not less, company stock when an employer offered company stock in a 401(k) plan. "Employees appear to interpret an employer match in company stock as implicit investment advice, namely, the endorsement of company stock," Weisbenner and Liang noted.

As a result, with the retirement savings of many employees tied to the health of a single company, they have "a large exposure to firm-specific risk." On the other hand, corporate 401(k) plans that offer more options than company stock encourage employees to diversify away from company holdings, thereby reducing risk.

Weisbenner and Liang attributed over-reliance on company stock not to any high-rolling instinct on the part of employees, but to "naive" strategies about investing.
"Participants view company stock as the most familiar investment option, and this familiarity appears to translate into lower perceived risk," they wrote in a working paper.

In fact, many firms use company stock for matching contributions to avoid paying out cash to employees and to gain tax deductions. Moreover, paying contributions in their own stock tends to bolster the share price.

In an interview, Weisbenner said that absent a cap on company stock holdings, Congress could reduce employee risk by requiring employers to offer a minimum number of alternative 401(k) plans.