Naïve Investing – Company Stock
PADM 5111 – Microeconomics for Policy
Analysis
Presented by Amanda Wright & Glenn Horne
Saturday, March 12, 2016
Agenda
 Background
 Survey
 Employee Attitudes
 Employer Attitudes
 Double Nudge
 Conclusion
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Background
 Employee Retirement Income Security Act 1974 (ERISA)
puts forth three fiduciary principles for retirement plan
investments:
– Exclusive benefit rule requires that plans be managed for the
benefit of participants
– Prudence rule requires that plan assets be invested according to
a ‘prudent investor’ standard
– Diversification rule requires that plans be diversified so to
minimize the risk of large losses
 Company stock is exempt from the diversification
requirement
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Post Enron
 U.S. Congress has considered a range of legal reforms that
would protect employees against the risks associated with
investments in their employer’s security (company stock)
 The most cautious proposal would require an annual disclosure
about company stock risks to participants and would limit an
employer’s ability to restrict a participants right to diversify
company stock
 More ambitious initiatives would require mandatory
diversification above some limit or disallow employee
contributions in stock when employers already match
 Legislation has not been passed because of questions
regarding its necessity
4
The Study: Reality and Perceptions
 Survey 501 employee respondents at 100 different
companies
 Goal to obtain a better understanding of how employees
think about the costs and benefits of owning company
stock
 The employer survey was 150 firms that offer company
stock in their retirement savings plans
 Goal was to obtain better understanding of employers
perspectives on the costs and benefits of requiring
employees to own company stock
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Employees and Company Stock
 11 million participants is U.S. define-contribution plans
have more than 20% of their account balance invested in
company stock.
 Within this group 5 million have more than 60%
concentrated in their employer’s stock.
 According to estimates $1 in company stock is worth less
than half the value of $1 in a mutual fund.
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Employer
Company Stock
%
Procter and Gamble Co.
90
Abbott Laboratories
78
Pfizer Inc.
75
General Electric Co.
68
Southern Co.
65
Marsh & McLennan
64
Target Corp.
60
Chevron Texaco Corp.
60
Meadwestvaco Corp.
59
Textron Inc.
55
Kimberly-Clark Corp.
55
Bank of America
54
Merrill Lynch & Co.
52
Johnson & Johnson
50
Merck & Co.
50
Allocation of
Retirement Plan
Assets to Company
Stock
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Benefits to Employee
Advantageous Tax Treatment:
 Investment in company stock does have tax advantages that
are not available for other investment funds in 401(k) plans
 Only 1/10 respondents aware of the preferential tax treatment
 12% think that company stock is taxed at higher rates
 Most respondents either didn’t know (35%) or think that
company stock has the same tax treatment as other
investments (44%)
 Those who know company stock has preferential tax treatment
allocate 20.9% of monthly contributions to company stock
 Those who thought has tax disadvantage allocate 28.3%
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Private Information:
 Employees might more know about their employer than of
outside investors
 Unconvincing because employees at a large company
unlikely to know about all the different products and
divisions
 Large extent of company stock allocation based on public
information
Nonmonetary Benefits:
 Feeling as part of the team?
 32% confirm they feel better for owning company stock
 However 59% said does not affect them
 Overall no evidence that employees value the benefits of
owning company stock
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Costs to the Employee
Idiosyncratic Risk:
 Investing in single stock very costly
 People can loose job and retirement funds all at once (Enron)
 People do not understand the risk-and-return profile of company
stock
 Only 16% of employees understand their employer’s stock is
riskier than the overall stock market
 Vanguard survey data indicates that average participant views
company stock as safer than a diversified stock fund
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 Even after educating people about the Enron bankruptcy
case, 25% of respondents said they believe their
company stock is safer than diversified fund and another
39% said they believe it has the same level of risk
 Participants base their risk perceptions on past returns
and not on the volatility of returns
Nonmonetary Costs:
 Not owning company stock may provoke employees to
feel they have betrayed their employer
 However no evidence that loyalty correlates with
decisions to invest in company stock
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Summary: The Employee
 Majority of employees do not place much weight
on the alleged benefits of owning company stock
 Most employees do not appreciate the risk of
investing in a single stock
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Benefits to Employer
 Increased motivation & productivity
 Advantageous tax treatment
 Advantageous treatment under fiduciary law
 “Friendly Hands”
 Cash flow
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Cost to Employers
 Costs as managers of the retirement
portfolio:
– Lack of diversification
 However, they also indicated if given the
opportunity to change the makeup of the
portfolio they would not.
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Employers Summary
 Benefits are limited at best.
 Employers do not appear to have a good
perception of the true costs and benefits of
having high rates of employee investment in
company stock.
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Double Nudge
 Employers are given a nudge via Employee
Retirement Income Security Act 1974
 Employers nudge employees based on
overestimation of true benefits.
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Conclusion
 You have to get at the root of the nudge.
 Eliminate the company stock exemption
from the diversification requirement.
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