Abstract

http://ssrn.com/abstract=573504
 
 

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Company Stock, Market Rationality, and Legal Reform


Shlomo Benartzi


University of California at Los Angeles

Richard H. Thaler


University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER)

Stephen P. Utkus


The Vanguard Group, Inc. - Center for Retirement Research

Cass R. Sunstein


Harvard Law School

July 2004

U Chicago Law & Economics, Olin Working Paper No. 218

Abstract:     
Some eleven million 401(k) plan participants take a concentrated equity position in their retirement savings account, investing more than 20% of the balance in their employer's common stock. Yet investing in the stock of one's employer is a risky investment on two counts: single securities are riskier than diversified portfolios (such as mutual funds), and the employee's human capital is typically positively correlated with the performance of the company. In the worst-case scenario, illustrated by the Enron bankruptcy, workers can lose their jobs and much of their retirement wealth simultaneously. For workers who expect to work for the company for many years, a dollar of company stock can be valued at less than 50 cents to the worker after accounting for the risks. But employees still invest voluntarily in their employers' stock, and many employers insist on making matching contributions in stock, despite the fact that a dollar of investment or contribution may be worth only 50 cents on the dollar. How can competitive labor markets sustain a situation in which employers and employees make such a fundamental miscalculation? We provide evidence that employees underestimate the risk of owning company stock, while employers overestimate the benefits associated with employee stock ownership relative to its costs. This evidence provides strong reasons to consider legal reforms in this domain. We make suggestions that would increase employees' freedom of choice and improve their welfare, but without imposing significant costs on well-meaning but ill-informed employers.

Number of Pages in PDF File: 49

Keywords: Bounded rationality, company stock, behavioral economics, employee compensation

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Date posted: August 9, 2004  

Suggested Citation

Benartzi, Shlomo and Thaler, Richard H. and Utkus, Stephen P. and Sunstein, Cass R., Company Stock, Market Rationality, and Legal Reform (July 2004). U Chicago Law & Economics, Olin Working Paper No. 218. Available at SSRN: http://ssrn.com/abstract=573504 or http://dx.doi.org/10.2139/ssrn.573504

Contact Information

Shlomo Benartzi
University of California at Los Angeles ( email )
D410 Anderson Complex
Los Angeles, CA 90095-1481
United States
310-206-9939 (Phone)
310-267-2193 (Fax)
Richard H. Thaler
University of Chicago - Booth School of Business ( email )
5807 S. Woodlawn Avenue
Chicago, IL 60637
United States
773-702-5208 (Phone)
773-702-0458 (Fax)
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Stephen P. Utkus
The Vanguard Group, Inc. - Center for Retirement Research ( email )
100 Vanguard Boulevard, M38
Malvern, PA 19355
United States
610-669-6308 (Phone)
Cass R. Sunstein (Contact Author)
Harvard Law School ( email )
1575 Massachusetts Ave
Areeda Hall 225
Cambridge, MA 02138
United States
617-496-2291 (Phone)
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