Company Stock in Pension Plans: How Costly is it?

Abstract

Firms' matching contributions to employees' defined contribution pension plans are an important spur to employee retirement savings. Firms frequently match employees' defined contribution pension plan using company stock and prohibit employees from selling; employees sometimes voluntarily invest their own contributions in company stock. But their concomitant loss in diversification is extremely risky and costly. While one might reason that employees willing to take on the increased risk should do so, holding company stock is inefficient for all employees, even risk tolerant ones. This paper investigates the extent of company stock ownership and estimates its cost, finding that employee investors sacrifice an average 42% of their company stock's market value by taking on risk that could otherwise have been "diversified away." By matching with cash rather than stock, firms could reduce this lost value, making both employees and the firm better off. Indeed, with such savings, firms could afford to increase their matching contributions. Risk tolerant employees who want to "swing for the fences" would be better off by investing in a diversified portfolio and levering it to their desired risk levels. The findings in this paper call into question the wisdom of requiring or allowing company stock holding within retirement plans.

Keywords: Defined contribution pensions, retirement savings, 401(k) asset allocation, company stock, employer securities, diversification.

JEL Classification: D31, G18, G38, H31, J26, J32, J33, J38