Investor Behavior and the Purchase of Company Stock in 401(K) Plans - the Importance of Plan Design

Abstract

This paper provides new evidence on the importance of employer stock in the 401(k) portfolios of individual investors, how investment decisions are affected by pension plan design, and what compels firms to offer matching contributions in company stock. After summarizing the quantitative importance of company stock as an investment option, we first document that the share of an individual's contributions invested in company stock declines with the number of options available. We cannot reject the null hypothesis that investors follow a simple "1/n" investment strategy, where n is the number of investment alternatives available. Participants purchase more, not less, company stock when an employer provides the match in company stock, leading to a lack of diversification. Moreover, workers appear to view other plan restrictions, such as minimum or maximum limits on company stock purchases, as implicit investment advice, providing further evidence of an endorsement effect. Finally, we find that the employer's dividend policy, rather than liquidity constraints, appears to be a primary determinant of whether an employer matches with company stock, as firms may be able to claim a tax deduction for subsequent dividends paid on the matched stock.

Keywords: 401(k) plan, company stock, behavioral finance, inertia, portfolio choice

JEL Classification: G11, J30, J32