Naïve Investing – Company Stock. PADM 5111 – Microeconomics for Policy Analysis Presented by Amanda Wright & Glenn Horne Thursday, September 18, 2014. Agenda. Background Survey Employee Attitudes Employer Attitudes Double Nudge Conclusion. Background.
PADM 5111 – Microeconomics for Policy Analysis
Presented by Amanda Wright & Glenn Horne
Thursday, September 18, 2014
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
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
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.
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%
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
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
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
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
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
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
Increased motivation & productivity
Advantageous tax treatment
Advantageous treatment under fiduciary law
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.
Employers are given a nudge via Employee Retirement Income Security Act 1974
Employers nudge employees based on overestimation of true benefits.
You have to get at the root of the nudge.
Eliminate the company stock exemption from the diversification requirement.