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Employee Ownership: A Good Benefit, an Inadequate Retirement Plan

By Corey Rosen, NCEO Executive Director

December 2001

There has been a lot in the news lately about employees being too heavily in company stock in their 401(k) plans. Overall, about 19% of total 401(k) assets are held in company stock, but these averages mask a lot of variation. There are many companies, including some very large ones, where most of the assets are in company stock. In some cases, such as Procter & Gamble, that has generally worked out very well; in others, such as Enron, it's been a disaster. As a long-time advocate of employee ownership, it may sound incongruous for me to argue that employer stock should not be a major part of most 401(k) plans, but to argue otherwise would be a disservice both to employee ownership and to employees.

Employee ownership is a growing part of the US economy. We estimate that about 25 to 30 million employees own stock in their companies through employee stock ownership plans (ESOPs), broad-based stock option plans, employee stock purchase plans, and 401(k) plans. Many employees participate in multiple plans. ESOPs, which cover about 8.5 million employees, are benefit plans companies provide for employees by funding employee trusts that invest in company stock. ESOPs have a variety of tax advantages, especially for closely held companies. While ESOPs are technically governed by the same laws that govern retirement pans, most (but not all) ESOPs companies are careful about providing more diverse retirement plans alongside their ESOPs. In fact, recent research at Rutgers University shows that ESOP companies are more likely to have other kinds of retirement plans than comparable non-ESOP companies. A major study by Washington State showed that the total retirement assets in company plans of typical ESOP participants was three times that of comparable employees in non-ESOP companies.

Another common vehicle for employee ownership is stock option plans. About 10 million employees now get options. Contrary to popular mythology, the vast majority of employee getting options do not take a reduction in pay or benefits for them -- that was only true of the relatively small number of people who went to work for start-up technology companies. Employee stock purchase plans are another popular vehicle, with about 15 million participants. These typically give employees the right to buy stock at a discount through payroll deductions, usually providing 15% off the price at the time they buy the stock or what the price was when they started putting money away, a "look-back" option that typically goes back six to 12 months. That means employees can often buy stock at a very substantial savings. They can sell it right away if they like.

Finally, millions of employees own stock in the companies through 401(k) plans. Unfortunately, it's not possible to know just how many millions, but the numbers are probably in the range of the plans described above. But 401(k) plans differ from the other three in that their primary purpose is not employee ownership; it is providing a secure retirement nest egg. ESOPs, options, and ESPPs are primarily employee benefit plans designed to help employees share in corporate growth through a company-provided benefit, and, data show, overall they have done that admirably. But 401(k) plans are meant to encourage employee savings. The plain fact is that putting most or all of a 401(k) plan's investments in any one investment is not a sensible plan for retirement. Company stock makes matters worse because employees are at both retirement and employment risk. In light of the Enron bankruptcy, and the devastation it has wreaked on employee savings, there are renewed calls to limit employer stock in 401(k) plans.

But the matter is a bit more complicated than it seems. Most 401(k) plans have two components -- what the employee puts in and what the company matches. Most plans in publicly traded companies allow employees to invest in company stock. For many employees, that's quite tempting. They may not know much about investing, but they do know about their own company. The CEO keeps talking about the company's rosy future, so why not buy its stock? At the same time, many companies match employee savings in the form of their own stock. It's cheaper to print more shares -- and take a tax deduction for their value -- than contribute cash. Some 401(k) plans allow employees to move these matching contributions into other things, but most don't.

Congress could limit the amount of employee investments that could be in company stock, although that would strike some as too paternalistic or inflexible (albeit we prevent people from taking foolish risks in a lot of other ways). But what about limiting employer matches in the form of company stock? It's entirely possible, and maybe likely, that the result would be lower matching contributions. Contributing company stock is cheaper, and so companies may well contribute more. So employees would have less risk, but, in general, smaller account balances.

In any event, it seems unlikely that Congress will change 401(k) plans any time soon. Previous efforts to enact strict rules for these plans resulted only in a rule that prevents companies from requiring employees to invest only in company stock. Employees can solve the problem largely on their own, however, by making diverse investments. If they are fortunate enough to have other kinds of employee ownership plans, these should be seen as gravy, investments that are not sure things. They can be, and usually are, very good benefits -- but they are not retirement plans.

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