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Employee Ownership as a Retirement Plan

As the amount of employee stock in retirement plans exploded in the mid-to-late 1990s, there appeared major articles in the Wall Street Journal, the New York Times, Business Week, and other publications on the subject of whether employees are counting too heavily on employer stock as part of their retirement plans. At Carter Hawley Hale, for instance, employees were strongly encouraged (some say pressured) to invest in company stock in the company's 401(k) plan. The company's matching contributions were also in its own stock. The company suffered through years of economic decline before declaring bankruptcy in 1993. Thousands of employees' retirement plans were wiped out.

These stories raise an important concern. If employees are basing their retirement mostly on the stock of their own company, are they making a foolish choice? And if so, what should employee ownership companies do about it?

The frequent glib reply to this issue is to quote Andrew Carnegie, who reputedly told a young man that to grow rich he needed to "put all his eggs in one basket and watch that basket very carefully." Frankly, that's not very good advice for saving towards retirement. First, unlike Carnegie or the young man, employees have little or no control over the basket. They cannot individually change the course of the company and, in ESOPs and similar plans, they cannot even sell the stock if the basket seems about to fall apart. Second, no financial advisor would ever counsel anyone to rely on an undiversified investment portfolio for retirement. Most telling, the people giving that advice, more often than not, either rely on diversified investments for their own retirement or are a good deal wealthier than the typical employee owner and can afford to take more risks.

An Investment, Not a Retirement Plan

All of this is not to say employee ownership has no value as part of a retirement plan. Although some employee owners have left their companies with little or nothing, more have retired with very substantial assets. Moreover, there is good evidence that companies contribute more to employee ownership plans than they do to other kinds of benefit plans. The typical employer contribution to an ESOP, for instance, is about 6% of pay in public firms and 8% to 10% in private firms. By contrast, the typical contribution of employers with retirement plans to all their retirement plans is only about 4% of pay. Diversification rules in ESOPs, plus the tendency of ESOPs to move out of company stock over time, also make these plans less risky than they might seem at first blush. Similarly, employers may also be willing to make larger matching contributions of their own stock to 401(k) plans than they would if contributing cash, and broad stock option programs are almost never a trade-off for retirement benefit plan contributions.

Nonetheless, the risk remains that an employee counting heavily on employer stock for retirement can end up like the employees at Carter Hawley Hale, or at least see a substantial decline in what they expected. For this reason, it is incumbent on companies to make sure employees understand that their ownership stake should be seen as a substantial investment, with real risks, that should be part of their retirement plan, not most or all of it. They should have alternative sources of income to provide a reasonable retirement in a worst-case scenario with company stock. These can come from several sources: social security, plan diversification, the employee's elective diversification at age 55 in ESOP plans, another retirement plan the company offers, home equity, other savings, or a spouse's plan.

More and more employee ownership companies are getting the message across to their employees that their stock ownership is an important investment, but not a retirement plan in itself. Many of these companies offer 401(k) plans to complement their employee ownership plans. Others, however, are fearful that telling employees there is potentially considerable risk will be demotivating. In fact, employees consistently tell us that they are much more motivated by being treated as people capable of understanding the benefits and the responsibilities of ownership.

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