- Are Empowerment and Education Enough?Underdiversification in 401(k) Plans
At the end of 2000, current and former employees of the energy trading company Enron Corporation held $2.1 billion in the firm's 401(k) retirement savings plan. Sixty-two percent of that money was invested in Enron stock, then trading at $83 a share. In October 2001 Enron's finances began to unravel as its accounting improprieties came to light. Enron stock plummeted over the next several weeks, and on December 2, 2001, the company declared bankruptcy, rendering its shares worthless. Thousands of Enron employees lost their jobs and a large fraction of their retirement wealth simultaneously.
Although the Enron 401(k) debacle was highly publicized, Enron was neither the first nor the last company whose collapse decimated its workers' 401(k) accounts. Over the past few years a similar fate has befallen employees of WorldCom, Global Crossing, Polaroid, Kmart, Lucent, and Providian, among others. In response, many bills have been proposed in Congress that would regulate employer stock holdings within 401(k) plans. Compared with existing law on defined-benefit pension plans, which strictly prohibits plans from holding more than 10 percent of their assets in employer securities, most of the bills proposed for regulating defined-contribution plans appear mild. Common themes in these proposals are empowerment and education rather than prohibition: give employees the right to sell the employer stock in their 401(k), and inform them about the risks of not doing so.
For example, one of only two bills that have so far come up for a vote in either house of Congress, the Pension Security Act (see table A-1 in the appendix), has two key provisions relating to employer stock. First, it would prohibit employers from requiring employees to invest their own 401(k) contributions in employer stock. Second, it would require that employers allow plan participants to diversify any matching funds contributed by the employer three years after receiving that match. Other proposed legislation would require that plan participants be notified if the fraction of their assets invested in employer stock exceeds a certain threshold (such as 20 percent), that companies offer a certain number of alternatives to employer stock if it is made an investment option, or that companies educate plan participants about the risks of not diversifying their assets.
This paper assesses how effective the "empower and educate" regulatory approach might be at reducing 401(k) employer stock holdings. We begin by studying five natural experiments in which employees experienced a discrete change in the restrictions on employer stock holdings. In these examples the restrictions changed for one of two reasons: either employees crossed an age or tenure threshold above which they were allowed to diversify their holdings, or the company changed its rules to enable all employees to diversify their investments. We find only a modest employee response to either type of change. Merely allowing diversification does not cause it to happen.
We then consider whether educational efforts might motivate employees to diversify out of employer stock. Although many studies have concluded [End Page 152] that financial education does affect employees' choices, the subset of studies that randomly assign education and measure subsequent actions have found small effects.1 These studies still leave open the possibility that other kinds of education might yield larger behavioral changes.
Here we evaluate a different form of education: witnessing the real-life experience of others. Economists since Armen Alchian in the 1950s have argued that the imitation of successful strategies (and, conversely, the avoidance of unsuccessful strategies) is an important force pushing economic actors toward optimal behavior.2 We test this hypothesis in the context of the media coverage surrounding the Enron, WorldCom, and Global Crossing bankruptcies. Specifically, we investigate how much workers at other companies reduced their employer stock holdings in response to the blizzard of media stories early in this decade illustrating the dangers of putting all of one's retirement savings in employer stock.
We chose Enron, WorldCom, and Global Crossing because a large percentage of their employees' 401(k) assets was held in employer stock, and because their...