Employer Stock in Retirement Plans: Investment Risk and Retirement Security

Publication Date: January 2003

Publisher: Library of Congress. Congressional Research Service

Author(s):

Research Area: Labor

Type:

Abstract:

The financial losses suffered by participants in the Enron Corporation's 401(k) retirement plan received wide publicity and prompted questions about the laws and regulations that govern these plans. In the wake of the Enron bankruptcy, numerous bills were introduced in the 107th Congress with the intent of protecting workers from the financial losses that employees risk when they invest a large proportion of their retirement savings in securities issued by their employers. Enron is not the only company whose employees and retirees have seen the value of their retirement accounts reduced by a plunge in the company's stock price. Employees of Rite Aid, Lucent Technologies, Nortel Networks, Qwest Communications, the Williams Companies, Providian Financial Corporation, IKON Office Solutions, Global Crossing, and WorldCom also have had their retirement accounts substantially reduced by sharp drops in the price of the companies' stock.

This CRS Report begins by describing the shift from traditional defined benefit pensions to defined contribution plans like the 401(k) that has occurred over the last 20 to 25 years. It then summarizes recent research findings on the extent to which employees' retirement savings are invested in employer stock. The third section of the report outlines the provisions of federal law that define an employer's duty to manage its retirement plan in the best interest of the plan's participants. The report concludes with a summary of pension reform legislation passed by the House of Representatives in April 2002 and a description of several pension reform bills that were introduced in the Senate in 2002.

Neither the Employee Retirement Income Security Act (ERISA) nor the Internal Revenue Code limit the proportion of assets in a defined contribution plan that can be invested in "qualifying employer securities," called "employer stock" or "company stock." Experts state that individuals who concentrate assets in employer stock assume unnecessary risk, because for any expected rate of return from employer stock there is a diversified portfolio that will provide the same rate of return with less investment risk. Although some employees might realize substantial gains by investing their retirement accounts in employer securities, all market participants will in the aggregate earn the market rate of return. There will be winners among workers who choose to invest heavily in employer stock, but there also will be losers.

A CRS analysis of forms filed with the Securities and Exchange Commission by 278 firms showed that, on average, company stock comprised 38.0% of the assets in their defined contribution plans. The median concentration of company stock was 24.7%. Both figures are higher than the 10% to 20% that many investment advisors recommend as the maximum exposure to a single firm's securities. A statistical analysis showed that three variables had positive and statistically significant relationships to the percentage of plan assets invested in company stock: (1) making the company matching contribution with company stock, (2) an average annual total return on company stock that exceeded the return on the S&P 500 over the previous three years, and (3) the size of the company measured in terms of total assets.