Though the amounts invested in employer stock have declined in recent years, new research offers some perspectives on the factors that seem to be influencing decisions despite diversification messages.
In “Does Social Conformity Influence Portfolio Choice? Evidence from 401(k) Allocations,” Charles Favreau, a PhD candidate at the University of Arizona, outlines the case that “social conformity” not only contributes to the levels of investment in employer stock, noting that research shows that “the pressure to conform is strong enough to illicit such irrational behavior.”
Favreau finds that the percentage allocated to company stock by employees in the 401(k) plan is positively related to both the net open-market purchases of company stock by management and the percentage of the defined benefit plan invested in company stock. He also finds evidence that the relationship between employees and management is influenced by geographic dispersion and trust within the firm — two factors that he says alter group cohesion and have been shown to influence social conformity.
One area that seems to run afoul of Favreau’s expectations: The allocation to company stock in 401(k) plans increases with investment in employee stock ownership plans (ESOPs). Favreau sees the one as a substitute for the other – in other words, if you’re investing in company stock in the ESOP (where you might be able to do so at a discount), you’d see no reason to make that same investment in your 401(k). His analysis fails to take into account the inclination among employers with a strong ownership culture to promote stock ownership widely.
Favreau notes that his conclusions do have implications for legislative reform, primarily that education alone is unlikely to restrict the tendency to invest in employer stock. “Based on the evidence, employees tend to make investment decisions based on the investment preferences of their co-workers or managers rather than on risk models,” he says. “Capping the limit or prohibiting the offering of company stock in 401(k) plans will likely be more effective than education alone.”
