Magazine

Table of Contents | Published in April 2000

Building Ownership

Too many limits can undermine the benefits of company stock investment

By Jinny St. Goar | April 2000

Too many limits can undermine the benefits of company stock investment

Coca-Cola, Procter & Gamble and Abbott Laboratories have about 80% of their defined contribution plan assets in company stock. General Electric employees have about 66% of their 401(k) assets invested in GE stock. Other companies—notably the SCANA Corporation—have just about all of their 401(k) plan assets in company stock.

Speaking in defense of such weightings is David Binns, associate director of the Foundation for Enterprise Development, a Washington-based nonprofit with offices in San Diego and New York that is dedicated to increasing employee ownership. Generally speaking, Binns favors company stock investments for defined contribution plans. Jinny St. Goar caught up with him recently to learn why.

PS: Given the dramatic statistics cited above, isn't there good reason to worry that 401(k) plans are overweighted in company stock?

BINNS:  Intuitively, I would agree that no portfolio should have more than, say, the same limit of 10% in employer securities that applies to defined benefit plans. But, there are counterpoints to that intuition. First, it is important not to look at a company's 401(k) plan in a vacuum. Most large companies—the ones generally with the highest allocations to company stock—offer other benefits: profit-sharing plans and/or defined benefit plans. That's the case at companies like GE and Coca-Cola. That is an important caveat in the risk equation.

However, with the boom in 401(k) plans, many small employers now do not have a defined benefit plan, only a 401(k). That is when the 401(k) plan becomes more significant in the [participants'] risk outlook. But, even here, I see exceptions. What about a small company that is looking to build employee ownership through its 401(k) plan? Many smaller companies design their 401(k) plans with an eye toward turning that into an employee stock ownership plan that will buy out the retiring owner.

Among 401(k) plans that offer company stock as an investment option and/or the company match, those with participant-directed plans have some 25% of plan assets in company stock. Those with company-directed allocations have an average of 30%. What conclusions do you draw from that?

BINNS:  The most common form of company match is the employer's equity shares. Remember that our tax structure favors this. Corporations can take a current tax deduction for the fair market value of the stock distributed [to employees' 401(k) accounts], while not making any cash outlay. That enhances benefits in the short term. To the extent that we consider limiting company stock in 401(k) plans, are we limiting employee benefits?

What is more, 401(k) plans are easier and cheaper to set up than other employee benefit plans—for example, an employee stock-ownership plan. [401(k) plans] are even easier than profit-sharing plans. And there are many profit-sharing plans that have more than 50% of their assets in company stock, such as Sears, Hallmark Cards, and Procter & Gamble. Given the ease and cost savings [that can be achieved] by using the 401(k) plan structure for employee ownership, I believe it's important to keep this mechanism available for management that favors significant levels of employee ownership.

The Employee-Ownership Index, a basket of 350 large, publicly traded companies that are more than 10% employee-owned, has increased 259.5% since its inception in mid-1992 through mid-1999. Over the same period, the Standard & Poor's 500 increased 229.6%. Do you see this as a rationale for maintaining the status quo?

BINNS:  Statistics show that employee-owned companies tend to perform better. And employee ownership clearly does not hurt. But, it is hard to winnow the causes of that good performance. Enlightened management tends to favor employee ownership as well as other good management practices that all work together for good performance. The problem is that the laws and regulations for 401(k) plans are the same for General Electric as they are for the mom-and-pop shop. And, it is clear that, in a [economic] downturn, the difficulties for a mom-and-pop operation are much greater than for GE. You don't need to be a Cassandra, waving the prospects of a 1929-style crash, to wonder about reasonable limits on company stock in 401(k) plans.

top

SPONSORED MESSAGES