I'm Okay, Your 401: The battle over savings and investment - k

In the wake of Enron's collapse, pundits who formerly defined retirement security as a single underfunded plan (Social Security) locked into a single major asset category (U.S. Treasuries) have suddenly discovered "sound investment principles."

Enron employees saw the value of their company stock depreciate from a high of $90 to a low of $0.26. Clearly, some financial counseling is in order-and Democrats are lining up to give it. Among those singing the "Song of the Portfolio Diversified" is Sen. Barbara Boxer, Democrat of California. "I believe," she said, "that the only way we can protect working people from losing their life savings in the course of an individual company bankruptcy is to make sure that workers are not disproportionately invested in any one company."

Of course, to deduce that company-stock ownership caused these thousands of investor calamities is to overlook a few other problems at Enron: earnings overstated by $580 million, a palimpsest of shredded financial documents, and officers who misrepresented the troubled stock's value even as they unloaded it. But never mind: Boxer and her New Jersey colleague Jon Corzine have proposed a bill limiting how much company stock several popular work-based investment plans can hold.

But the decisions of companies to offer their stock in work-based plans, and of their employees to participate in these plans, are neither diabolical nor irrational. There are three major ways in which firms sell their securities to employees: defined-contribution plans, employee-stock-ownership plans, and broad-based stock options. Each strategy meets particular investment objectives of employers as well as savings objectives of employees. Participants in none of these strategies will benefit from the changes contemplated in the Boxer bill; some, in fact, may suffer because of them.

Defined-contribution (DC) plans, such as 401(k)s, are the primary target of the Boxer reforms. Fifty-five million Americans own retirement accounts in these tax-sheltered vehicles. Enron's contributions to these employee accounts consisted of company stock, but the workers' own contributions were not so restricted: They could invest in diversified, professionally managed mutual funds. But many, blinded by the company's meteoric rise, chose the company-stock fund. And there was nothing generically foolish in their preference for the stock of a blue-chip employer. Company-stock funds are, however, a rapidly shrinking orb within the DC firmament. Most 401(k)s are marketed as offering choices; the typical DC plan now offers a worker ten investment options, covering both his own contribution and his employer's.

Democratic economist Paul Krugman claims that "workers across the country have been cajoled or coerced into holding a high proportion of their retirement assets in their employers' own stock," but the facts do not support this assertion. A 2001 survey by the Profit Sharing/401(k) Council of America found that 78 percent of DC companies offered no investment advice at all; the most common explanation, voiced by 72 percent of employers, was their "fiduciary concern about liability for advice that results in a loss, even if the advisor is competent and there is no conflict of interest."

The ostensible goal of the Boxer regulatory scheme is to ensure that employees hold diversified portfolios, but they already do: As firms compete for employees, they diversify their plans. They offer company- stock funds less frequently than actively managed equity and bond funds, money-market accounts, and stable-value funds. The share of company-stock funds within DC plans is also decreasing: Only 1 percent of 401(k) employers offer them at all.

But to the extent that some 401(k)s still have too much company stock, the Boxer bill isn't the cure. Newsweek's investment columnist, Jane Bryant Quinn, understands this: "It's not enough to reform only 401(k)s. Companies can readily switch the matching-stock portion of a 401(k) into something called an Employee Stock Ownership Plan (ESOP)."

As their name implies, ESOPs are not retirement accounts. Rather, they are designed to provide employees an ownership share in their workplace. Legislation supporting ESOPs was enacted by Congress in the 1970s, with bipartisan support. The ESOP backers had an ambitious agenda: They wanted to transform corporate culture by mediating the interests of capital and labor through shared equity and shared management. The employee-owner, they hypothesized, would be more productive, loyal, and innovative than the alienated proletarian.

Two decades of research on ESOPs by Douglas Kruse and Joseph Blasi of Rutgers have largely confirmed this sunny thesis. By measures as diverse as output per employee, annual sales growth, stock-price changes, and worker satisfaction, ESOPs have been a rousing success. Currently, 8.5 million workers are enrolled in ESOPs. Firms whose employees own over half their equity include such giants as United Airlines and Publix Supermarkets. More commonly, ESOP companies are small; 95 percent of them are privately held. They dot the entire business landscape, from engineering to construction, from fast foods to metal fabrication.