PLANSPONSOR - October/November 2020 - 31

INVESTMENT FOCUS
But there are incentives involved,
too. " There's a philosophical origin we
have seen many times, " says Ed McIlveen,
director of research at Francis Investment
Counsel, retirement plan advisers in the
Milwaukee suburb of Brookfield. " When
we come on the scene to a plan that offers
company stock, someone on the board
will tell us, 'The last CEO or CFO [chief
financial officer] strongly believed that we
had to have this, in order to align the interests
of the employee and the company.' "
Risk Management
" The other side of the story is risk management, "
for both employees and sponsors,
says McIlveen. " Our message has been
that, as an ERISA [Employee Retirement
Income Security Act] fiduciary, having
company stock in a plan increases a sponsor's
fiduciary risk, because of participant
lawsuits that have come forward from
large drops in companies' share prices. "
Participants can face greater risks,
too, from being overly concentrated in
employers' shares. " If a sponsor makes
matching contributions in company
stock, employees might take that as guidance
from the employer and put in their
own contributions, too, " Credico says.
" Then the employees may be putting all
of their eggs in one basket, if something
happens to the company, the share price
and their jobs. "
Even barring catastrophe, the math of
returns works against concentration due
to the higher volatility of a single stock
vs. a diversified equity index, concludes
Mark Teborek, a researcher at Russell
Investments, in a 2018 report. " An allocation
of 20% to employer stock and 80% to
the S&P 500 Index would mean that the
stock would have to outperform the index
3.9% to justify the additional risk. " Such
outperformance, year in and year out,
could be a lot to expect.
Adviser McIlveen strives to remove
company stock from 401(k) investment
lineups but suggests that sponsors
wishing to keep the arrangements
establish a specific monitoring process
that scrutinizes the investment quality of
the shares. This includes reviewing the
audited financial statements, opinions
of sell-side analysts, trading ranges and
market depth. " All of this can be brought
together to tell the sponsor whether the
company stock should be placed on the
watch list. We treat it like any other investment,
and of course sponsors need to
document any decisions. "
While interest
in company
stock is waning,
ESOPs have held
fairly steady.
Vanguard Group publishes periodic
special reports on company stock, and its
most recent, from 2017, painted a picture of
declining interest, from a data set of 1,020
sponsors that had been on their 401(k)
recordkeeping systems continuously
from December 2005 to June 2017. The
percentage of sponsors offering company
stock fell from 11% to 8%, while the
proportion of employees owning company
stock, where offered, dropped from 58%
to 39%. Moreover, among all participants,
those with company stock concentrations
above 20% of their assets went from 17% to
6%. The 2020 PLANSPONSOR Defined
Contribution Industry Report shows that
larger plans-i.e., those with more than
$500 million in assets-offer company
stock more frequently, above 20%, versus
10% or less for smaller plans.
Vanguard points out that plans
with company stock tend to have higher
balances than those without-by 25%.
This is due in part to more generous contribution
policies from those employers, as
well as higher worker deferrals.
While interest in company stock is
waning, ESOPs have held fairly steady.
In the Department of Labor (DOL)'s most
recent tally, ESOPs numbered about 6,500
in 2017, covering 14 million employees
and valued at $1.6 trillion-down 5% in
number but 3% ahead in employees and
up 46% in assets vs. in 2012.
How ESOPs Work
The structure of an ESOP is essentially
different from other types of plans: An
employer, typically a closely held company,
establishes a trust to which it makes contributions
and sells shares to the trust for the
benefit of employees. Employees do not
defer earnings but are allocated shares
from time to time, typically based on their
salary or seniority. McIlveen notes, " The
contributions made by the employer can
be substantial and are not viewed lightly. "
Many ESOPs will include a 401(k)
feature that holds the company shares-
these are deemed " KSOPs. " Complicating
matters a little more, most ESOP employees
also have a second 401(k) without company
shares, with the more typical investment
in diversified portfolios.
Blasi and his Rutgers colleague
Douglas Kruse have studied the power
of ESOPs. " From a data set of companies
with 300,000 employees, we found
that, with employee ownership, there's
evidence of better company performance,
higher employee motivation and reduced
turnover, " Blasi says.
And there is a meaningful payoff to
the ESOP company employees: Based on
Kruse's detailed review of Forms 5500
filed by closely held companies for 2016,
the average account balance was about
$142,000, excluding separate 401(k)
accounts. For that year, Vanguard reported
an average 401(k) account balance in its
recordkeeping universe of about $96,500.
The big differences of ESOPs are probably
not financial but rather of corporate
culture. " The culture at companies with
ESOPs is intense, " McIlveen observes. " It
fosters a heightened expectation among
co-workers that everyone will work hard
and needs to be on the same page. Because
the ESOP contributions are so generous,
we've seen cases where people were able to
retire at very young ages. " -John Keefe
PLANSPONSOR.COM October - November 2020 31
http://www.PLANSPONSOR.COM
PLANSPONSOR - October/November 2020

Table of Contents for the Digital Edition of PLANSPONSOR - October/November 2020
