Are ESOPs Still a Good Idea for Employee Retirement Security?

In the face of the stock market's sharp decline, more people are calling for a reduction of employer stock in retirement plans. While this has focused primarily on 401(k) plans so far, critics of ESOPs will surely add their voices to argue that companies should not be encouraged to make these plans part of their retirement packages.

Data from the NCEO and other researchers show this would be a serious error. First, ESOP companies are much more likely to have a diversified retirement plan alongside the ESOP than comparable companies are to have any kind of retirement plan at all, a relationship that is especially strong in the companies with fewer than 100 employees, where only 34% of companies have any kind of retirement plan. Just less than half the work force is even eligible for any kind of retirement plan. Companies that do have retirement plans generally contribute only about 3% to 4% of pay per year to the plans, and that money disproportionately goes to more highly paid workers because it is in the form of a match based on employee deferrals. Moreover, many lower paid employees do not defer anything and thus are left out altogether. In ESOPs, by contrast, all employees meeting the basic eligibility requirements (the same as those for 401(k) plans) get contributions of the same percentage of pay or, in some companies, contributions even more tilted to lower-paid employees. Typical ESOP contribution rates are about 6% of pay per year, based on Form 5500 data, and companies usually make contributions to their other retirement plans as well. So yes, the employees are less diversified in their ESOP accounts, but 56% of the work force is not in any kind of retirement plan. Even in the uncommon case that the ESOP is the only retirement plan and never becomes at all diversified (most do over time, at least somewhat) that beats being 100% diversified in nothing.

In a response to my blog posting on this topic, Dallas Salisbury, head of the Employee Benefit Research Institute, the most credible source of retirement plan data in the U.S., had this to say about this issue:

"[Companies] that use an ESOP alone might choose to do nothing if the ESOP was not available as a voluntary option, and those workers would be worse off as a result.

"Labor economics argues that all that ESOP money would be paid as added wages if it did not go for the ESOP, but most employers say that is seldom true. And, even if true over the very long term in the aggregate, it is not true on an individual by individual basis. Thus, many workers are getting ESOP savings that would get nothing above the current wage level were the ESOP not to exist.

"The investment diversification issue misses this added value in place of nothing added (in) reality. Being a voluntary system, even a worthy objective like investment diversification should not be allowed to result in no savings for the worker. The rules must be balanced with the facts of voluntarism and added value."