ORGANIZATION OF PENSION FUNDS
Enron Corporation sponsored a 401(k) pension plan for its employees, the plan allowed the employee to contribute up to 15% of his or her salary, subject to a ceiling. Enron Corporation made a matching contribution of half of what the employee contributed. The sums contributed by both employee and employer were tax deferred under sections 401(a) and 401(k) of the Internal Revenue Code. The plan provided that Enron's contribution would be entirely in Enron stock. The employee-participant could choose to invest his or her contribution among a wide range of choice, including leading well-diversified mutual funds or more Enron stock. The plan required employee-participant to hold the employer-contributed Enron shares until the age of 50.Only at that age could he or she direct that the Enron shares be sold and the proceeds redirected into other investments. With respect to this match shares, the plan made the employee-participants into the involuntary Enron shareholders until the age of 50(John H. Langbein, 2000).
After the ERISA (Employment Retirement Income Security) Act was passed the DB (Defined Benefit) plan was gradually replaced by the DC (Defined Contribution) plan.ERISA Act was amended to address concerns with the increased exposure to company stock risk. The passage of the 1997 Taxpayer Relief Act prohibited employers from mandating that employees invest more than 10% of their own contributions in company stock unless the employees could reallocate those investments. The rule did not prohibit employers from directing employer contributions (as a match or otherwise) into company stock.
Pension Security Act of 2002 includes a provision to allow plan participants to sell company stock holdings no more than 3 years after they receive it.
The Protecting America's Pensions Act of 2002 would prohibit employers from requiring that any elective employee contributions to a non-ESOP plan be invested in company stock, and mandate that employees are able to sell company stock purchased with employer contributions (Mitchell and Utkus, 2002).
Enron was a highly valued company the employees had become loyal with time and they invested their pension in the stock option. The returns were high and secure so they did not opt to diversify their investments elsewhere, investments in company stock improved the efficiency of the employment contract and benefited both the employer and the worker.All the employees of the company comply to the same rules as they too conform to ESOPs(Employee Stock Ownership Plans).The only difference is that the top managers are allocated a higher number of shares than the ordinary employees by virtue of their managerial enterprise in the.A pension fund portfolio holding a massive part of its assets in any one stock is bad; but holding such a concentration in the stock of the employer is worse. For the employees of any firm, diversification away from the stock of that employer is even more important. The simple reason is that the employee is already horrifically under diversified by having his or her human capital tied up with the employer. The employee is necessarily exposed to the risks of the employer by virtue of the employment relationship. The last thing in the world that the employee needs is to magnify the intrinsic under diversification of the employment relationship, by taking his or her diversifiable investment capital and tying that as well to the fate of the employer. The Enron debacle illustrates this point poignantly. Just when many of the employees have lost their jobs, they have also lost their pension savings, which in a 401(k) plan they could have borrowed against (or with a penalty, withdrawn) in order to tie them over. The argument is that employers want to incentivize employees to identify with the stockholders of the firm. Making employees into stockholders will motivate them to care about the firm's profitability. Moral point of view: If you want to sell stock to your employees for such sound business reasons, go right ahead and do so (subject to adequate disclosure of the risks--a subject to which I shall return). But you should not be able to treat such a program as a pension fund, for two very good reasons: It abuses the pension tax subsidy and it misleads employee-participants. Under commonly accepted principles of good investment practice, a retirement account should be invested in a broadly diversified portfolio of stocks and bonds. It is particularly unwise for employees, who are already subject to the risks incident to employment, to hold significant concentrations of employer stock in an account that is meant for retirement saving. In conclusion in general terms the company should have a vigilant and motivated board of trustees. The option between professional outsiders or caring insiders depends on whether career incentives to outsiders are expected to function effectively. If the sponsor and the beneficiary have complete contracting ability the allocation of residual claim becomes irrelevant from a governance point of view. The problem is present is also in defined benefit plans if there is a possibility of insolvency.Underfunding is not an issue in defined contribution plans but it can be a problem in defined benefit plans if there is a possibility of insolvency(Besly and Prat 2003).
Work cited:
Mitchell and Utkus, Company Stock and Retirement Plan Diversification Pension Research Council Working Paper Philadelphia, A; University of Pennsylvania Pension Research Council, April 2002.
Besley and Prat, A. Pension Fund Governance and The Choice Between Defined Benefit and Defined Contribution Plans, London School of Economics, 1st June 2003 <http://www.lse.ac.uk/ubs/>
