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2-1.4. Endorsement Effects

Course video 19 of 58

In Module 2, we discuss the investment decisions of participants in defined-contribution (DC) pension plans like 401(k) plans in the U.S. Not falling prey to common behavioral biases is key to sound financial decision-making in these retirement plans, so we will discuss common behavioral biases of DC pension plan participants.

Investments II: Lessons and Applications for Investors

伊利诺伊大学香槟分校

課程 4（共 7 門，财务管理專項課程）

In this course, you will start by reviewing the fundamentals of investments, including the trading off of return and risk when forming a portfolio, asset pricing models such as the Capital Asset Pricing Model (CAPM) and the 3-Factor Model, and the efficient market hypothesis. You will be introduced to the two components of stock returns – dividends and capital gains – and will learn how each are taxed and the incentives provided to investors from a realization-based capital gains tax. You will examine the investment decisions (and behavioral biases) of participants in defined-contribution (DC) pension plans like 401(k) plans in the U.S. and will learn about the evidence regarding the performance of individual investors in their stock portfolios. The course concludes by discussing the evidence regarding the performance of actively-managed mutual funds. You will learn about the fees charged to investors by mutual funds and the evidence regarding the relation between fees charged and fund performance. Segments of the portfolios of mutual funds that may be more likely to outperform and examples of strategies designed to “earn alpha” will also be introduced. Learners are welcome to take this course even if they have not completed "Investments I: Fundamentals of Performance Evaluation," as the first module contain a review of investment fundamentals and regression analysis to get everyone up to speed. Also, the course contains several innovative features, including creative out-of-the-studio introductions followed by quick-hitting "Module in 60" countdowns that highlight what will be covered in each module, four "Faculty Focus" interview episodes with leading professors in finance, and a summary of each module done with the help of animations! This course is part of the iMBA offered by the University of Illinois, a flexible, fully-accredited online MBA at an incredibly competitive price. For more information, please see the Resource page in this course and onlinemba.illinois.edu.

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Stock, Financial Markets, Investment Strategy, Investment

教學方

Scott Weisbenner
William G. Karnes Professor of Finance

腳本

[MUSIC]

>> So, ticking down our list here of behavioral biases that we want

to talk about in the context of investment decisions in DC pension plans,

next on the docket, endorsement effect.

So what do we mean by endorsement effect?

Well, first a little, kind of, background,

firms are very reluctant in a litigious society to give any form of investment

advice to pension plan participants, for fear of being sued.

So what's kind of an implication that kind of comes from that?

Well, participants may then try and interpret a firm's choice of the pension

plan structure, such as the type of investment options that are available,

whether the firm contributes to company stock, or cash,

as providing suggestions to the worker as to how to invest.

So, for example, I look at the plan and, the firm is giving me a match in

company stock, maybe the firm thinks company stock is a good investment,

maybe, therefore, I should put more in company stock.

Or we see the firm has a plan, there's ten options, seven of which are stock funds,

maybe the firm is trying to send me a signal, hey, you should invest a lot

in stock because seven out of the ten options are stock related investments.

The firm may not even be trying to send these signals at all but

it might be natural for participants to try and

interpret these planned parameters as maybe providing investment advice.

Okay, so thus, planned details may provide perceived cues to participants

as how they should invest, even if that isn't the intention.

Okay, so let's think about this endorsement effect, and

how it might affect behavior here.

We know when we see Le Penseur, we know what that means, so what's the question?

Well, suppose you work for a firm, and

that firm will provide matching contributions to you.

So the employer is contributing contributions to your retirement plan,

and let's say these matching contributions represent 50% of your

contributions to the plan, which should be a typical match, I contribute $10,000,

the firm will add $5,000.

Would you invest more or less of your contributions in your firm's stock

if your employer matches in company stock instead of matching in cash,

which then you can invest however you want?

So the employer is giving you a match.

Are you going to put more of your own contributions in company stock

if you see your employer matching you in company stock?

So let's think about that and then I will give you my take.

Okay, so let's think about this question.

The employer match is sizeable, so you give a $10,000 contribution,

your employer gives $5,000, that $5,000, instead of being in cash,

let's say it's the stock of your company.

So if you work at Ford, it's $5,000 of Ford stock,

how are you going to respond to that, okay?

Well Finance 101 would suggest, wow, I've just been given $5,000 of Ford stock,

I don't need anymore Ford stock, given my total investment is $15,000,

that's going to make me less likely to invest in Ford with my own contributions,

but behaviorally, maybe it could actually cause you to invest more in Ford stock.

You might say wow, Ford is putting all this money, and this is just

a hypothetical example here, Ford is putting all this money, giving it to me in

their stock, maybe they think their stock is going to go up a lot in the future,

maybe I should respond by investing even more of my money and company stock.

That would be the endorsement effect prediction here.

So, Benartzi, in his 2000 work, and me and

some work with Jeff Brown and Nellie Liang, we actually find support for

this endorsement effect that we find in the cross section participants at firms

that provide an employer matching contribution in company stock,

invest more of their own contributions in company stock, not less.

So this is clearly opposite of what you'd expect from portfolio

diversification perspective, and is consistent with an endorsement effect,

that people see their employer giving them stock,

they put more of their own contributions in company stock, not less.

Not surprisingly, we also find that firm-level heterogeneity is also important

in understanding why some firms' workers put more in company stock than others.

You can think there's a lot of differences across firms

besides just match policy in the 401k plan.

For example, some companies do a better job creating a company culture

that may cause their workers to invest in company stock there.

But certainly in the cross-section, a lot of evidence for this endorsement effect,

seeing how workers respond to a match that's in company stock.

All right, so let's do one final Le Penseur question here, and

this is relevant for any of you who might be in a human resources department.

So, suppose you're in this human resources department, you wish to restrict how much

workers invest in company stock but you don't want to have an outright ban.

How can you set up the plan so

that company stock investments are likely limited, without materially affecting

the investment options in the plan that are available for the participants?

So you want to send a signal like, hey, don't invest too much in company stock,

but you don't want to kind of have any kind of outright ban.

You don't want to materially affect a participant's choice

over investment options.

So let's use our insights from behavioral finance

to kind of structure the plan in the right way.

So think about this, and then I'll give you a suggestion after the break.

So here is one way that you could accomplish this by sending a signal that

hey, think about investing company stock but

not materially affecting investment choices, just to have a prohibition

that no more than 50% of your portfolio can be in company stock.

So that seems like, hey, is that likely to be a binding constraint?

That seems like a, you might say it's pretty high, right, no more than 50%.

Some people propose that we shouldn't allow 401K participants to invest anything

in their company's stock.

Now, from an economics point of view, it'd say hey, you set the constraints so

high it's not really useful, like 50% for a limit is too high, but behaviorally,

just by having any limit, is enough to signal, hey, you should maybe be thinking

about company stock and its potential risk, particularly if given this

is a firm where you work for, so that endorsement effect could be very powerful,

even if the limit you set is high, because it gets people thinking about it.

[SOUND]

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