[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]
