A Lesson From Bear: Don't Hold Large Chunks of Company Stock

Amidst the fallout from Bear Stearns' collapse is word that employees are out some $5.2 billion as the company's stock plummeted.

Like many other Wall St. firms, Bear has an employee stock ownership plan and about a third of outstanding stock is held by workers.

(It's unclear, however, how many employees had a large portion of their portfolios in Bear stock. On one hand, people working at an investment bank might be expected to be knowledgeable enough to avoid concentrated positions, but then again, Bear has been proud of its partnership roots so ownership of company stock was encouraged.)

But while Bears' demise is an outlier, it still highlights the potentially large risk in tying up a large portion of your savings in company stock.

Across the country, employee stock ownership is on the rise -- at least through 2007 -- according to The National Center for Employee Ownership. Over 11 million employees in the U.S. participated in ownership plans worth $928 billion in 2007, up nearly 40 percent from 2006's $675 billion figure. Outside of the world of employee stock ownership plans, some 11 million 401(k) plan participants are estimated to hold at least 20 percent of their retirement portfolios in company stock.

Defenders of stock ownership plans point to the tax benefits employees are eligible for and the "ownership culture" that the plans foster.

But a survey of employees conducted jointly by researchers at the University of Chicago, UCLA, and Vanguard published last year in the The Journal of Law & Economics found that less than 10 percent of employees were aware of the tax breaks.

The research also found very little support for the idea that companies with such plans experience gains in productivity. In fact, there was evidence that employees might actually become less motivated during a bear market.

The lesson from this, of course, is that diversification is the way to go, especially if you work at a large company like Bear where it's much harder to see how productivity improvements by one peon impact the bottom line.

But the real kicker comes from this bit of research by Lisa Meulbroek of Claremont McKenna College in California. When taking into account the risks associated with owning company stock in an undiversified portfolio for workers who expect to stay with a company for a long time, she found that one dollar of company stock was only worth 50 cents. For Bear Stearns employees, it's much less than that.

UPDATE
Corey Rosen, the cofounder of the National Center for Employee Ownership, writes helpfully in the comments that:

There were three retirement plans with about $1.35 billion at the end of 2007. The employee stock ownership plan (ESOP) owned $285 million in Bear Stearns stock, under 3%. So from a retirement asset standpoint, employees lost about 22% of their retirement assets.

Read the rest of his comment for another viewpoint.