Does Social Conformity Influence Portfolio Choice? Evidence from 401(K) Allocations

Abstract

Financial researchers agree that allocating money to employer stock in a 401(k) plan is a poor strategy, yet many employees do so. Not only does this investment strategy bear unrewarded idiosyncratic risk, but it also correlates employees' retirement portfolios with their human capital. I find evidence that social conformity contributes to this selection. Specifically, the percentage allocated to company stock by employees in the 401(k) plan is positively related to both the net open-market purchases of company stock by management and the percentage of the defined benefits plan invested in company stock. Surprisingly, the allocation to company stock in 401(k) plans increases with investment in employee stock ownership plans (ESOPs), which are a dominant substitute since they often offer stock at a discount. Lastly, I provide additional support for the social conformity hypothesis through interaction tests. The relationship between employees and management is influenced by geographic dispersion and trust within the firm -- two factors that alter group cohesion and, in turn, social conformity.