These plans receive tax benefits in that contributions and earnings are nottaxed to individuals until received as pensions (or payments on separation). These plans fall into twobasic types: defined benefit plans (where workers are guaranteed a certain benefit related to earningsand years of service) and defined contribution plans, where employees receive benefits based on thesize of assets and accumulated earnings. Employer stock may be one of the choices; employercontributions may also be made in the form of employer stock. Only defined benefit plans have restrictions on theamount of employer stock that can be held (10%). Some types of plans with retirement features(Employee Stock Ownership Plans, or ESOPs) must hold assets primarily in the form of employerstock. Plans may be combined. Tax benefits are also provided for acquiring employer stock that is not restricted to retirement plans. These problems apply bothto general education and to certain types of on-the-job training. One way that firms may attempt to remedy this problem is through use of stock options(which provide employees an incentive to increase the firm's value) and stock ownership plans,which provide some alignment with the shareholders' objectives. (2)
Employee stock ownership can also work against shareholder interests and economic efficiency. Firms where employees hold a large fraction of stock are more impervious to hostile takeovers, asemployees and managers may otherwise fear loss of pay and jobs in such a circumstance. Rationales for Government Intervention

The previous section has suggested private motives even in the absence of tax benefits fordefined benefit pension plans and for stock ownership plans, but there does not appear to be a strongprivate rationale for defined contribution plans not held in the form of employer stock. Clearlyanother reason for pension and profit sharing plans that may play a crucial role in encouraging theseplans, particularly defined contribution plans not invested in employer stock, is the tax benefitsassociated with them. And why should it intervene with mixed signals, including both benefitsfor and restrictions on ownership of employer stock in pension plans? For example, rules mandating earlyvesting are in conflict with objectives to increase on-the-job training (objectives that might be worthyof pursuit by the government as well), although they may be appropriate to increase pension coverageand employee security. Economic problems arising from principal-agent costs or worker monitoring costs may beargued to justify government subsidies to stock ownership plans to increase efficiency beyond whatprivate markets may do. However, they are unlikely to be addressed by ownership of employerstock among rank and file employees of large companies, where most tax subsidies for pensions aredirected. It would appear better for administrative and other reasons to impose the limits on the share of contributions made ratherthan the share of assets. Of course, investmentadvice is not costless, and it could significantly discourage the use of these plans in the case of smallfirms. Moreover, virtually any independent investment advisor would counsel against holding alarge part of retirement assets in a single stock, but many advisors would suggest taking on generalstock market risk.
The loss of retirement assets held in Enron stock by Enron employees has stimulated proposals to restrict the holding of employer stock in retirement plans, and other proposals to regulate theseplans. Stock in the Enron plan came from firm contributions in the form of stock that was notallowed to be sold and from voluntary investment by employees. This report focuses on rationalesfor providing employer retirement plans and for holding (or not holding) employer stock in theseplans, both from the perspective of the private sector and of government policy.
Retirement plans fall into two types: defined benefit plans, where a pension based on earningsand years of service is provided; and defined contribution plans, where individuals receive benefitsbased on accumulated principal and interest. Either plan can hold employer stock, but holdings arelimited to 10% of assets in the case of defined benefit plans. These plans receive tax subsidies, asdo employee stock purchase plans and certain types of stock options.
The analysis suggests that there are economic reasons that firms and employees may engage in pension and profit sharing (or stock ownership) plans even in the absence of tax subsidies. Pensionplans, primarily defined benefit plans, may be attractive for administrative and risk-reductionreasons, for dealing with inadequate investment in on-the-job training, and for smoothing theretirement of older workers. Stock options and stock ownership plans may be useful for addressinginconsistency in objectives between shareholders and managers and worker monitoring problems,although these benefits are not likely to accrue to stock ownership by the rank and file of largecompanies. These employee stock ownership plans may also deter hostile takeovers, which mayundermine economic efficiency and stockholder interests. Stock contributions are also popularbecause they do not reduce cash flow, which has both benefits and costs from an economic efficiencyperspective.
Government subsidies to plans may be justified to increase retirement incomes and access to annuities because of a shortfall in optimal savings and certain economic problems with self selectionin purchasing annuities. These objectives also underlie the justification of Social Security. Pursuingthese goals may actually conflict with another worthy objective, on-the-job training. However,objectives that are addressed via employee stock ownership do not appear important in shaping thenature of large, broadly-based, retirement plans. Diversification of plan assets and prudentinvestment portfolios do appear consistent with rationales for government intervention.
Attempts to address this issue might take several forms: restrictions on shares of employer stock in plans, prohibiting employer stock contributions or lifting restrictions on sale, denying a taxdeduction on employer contributions until they could be sold, and requiring independent investmentadvice. The last proposal is not costless and could undermine participation for small firms. Foradministrative and other reasons, it may be rational to impose share restrictions on allocations ofcontributions, rather than on assets. There are no plans to update this report.