Employee stock ownership and diversification

A small to moderate size investment in company stock results in a relatively small increase in the riskiness of an employee’s portfolio, even if the company’s volatility is substantially greater than that of a diversified portfolio which we assume the employee would hold otherwise. Thus the employee suffers relatively little loss in “expected utility” from such an investment, whether or not the extra motivation due to this investment by the employee and his or her colleagues leads to an increase in productivity. However, increasing the investment beyond certain limits leads to substantial, and increasingly large, increments in the riskiness of the portfolio. This article presents the theory behind these assertions, and presents a plausible numerical example of the effects described. This example implies that the optimal investment in company stock in a diversified portfolio is $8\frac{2}{3}\%$ while a higher amount of ten or even fifteen percent would not be imprudent. Copyright Springer Science+Business Media, LLC 2010