Financial Sophistication and Conflicts of Interest: Evidence from 401(k) Investment Menus

Abstract

We analyze the investment menus offered within 401(k) pension plans to the employees of the largest finance and non-finance firms. Within the sample of finance firms, we distinguish between finance firms that hire an external independent trustee and finance firms that serve also as a trustee of their own pension plan. We find that employees of finance firms with an external trustee invest less in sponsor equity and options affiliated with the trustee as compared to those of non-finance firms and of finance firms with an internal trustee. The changes of mutual funds on the investment menu offered by finance firms with an independent trustee are also more sensitive to past performance and their plan participants benefit from the removal of underperforming mutual funds. These findings suggest that greater financial sophistication among plan participants and the sponsoring company can improve the quality 401(k) menus, but only when it is accompanied with an independent governance structure.