401(k)s as Strategic Compensation: Align Pay with Productivity and Enable Optimal Separation

Companies are increasingly compensating employees with 401(k)s. Other forms of compensation, including defined benefit (DB) pensions, are thought to affect employee behavior and improve workforce productivity. Ippolito (1997) suggests that if individual discount rates and productivity are related then 401(k)s affect productivity. However, empirical results are limited to public sector employees and are inconclusive. Results presented in this paper from a new data set of a representative sample of private sector firms indicate that discount rates and productivity are negatively correlated. This allows 401(k)s, through the employer match, to align pay with productivity. Furthermore, additional tests show that 401(k)s increase workforce productivity by inducing less productive workers to leave their jobs in order to access 401(k) lump sum distributions. These results have implications for how 401(k)s affect workers, how firms should design their retirement plans, and for federal regulation and public pension plans such as Social Security.