Corporate Pension Plans

Abstract

This article reviews the rich and vast literature on defined-benefit (DB) corporate pension plans. The analysis of how firms react to the taxation and regulation of pension plans and to the guarantees provided by the government has allowed researchers to test alternative corporate finance theories, including risk-shifting and risk management. The difficulty in measuring the value of pension liabilities has motivated the study of whether such liabilities are reflected in the cost of capital and in the value of sponsoring firms. The study of the sponsoring firms' reaction to mandatory pension contribution has provided evidence on financing constraints and on the free-cash-flow hypothesis. Pension plan terminations and freezes have shed light on the nature of the employment contract between the firm and workers.

Pension Deficits and the Design of Private Debt Contracts

“…Cash holdings are more valuable to these firms than to firms with easy access to financial markets (Faulkender and Wang (2006)). Larger pension deficits increase the risk of cash shortfalls because larger pension deficits require larger mandatory contributions (Cocco (2014)). Because cash shortfalls have a more severe impact on financially constrained firms, we argue that the effect of pension underfunding on the cost of bank loans should increase with the degree of financial constraints.…”

“…Extant research reveals that understanding the level of pension funding is rather complex due to numerous regulations and actuarial assumptions (Bergstresser, Desai, and Rauh (2006), Cocco and Volpin (2013), and Comprix and Muller (2011)). In addition, simply focusing on the size of pensionplan deficits and ignoring the risks of pension assets and liabilities may give an incomplete picture of the risks arising from the pension plan (Cocco (2014)). Indeed, prior empirical studies examine the stock market reaction to pensionfunding decisions and yield mixed results.…”

“…Besides the level of underfunding in the DB pension plan, the sponsoring firm has discretion to determine the plan's investment policy (Rauh (2009)). Cocco (2014) points out that the amount of pension underfunding may not fully reflect the risk of DB pension plans because it does not capture the riskiness of pension investment. As such, we examine the combined effect of pension underfunding and the risk of pension-investment policy on loan costs and find that the effect of pension deficits on loan costs is acutely strong when the borrower adopts a risky investment strategy in the pension plan.…”

The Dark Side of Hedge Fund Activism: Evidence from Employee Pension Plans

“…The liabilities of the plan are the pension promises that the firm has made to its employees, and the assets of the plan fund these liabilities. Underfunding means that a plan has more liabilities than assets, implying that fund assets may be insufficient to keep its promises (Cocco, 2014). Thus, any deterioration in the pension plan such as underfunding in a DB plan can have a significant impact on employees' welfare after retirement.…”

“…Second, what are the factors that affect the financial stability of employee pension plans? This question is important because underfunding of employee pension plans puts a potential burden on (1) taxpayers via the guarantees provided by the Pension Benefit Guarantee Corporation (PBGC) and (2) workers whose promised pensions exceed insurance limits (Cocco, 2014). This paper sheds light on both these issues by examining how employee pensions fare when firms become targets of HF activists.…”