Do Markets Like Frozen Defined Benefit Pensions? An Event Study

Abstract

An increasing number of North American companies are freezing or terminating their traditional defined benefit (DB) pension plans. In this article we document a positive announcement effect when a publicly traded company discloses that it has partially or fully frozen its DB plan and replaced it with-or enhanced-the 401(k) defined contribution (DC) plan. This positive risk-adjusted return is greater for firms with higher beta and/or lower return on equity (ROE) prior to the freeze. In other words the positive impact is more pronounced for firms that are likely to face financial distress if they maintain their traditional pension plan and the associated long-term promises. Copyright (c) The Journal of Risk and Insurance, 2010.

Effects of pension fund freezing on firm performance and risk

“…Table presents the main results surrounding companies’ abnormal performance. For both conditional and unconditional models, the average (median) companies’ abnormal performance is not significantly different from zero (no signal bias) when analysis periods are shorter, which is the opposite of the short‐term positive average performance obtained by Rubin () and Milevsky and Song (). On one hand, Rubin's () findings can be explained by that study's small sample of only 14 pension fund freezes.…”

“…On one hand, Rubin's () findings can be explained by that study's small sample of only 14 pension fund freezes. On the other, abnormal performance measurements obtained through the market model by Milevsky and Song () were dissociated neither from the effect of systematic risk variations—which can for example be attributed to the announcement effect—nor from the effect of the various risk factors and macroeconomic factors that may be correlated with the regressions’ error terms. McFarland et al (), meanwhile, obtained short‐term abnormal performances that were generally not different from zero, though they were negative on average over a period of nearly 20 days following the announcement.…”

“…Rubin () showed that, across a sample of 14 companies, 50 days following a pension freeze announcement, a company's value increases on average by 10%. Basing their results on an 84‐company sample, Milevsky and Song () showed a nonsignificant average value increase of 3.8% following pension fund freezes. McFarland et al (), however, found that the 82 companies sampled in their study showed negative average financial performance following a pension fund freeze announcement.…”

Corporate Pension Plans

“…Milevsky & Song (2010) document a positive stock price reaction that is more pronounced for firms that are more likely to face financial distress in the future. Rubin (2007) also finds a positive response, but it is lagged.…”

The Revenue Demands of Public Employee Pension Promises

“…See Section III for further details. 8 Our analysis of pension freezes thus relates to a small academic literature on the effects of freezes on costs or firm value, including Comprix and Muller (2010), Milevsky and Song (2010), and Rauh and Stefanescu (2009). 1.7%. This assumption implies that the nominal value of assets grows at inflation plus 1.7%.…”