How does the Funding Status of Defined Benefit Pension Plans Affect Investment Decisions of Firms in the United States?

Abstract

We investigate whether the flexibility in making contributions towards defined benefit pension plans sponsored by firms in the United States allows managers to save cash and increase investments. Firms invest more at higher levels of pension deficit, defined as pension benefit obligations less pension assets, and scaled by total assets. At the median level (90 th percentile) of pension deficit, investments increase by 6.7 cents (9.4 cents) for every dollar increase in cash. As the pension deficit increases, firms deviate more from the predicted level of investment. These findings suggest that the incremental investments are more likely to represent overinvestment by managers. Our results are robust to alternative model specifications and endogeneity concerns that may arise if investments are jointly determined with the funding policy of pension plans and the firm's target cash level. We repeat our main analysis for the United Kingdom and also find for that country that, at a fixed cash level, total investment increases as pension deficit increases.

Executive compensation and cash contributions to defined benefit pension plans

“…A more balanced view will be that pension contributions and investment/financing decisions are jointly determined. This view is consistent with recent research documenting that, as the level of underfunding increases, firms are more likely to engage in overinvestment (Chaudhry, Au Yong, & Veld 2017).…”

“…When a firm faces financial constraints, a dollar contributed to the pension plan is a dollar less available for other purposes. A firm might delay pension contributions if the benefit of the alternative use of cash is high, or if the cost of ignoring alternative demands for cash is high (Chaudhry et al, 2017). Thus, pension contributions can be jointly determined with other needs for cash.…”

“…Firms may face political costs and public scrutiny if their DB plans are labeled as high risk by the PBGC. However, research has highlighted the flexibility management has in the contribution decision, suggesting these mechanisms may not be binding (Chaudhry et al., ). Therefore, our analyses add to the literature that speaks to the effectiveness of these mechanisms put in place by regulators and the PBGC (Guan & Lui, ).…”

CEO overconfidence and corporate risk taking: Evidence from pension policy

“…An overconfident manager who believes she can earn superior returns in a firm's other projects would most likely exhibit similar behavior when it comes to their pension fund decisions. For example, Chaudhry et al (2017) argue that managers in the US intentionally underfund their pension plans to build financial slack for new investments.…”

Ask of National Pension Service for Higher Dividend and Firm Value: Evidence from Korea

“…We use variables that are known to affect investment in previous studies as control variables [11,12]. Since the firm size and profitability affect investment, SIZE, which takes natural logarithm of total assets, and ROA, which shows profitability, are used as control variables.…”