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Creating Value In Pension Plans (Or, Gentlemen Prefer Bonds)

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  • Jeremy Gold
  • Nick Hudson
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    Abstract

    Pension funds are typically one-half to two-thirds invested in equities because equities are expected to outperform other financial assets over the long term, and the long-term nature of pension fund liabilities seems well suited to absorbing any short-term return volatility. What's more, U.S. GAAP currently makes it possible to take credit in advance for the higher anticipated earnings on equity investments without acknowledging their inherent risk. But by allowing the higher expected returns from stocks to reduce a company's current pension expenses, the accounting treatment conflicts with some very basic principles of finance (in particular, the idea that investors must earn higher returns on riskier investments just to "break even"), conceals systematic biases in the actuarial analysis, and gives managers considerable latitude to manipulate the bottom line. 2003 Morgan Stanley.

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    Bibliographic Info

    Article provided by Morgan Stanley in its journal Journal of Applied Corporate Finance.

    Volume (Year): 15 (2003)
    Issue (Month): 4 ()
    Pages: 51-57

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    Handle: RePEc:bla:jacrfn:v:15:y:2003:i:4:p:51-57

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    Cited by:
    1. Jeffrey R. Brown, 2007. "Guaranteed Trouble: The Economic Effects of the Pension Benefit Guaranty Corporation," NBER Working Papers 13438, National Bureau of Economic Research, Inc.
    2. David Love & Paul Smith & David Wilcox, 2007. "Why Do Firms Offer Risky Defined Benefit Pension Plans?," Department of Economics Working Papers 2007-04, Department of Economics, Williams College.
    3. David A. Love & Paul A. Smith & David Wilcox, 2009. "Should risky firms offer risk-free DB pensions?," Finance and Economics Discussion Series 2009-20, Board of Governors of the Federal Reserve System (U.S.).

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