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Funding and Asset Allocation in Corporate Pension Plans: An Empirical Investigation

In: Issues in Pension Economics

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  • Zvi Bodie
  • Jay O.. Light
  • Randall Morck

Abstract

This paper contrasts and empirically tests two different views of corporate pension policy: the traditional view that pension funds are managed without regard to either corporate financial policy or the interests of the corporation and its shareholders, and the corporate financial perspective represented by the recent theoretical work of Black (1980), Sharpe (1916),Tepper (1981), and Treynor (1971), which stresses the potential effects of a firm's financial condition on its pension funding and asset allocation decisions. We find several pieces of evidence supporting the corporate financial perspective. First, we find that there is a significant inverse relationship between firms' profitability and the discount rates they choose tor eport their pension liabilities. In view of this we adjust all reported pension liabilities to a common discount rate assumption. We then find a significant positive relationship between firm profitability and the degree ofpension funding, as is consistent with the corporate financial perspective. We also find some evidence that firms facing higher risk and lower tax liabilities are less inclined to fully fund their pension plans. On the asset allocation question, we find that the distribution of plan assets invested in bonds is bi-modal, but that it does not tend to cluster around extreme portfolio configurations to the extent predicted by the corporate financial perspective. We also find that the percentage of plan assets invested in bonds in negatively related to both total size of plan and the proportion of unfunded liabilities.The latter relationship shows up particularly among the riskiest firms and is consistent with the corporate financial perspective on pension decisions.

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This chapter was published in:

  • Zvi Bodie & John B. Shoven & David A. Wise, 1987. "Issues in Pension Economics," NBER Books, National Bureau of Economic Research, Inc, number bodi87-1, October.
    This item is provided by National Bureau of Economic Research, Inc in its series NBER Chapters with number 6852.

    Handle: RePEc:nbr:nberch:6852

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    References

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    1. J. Michael Harrison & William F. Sharpe, 1982. "Optimal Funding and Asset Allocation Rules for Defined-Benefit Pension Plans," NBER Working Papers 0935, National Bureau of Economic Research, Inc.
    2. Treynor, Jack L, 1977. "The Principles of Corporate Pension Finance," Journal of Finance, American Finance Association, American Finance Association, vol. 32(2), pages 627-38, May.
    3. Zvi Bodie & John B. Shoven, 1983. "Financial Aspects of the United States Pension System," NBER Books, National Bureau of Economic Research, Inc, number bodi83-1, October.
    4. Martin Feldstein & Randall Morck, 1983. "Pension Funding Decisions, Interest Rate Assumptions, and Share Prices," NBER Chapters, in: Financial Aspects of the United States Pension System, pages 177-210 National Bureau of Economic Research, Inc.
    5. Irwin Tepper, 1981. "Taxation and Corporate Pension Policy," NBER Working Papers 0661, National Bureau of Economic Research, Inc.
    6. Sharpe, William F., 1976. "Corporate pension funding policy," Journal of Financial Economics, Elsevier, Elsevier, vol. 3(3), pages 183-193, June.
    7. Bodie, Zvi & Shoven, John B. (ed.), 1983. "Financial Aspects of the United States Pension System," National Bureau of Economic Research Books, University of Chicago Press, edition 0, number 9780226062815.
    8. Miller, Merton H, 1977. "Debt and Taxes," Journal of Finance, American Finance Association, American Finance Association, vol. 32(2), pages 261-75, May.
    9. Tepper, Irwin, 1981. "Taxation and Corporate Pension Policy," Journal of Finance, American Finance Association, American Finance Association, vol. 36(1), pages 1-13, March.
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    Cited by:
    1. Comprix, Joseph & Muller III, Karl A., 2011. "Pension plan accounting estimates and the freezing of defined benefit pension plans," Journal of Accounting and Economics, Elsevier, Elsevier, vol. 51(1-2), pages 115-133, February.
    2. Joseph G. Haubrich & James B. Thomson, 1994. "A conference on federal credit allocation," Economic Review, Federal Reserve Bank of Cleveland, Federal Reserve Bank of Cleveland, issue Q III, pages 2-13.
    3. Cocco, Joâo Francisco P.D. & Volpin, Paolo, 2005. "The Corporate Governance of Defined-Benefit Pension Plans: Evidence from the United Kingdom," CEPR Discussion Papers, C.E.P.R. Discussion Papers 4932, C.E.P.R. Discussion Papers.
    4. Choy, Helen & Lin, Juichia & Officer, Micah S., 2014. "Does freezing a defined benefit pension plan affect firm risk?," Journal of Accounting and Economics, Elsevier, Elsevier, vol. 57(1), pages 1-21.
    5. Josa-Fombellida, Ricardo & Rincón-Zapatero, Juan Pablo, 2012. "Stochastic pension funding when the benefit and the risky asset follow jump diffusion processes," European Journal of Operational Research, Elsevier, Elsevier, vol. 220(2), pages 404-413.
    6. An, Heng & Huang, Zhaodan & Zhang, Ting, 2013. "What determines corporate pension fund risk-taking strategy?," Journal of Banking & Finance, Elsevier, Elsevier, vol. 37(2), pages 597-613.
    7. Kalra, Raman & Jain, Gautam, 1997. "A continuous-time model to determine the intervention policy for PBGC," Journal of Banking & Finance, Elsevier, Elsevier, vol. 21(8), pages 1159-1177, August.
    8. Lila J. Truett & Dale B.Truett, . "Firm Size and Efficiency in the South African Motor Vehicle Industry," Working Papers, College of Business, University of Texas at San Antonio 0021, College of Business, University of Texas at San Antonio.
    9. Julia Lynn Coronado & Steven A. Sharpe, 2003. "Did Pension Plan Accounting Contribute to a Stock Market Bubble?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 34(1), pages 323-371.
    10. Li Jin & Robert Merton & Zvi Bobie, 2004. "Do a Firm's Equity Returns Reflect the Risk of Its Pension Plan?," NBER Working Papers 10650, National Bureau of Economic Research, Inc.

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