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

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  • Jeremy Gold
  • Nick Hudson

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.

Suggested Citation

  • Jeremy Gold & Nick Hudson, 2003. "Creating Value In Pension Plans (Or, Gentlemen Prefer Bonds)," Journal of Applied Corporate Finance, Morgan Stanley, vol. 15(4), pages 51-57.
  • Handle: RePEc:bla:jacrfn:v:15:y:2003:i:4:p:51-57
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    Cited by:

    1. David A. Love & Paul A. Smith & David W. 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.).
    2. Jeffrey R. Brown, 2008. "Guaranteed Trouble: The Economic Effects of the Pension Benefit Guaranty Corporation," Journal of Economic Perspectives, American Economic Association, vol. 22(1), pages 177-198, Winter.
    3. Love, David & Smith, Paul A. & Wilcox, David, 2007. "Why Do Firms Offer Risky Defined–Benefit Pension Plans?," National Tax Journal, National Tax Association, vol. 60(3), pages 507-519, September.
    4. Samuel H. Cox & Yijia Lin & Ruilin Tian & Jifeng Yu, 2013. "Managing Capital Market and Longevity Risks in a Defined Benefit Pension Plan," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 80(3), pages 585-620, September.
    5. David W. Wilcox, 2006. "Reforming the Defined-Benefit Pension System," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 37(1), pages 235-304.

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