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Financing Constraints and the Cost of Capital: Evidence from the Funding of Corporate Pension Plans

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  • John L. Campbell
  • Dan S. Dhaliwal
  • William C. Schwartz

Abstract

We investigate the relation between firms' weighted average cost of capital and internal financial resources, using mandatory pension contributions as a proxy for internal financial resources. Rauh (2006) documents a negative association between mandatory pension contributions and capital expenditures. We find that an increase in mandatory pension contributions increases the cost of capital, but only for firms facing greater external financing constraints. Our results suggest that firms' cost of capital is an intervening variable that can explain Rauh's finding that mandatory pension contributions (i.e., internal financing constraints) result in foregone investment. Overall, we provide evidence consistent with recent studies (Rauh 2006; Almeida and Campello 2007) that conclude that financial market frictions affect real economic activity and, in particular, corporate investment. The Author 2011. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oup.com., Oxford University Press.

Suggested Citation

  • John L. Campbell & Dan S. Dhaliwal & William C. Schwartz, 2012. "Financing Constraints and the Cost of Capital: Evidence from the Funding of Corporate Pension Plans," Review of Financial Studies, Society for Financial Studies, vol. 25(3), pages 868-912.
  • Handle: RePEc:oup:rfinst:v:25:y:2012:i:3:p:868-912
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    File URL: http://hdl.handle.net/10.1093/rfs/hhr119
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    References listed on IDEAS

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    1. Geanakoplos, John, 1990. "An introduction to general equilibrium with incomplete asset markets," Journal of Mathematical Economics, Elsevier, vol. 19(1-2), pages 1-38.
    2. Duffie Darrell & Rahi Rohit, 1995. "Financial Market Innovation and Security Design: An Introduction," Journal of Economic Theory, Elsevier, vol. 65(1), pages 1-42, February.
    3. Cass, David & Chichilnisky, Graciela & Wu, Ho-Mou, 1996. "Individual Risk and Mutual Insurance," Econometrica, Econometric Society, vol. 64(2), pages 333-341, March.
    4. Gyutaeg Oh, 1996. "Some Results in the CAPM with Nontraded Endowments," Management Science, INFORMS, pages 286-293.
    5. Demange Gabrielle & Laroque Guy, 1995. "Optimality of Incomplete Markets," Journal of Economic Theory, Elsevier, pages 218-232.
    6. Magill, Michael & Shafer, Wayne, 1991. "Incomplete markets," Handbook of Mathematical Economics,in: W. Hildenbrand & H. Sonnenschein (ed.), Handbook of Mathematical Economics, edition 1, volume 4, chapter 30, pages 1523-1614 Elsevier.
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    Citations

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    Cited by:

    1. Brushwood, James & Dhaliwal, Dan & Fairhurst, Douglas & Serfling, Matthew, 2016. "Property crime, earnings variability, and the cost of capital," Journal of Corporate Finance, Elsevier, vol. 40(C), pages 142-173.
    2. Iqbal Owadally, 2014. "Tail risk in pension funds: an analysis using ARCH models and bilinear processes," Review of Quantitative Finance and Accounting, Springer, vol. 43(2), pages 301-331, August.
    3. Gustafson, Matthew T., 2017. "The market sensitivity of retirement and defined contribution pensions: Evidence from the public sector," Journal of Public Economics, Elsevier, pages 1-13.
    4. Tao, Qizhi & Chen, Carl & Lu, Rui & Zhang, Ting, 2017. "Underfunding or distress? An analysis of corporate pension underfunding and the cross-section of expected stock returns," International Review of Economics & Finance, Elsevier, vol. 48(C), pages 116-133.
    5. Dang, Viet Anh & Kim, Minjoo & Shin, Yongcheol, 2014. "Asymmetric adjustment toward optimal capital structure: Evidence from a crisis," International Review of Financial Analysis, Elsevier, vol. 33(C), pages 226-242.
    6. repec:eee:intfin:v:48:y:2017:i:c:p:99-116 is not listed on IDEAS
    7. repec:spr:jecfin:v:42:y:2018:i:1:d:10.1007_s12197-016-9372-8 is not listed on IDEAS
    8. repec:eee:corfin:v:46:y:2017:i:c:p:25-33 is not listed on IDEAS
    9. Dhaliwal, Dan & Judd, J. Scott & Serfling, Matthew & Shaikh, Sarah, 2016. "Customer concentration risk and the cost of equity capital," Journal of Accounting and Economics, Elsevier, vol. 61(1), pages 23-48.
    10. Mulier, Klaas & Schoors, Koen & Merlevede, Bruno, 2016. "Investment-cash flow sensitivity and financial constraints: Evidence from unquoted European SMEs," Journal of Banking & Finance, Elsevier, vol. 73(C), pages 182-197.
    11. Klaas Mulier & Koen Schoors & Bruno Merlevede, 2014. "Investment-Cash Flow Sensitivity and the Cost of External Finance," Working Papers of Faculty of Economics and Business Administration, Ghent University, Belgium 14/890, Ghent University, Faculty of Economics and Business Administration.

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