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Optimal Funding and Asset Allocation Rules for Defined-Benefit Pension Plans

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  • J. Michael Harrison
  • William F. Sharpe

Abstract

This paper considers a world in which pension funds may default, the cost of the associated risk of default is not borne fully by the sponsoring corporation, and there are differential tax effects. The focus is on ways in which the wealth of the shareholders of a corporation sponsoring a pension plan might be increased if the Internal Revenue Service (IRS) and the Pension Benefit Guaranty Corporation (PBGC) follow simple and naive policies. Under the conditions examined, the optimal policy for pension plan funding and asset allocation is shown to be extremal in a certain sense. This suggests that the IRS and the PBGC may wish to use more complex regulatory procedures than those considered in the paper.

Suggested Citation

  • 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.
    • Handle: RePEc:nbr:nberwo:0935
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    References listed on IDEAS

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    1. Litzenberger, Robert H & Van Horne, James C, 1978. "Elimination of the Double Taxation of Dividends and Corporate Financial Policy," Journal of Finance, American Finance Association, vol. 33(3), pages 737-750, June.
    2. Irwin Tepper, 1981. "Taxation and Corporate Pension Policy," NBER Working Papers 0661, National Bureau of Economic Research, Inc.
    3. Sharpe, William F., 1976. "Corporate pension funding policy," Journal of Financial Economics, Elsevier, vol. 3(3), pages 183-193, June.
    4. Tepper, Irwin, 1981. "Taxation and Corporate Pension Policy," Journal of Finance, American Finance Association, vol. 36(1), pages 1-13, March.
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    Cited by:

    1. Himick, Darlene & Brivot, Marion, 2018. "Carriers of ideas in accounting standard-setting and financialization: The role of epistemic communities," Accounting, Organizations and Society, Elsevier, vol. 66(C), pages 29-44.
    2. Sharad Asthana, 1999. "Determinants of Funding Strategies and Actuarial Choices for Defined†Benefit Pension Plans," Contemporary Accounting Research, John Wiley & Sons, vol. 16(1), pages 39-74, March.
    3. Zvi Bodie & Jay O. Light & Randall Morck, 1987. "Funding and Asset Allocation in Corporate Pension Plans: An Empirical Investigation," NBER Chapters, in: Issues in Pension Economics, pages 15-48, National Bureau of Economic Research, Inc.
    4. Michaelides, Alexander & Papakyriakou, Panayiotis & Milidonis, Andreas, 2019. "Corporate Pension Plan Funding Levels and Pension Assumptions," CEPR Discussion Papers 13591, C.E.P.R. Discussion Papers.
    5. Webb, David C., 2004. "Sponsoring company finance and investment and defined benefit pension scheme deficits," LSE Research Online Documents on Economics 24699, London School of Economics and Political Science, LSE Library.
    6. Kalra, Raman & Jain, Gautam, 1997. "A continuous-time model to determine the intervention policy for PBGC," Journal of Banking & Finance, Elsevier, vol. 21(8), pages 1159-1177, August.
    7. Love, David & Smith, Paul A. & Wilcox, David, 2007. "Why Do Firms Offer Risky Defined–Benefit Pension Plans?," National Tax Journal, National Tax Association;National Tax Journal, vol. 60(3), pages 507-519, September.
    8. Alan Marcus, 1987. "Corporate Pension Policy and the Value of PBGC Insurance," NBER Chapters, in: Issues in Pension Economics, pages 49-80, National Bureau of Economic Research, Inc.
    9. Bartram, Söhnke M., 2018. "In good times and in bad: Defined-benefit pensions and corporate financial policy," Journal of Corporate Finance, Elsevier, vol. 48(C), pages 331-351.
    10. Pesando, James E, 1987. "Discontinuities in Pension Benefit Formulas and the Spot Model of the Labor Market: Implications for Financial Economists," Economic Inquiry, Western Economic Association International, vol. 25(2), pages 215-238, April.
    11. Zvi Bodie, 1989. "Pension Funds and Financial Innovation," NBER Working Papers 3101, National Bureau of Economic Research, Inc.
    12. Leslie E. Papke, 1991. "The Asset Allocation of Private Pension Plans," NBER Working Papers 3745, National Bureau of Economic Research, Inc.
    13. Zvi Bodie, 1988. "Pension Fund Investment Policy," NBER Working Papers 2752, National Bureau of Economic Research, Inc.
    14. 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.).
    15. Mayur Ankolekar & Ramnath Shenoy & Nandan Nadkarni & Rajendra Shah, 2016. "Indian Defined Benefit Pension Plans: Evidence on Investment Risks, Fund Mandates and Funding Levels," Management and Labour Studies, XLRI Jamshedpur, School of Business Management & Human Resources, vol. 41(4), pages 355-383, November.
    16. Joshua Rauh, 2007. "Risk Shifting versus Risk Management: Investment Policy in Corporate Pension Plans," NBER Working Papers 13240, National Bureau of Economic Research, Inc.

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