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Discontinuities in Pension Benefit Formulas and the Spot Model of the Labor Market: Implications for Financial Economists

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  • James E. Pesando

Abstract

When analyzing tax and related issues, financial economists typically invoke the simplest and the most tractable model of the labor market. This is the spot model, in which the worker's cash wage plus accruing pension benefit must equal the value of the worker's marginal product in each and every period. This paper first identifies the discontinuities in a worker's cash wage that must occur under the spot model if the pension plan has typical"cliff" vesting and early retirement provisions. The paper then calculates the pension benefits actually accrued, at and around the dates of eligibility for these benefits, by members of five pension plans in Canada. Both exercises serve to discredit the spot model. The paper reviews the underfunding puzzle, the measurement of pension liabilities, and the recapture of surplus assets in overfunded plans in light of these findings.

Suggested Citation

  • James E. Pesando, 1986. "Discontinuities in Pension Benefit Formulas and the Spot Model of the Labor Market: Implications for Financial Economists," NBER Working Papers 1795, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:1795
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    1. Lazear, Edward P, 1981. "Agency, Earnings Profiles, Productivity, and Hours Restrictions," American Economic Review, American Economic Association, vol. 71(4), pages 606-620, September.
    2. J. Michael Harrison & William F. Sharpe, 1983. "Optimal Funding and Asset Allocation Rules for Defined-Benefit Pension Plans," NBER Chapters,in: Financial Aspects of the United States Pension System, pages 91-106 National Bureau of Economic Research, Inc.
    3. James L. Medoff & Katharine G. Abraham, 1981. "Are Those Paid More Really More Productive? The Case of Experience," Journal of Human Resources, University of Wisconsin Press, vol. 16(2), pages 186-216.
    4. Jeremy I. Bulow & Myron S. Scholes, 1983. "Who Owns the Assets in a Defined-Benefit Pension Plan?," NBER Chapters,in: Financial Aspects of the United States Pension System, pages 17-36 National Bureau of Economic Research, Inc.
    5. Pesando, James E, 1982. " Investment Risk, Bankruptcy Risk, and Pension Reform in Canada," Journal of Finance, American Finance Association, vol. 37(3), pages 741-749, June.
    6. 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.
    7. Jeremy I. Bulow, 1981. "Early Retirement Pension Benefits," NBER Working Papers 0654, National Bureau of Economic Research, Inc.
    8. 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, July.
    9. Lazear, Edward P, 1979. "Why Is There Mandatory Retirement?," Journal of Political Economy, University of Chicago Press, vol. 87(6), pages 1261-1284, December.
    10. Ippolito, Richard A, 1985. "The Economic Function of Underfunded Pension Plans," Journal of Law and Economics, University of Chicago Press, vol. 28(3), pages 611-651, October.
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    1. repec:lap:journl:598 is not listed on IDEAS
    2. Pearce, Douglas K & Roley, V Vance, 1988. " Firm Characteristics, Unanticipated Inflation, and Stock Returns," Journal of Finance, American Finance Association, vol. 43(4), pages 965-981, September.

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