Why Do Firms Offer Risky Defined Benefit Pension Plans?
Even risky pension sponsors could offer essentially riskless pension promises by contributing a sufficient level of resources to their pension trust funds and by investing those resources in fixed-income securities designed to deliver their payoffs just as pension obligations are coming due. However, almost no firm has chosen to fund its plan in this manner. We study the optimal funding choice for plan sponsors by developing a simple model of pension financing in which the total compensation offered to workers must clear the labor market. We find that if workers understand the implications of pension risk, they will demand greater compensation for riskier pension promises than for safer ones, all else equal. Indeed, in our model, pension sponsors maximize their value by making their pension promises free of risk. We close by positing some explanations for why no real-world firm follows the prescription of our model.
|Date of creation:||Jun 2007|
|Date of revision:|
|Publication status:||Published in National Tax Journal, 2007, Vol. 60 (September), pp 507-519|
|Contact details of provider:|| Postal: Williamstown, MA 01267|
Phone: 413 597 2476
Fax: 413 597 4045
Web page: http://econ.williams.edu
More information through EDIRC
|Order Information:|| Email: |
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Kimball, Miles S, 1990.
"Precautionary Saving in the Small and in the Large,"
Econometric Society, vol. 58(1), pages 53-73, January.
- Miles S. Kimball, 1989. "Precautionary Saving in the Small and in the Large," NBER Working Papers 2848, National Bureau of Economic Research, Inc.
- Tepper, Irwin, 1981. "Taxation and Corporate Pension Policy," Journal of Finance, American Finance Association, vol. 36(1), pages 1-13, March.
- Julia Lynn Coronado & Steven A. Sharpe, 2003.
"Did pension plan accounting contribute to a stock market bubble?,"
Finance and Economics Discussion Series
2003-38, Board of Governors of the Federal Reserve System (U.S.).
- 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.
- Jeremy I. Bulow, 1982. "What are Corporate Pension Liabilities?," The Quarterly Journal of Economics, Oxford University Press, vol. 97(3), pages 435-452.
- Pennacchi, George, 2006. "Deposit insurance, bank regulation, and financial system risks," Journal of Monetary Economics, Elsevier, vol. 53(1), pages 1-30, January.
- 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.
- 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.
- 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.
- Treynor, Jack L, 1977. "The Principles of Corporate Pension Finance," Journal of Finance, American Finance Association, vol. 32(2), pages 627-38, May.
- Deborah Lucas, 2007. "Valuing & Hedging: Defined Benefit Pension Obligations - The Role of Stocks Revisited," Money Macro and Finance (MMF) Research Group Conference 2006 169, Money Macro and Finance Research Group.
- Irwin Tepper, 1981. "Taxation and Corporate Pension Policy," NBER Working Papers 0661, National Bureau of Economic Research, Inc.
- Sharpe, William F., 1976. "Corporate pension funding policy," Journal of Financial Economics, Elsevier, vol. 3(3), pages 183-193, June.
- Zvi Bodie, 1988. "Pension Fund Investment Policy," NBER Working Papers 2752, National Bureau of Economic Research, Inc.
When requesting a correction, please mention this item's handle: RePEc:wil:wileco:2007-04. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Stephen Sheppard)
If references are entirely missing, you can add them using this form.