Corporate Pension Policy: An Empirical Investigation

Abstract

An empirical investigation of pension funding levels and plan asset allocations suggests that corporations manage their pension funds as if they are an integral part of overall corporate financial policy. This corporate financial perspective contrasts with the traditional view of pension management, whereby pension assets are seen as a separate pool to be managed in the best interests of beneficiaries. The primary evidence concerns the links between corporate profitability and pension policies. First, reported pension fund liabilities are linked systematically to company profitability by management 's choice of a discount rate. More profitable firms tend to choose lower discount rates, hence to overstate their pension liabilities relative to those of less profitable firms. Second, profitability has a strong positive association with funding level. The proportion of pension assets invested in fixed income securities also has a positive association with funding level. Corporations with taxable income can maximize tax-savings by having fully funded plans invested in heavily taxed securities such as bonds. Evidence regarding specific motivations behind the corporate pension perspective emerges when the sample is investigated more closely. For example, the subsample of firms with the heaviest tax burdens exhibits a significant relation between level of funding and tax-paying status. Similarly, the subsample of riskiest firms tends to hold underfunded portfolios invested in riskier assets-stocks, rather than bonds. This is consistent with the presence of a PBGC insurance effect-the tendency of less financially sound firms to 'lay off their pension burden on the Pension Benefit Guaranty Corporation.