Does Freezing a Defined Benefit Pension Plan Affect Firm Risk?

Abstract

This paper examines the impact of a defined benefit (DB) pension plan freeze on the sponsoring firm’s risk and risk-taking activities. Using a sample of firms declaring a hard freeze on their DB plans during the period 2002-2007, we observe an increase in total risk (standard deviation of returns) following a DB plan freeze. This increase in overall risk is attributable to an increase in idiosyncratic risk, as we do not observe any significant change in systematic risk for firms freezing DB plans. Consistent with the increase in risk, yields on bonds issued by firms freezing their DB plans also increase significantly after the freeze event. When we examine investment strategies, we observe a shift in investment from capital expenditures before the freeze to more-risky R&D projects after the freeze. Firms also increase leverage following DB plan freezes. These strategies (increased focus on R&D and higher leverage) increase the operating and financial risk the firm faces. Overall, we observe an increase in risk-taking following DB plan freezes, consistent with theories that DB plans act as “internal debt” that aligns managers’ interests with bondholders.