Internal Capital and Investment: Evidence from 2012 Pension Relief

Abstract

We exploit pension funding relief enacted in 2012 to estimate the effects of a positive shock to internal liquidity on market prices and investment. Measuring unexpected increases in internal liquidity using a priori expected pension contributions disclosed under FAS132R, we report positive market returns around the date of Congressional approval for financially constrained firms and find that weak institutional monitoring attenuates these returns. We estimate the likelihood firms will benefit from reductions in mandatory contributions and find that financially constrained firms increase R&D expenditures in the months following the legislation and increase capital expenditures in the year following the enactment date. Overall, we provide evidence that pension disclosures provided useful information to investors in assessing the benefits of pension relief and our results shed light on the importance of capital adjustment costs for capital expenditures vis-a-vis R&D.