Pension Risk Transfer and Firm Leverage: The Cash Flow Volatility Channel

Abstract

I develop a novel dataset to examine the impact of pension group annuity purchases on capital structure and corporate policies. Pension obligations are shown to contribute to rising cash flow volatility to stakeholders, which is a prominent factor in the decision to offload these liabilities. I find the reduction in pension debt is replaced with a commensurate dollar value of long-term debt. The substitution is concentrated in financially unconstrained firms, while those facing greater financial constraints reduce total leverage. Firms engaging in a group annuity purchase increase pension contributions and capital expenditures in the event year. Consistent with a lower expected probability of future cash shortfalls, changes to investment policy are concentrated in financially constrained firms. Short and long horizon event studies reveal pension annuity buyouts are associated with significantly negative abnormal returns due to disappointing cash flow news upon announcement.