Post-Retirement Benefit Plans, Leverage, and Real Investment

Abstract

This paper shows that defined benefit pension and health care plans are important for firm leverage around the world. While consolidating off-balance sheet post-retirement plans typically increases effective leverage by 32%, firms reduce their level of regular debt by only 22 cents for every dollar of projected benefit obligation, yielding overall 23% higher total leverage of plan sponsors compared to similar firms without post-retirement plans. The most important driver of substitution rates between regular debt and post-retirement obligations is rule of law, followed by labor market freedom and taxes, where countries with a better rule of law, less labor market freedom and higher marginal corporate tax rates show higher substitution rates. In contrast, pension guarantee funds and priority of unfunded pension obligations are less important for substitution rates.