The External Shock on the Speed of Adjustment Toward Target Ratios: Evidence from DB Pension Plans

Abstract

This paper investigates the influence of the external shock on the speed of adjustment (SOA) toward several target ratios of firms. To look at the impact of an exogenous shock on SOA, I employ mandatory contributions (MCs) of defined benefit (DB) pension plans as a measure of the external shock, and I find a negative impact of the exogenous shock on the level of leverage and SOA toward target leverage. This result is robust when including firm and year fixed effects, when using GMM or long differencing estimation to reduce the biases in estimation, and when assuming that mandatory contributions are endogenously determined. The negative impact of MCs on SOA is especially bigger for firms which have volatile historical leverage or stronger governance structure. Though the total liability level of DB pension plans has a negative impact on both the level of leverage and SOA toward target leverage, it becomes statistically insignificant or trivial in magnitude after including firm fixed effects and year dummies in the model. When examining the impact of MCs on SOA toward other target ratios of firms, I find a negative impact of MCs on SOA toward the target investment level.