The influence of DB pensions on the market valuation of the pension plan sponsor: For the FTSE 100 companies, size really does matter

Abstract

This study examines the relationship between market valuations for the FTSE100 listed companies and their DB pension deficits and obligations over the period 2006 to 2012. A number of simple valuation models are estimated, relating the market valuations of each company to its non-pension book value and earnings and its corresponding pension liabilities, deficits and costs. In contrast to earlier U.S. studies, evidence is found of a well-defined and significant relationship between market valuations and DB pension deficits. Taken at face value, the influence of the pension deficit appears to be disproportionate, but this result is found to reflect the insufficiency of published data for pension deficits in representing the underlying structural factors, because of risk premia attached to the scale of disclosed pension obligations or inconsistencies and uncertainties in their measurement. Allowing for such risk premia suggests a more or less one-for-one relationship between market valuation and the pension deficit, but subject to an additional 20% risk premium attached to the values of disclosed pension liabilities. However, a more satisfactory one-for-one relationship is found by putting pension liability estimates on a consistent “risk free” basis, using standardized gilt rates in calculating their net present values. An important implication of these results is that the market values of companies with larger pension liabilities are likely to be penalized relative to smaller schemes having otherwise similar net pension asset positions.