Financial Education

In the Financial Analysts Journal for January/February 2007, Joao Cocco and Paolo Volpin published a study of the corporate governance of defined benefit pension plans in the U.K. In particular they want to determine whether pension trustees who are also corporate officers tend to act in behalf of the company or of pension beneficiaries in their decision making.

If the pension trustee is acting on behalf of the company, the authors would expect to find a higher asset allocation to equities, particularly if the company is leveraged. The added risk represents a wealth transfer from debtholders to equity holders. It will also, if the equities perform well, allow the company to contribute less into the plan. The authors thus predict that pension funds with more insider trustees will make lower contributions to the plan. Both of these hypotheses are supported by the findings.

A more favorable view of insider trustees is that they facilitate information flow between company and plan. One manifestation of that would be allowing the company to borrow more and invest the proceeds in bonds for the fund. The borrowings would reduce taxes while the earnings on the plan’s bonds would be tax free, resulting in a tax arbitrage without increasing total company risk. Another would be that plan contributions would increase in years the company faced a higher tax rate. These hypotheses were not supported by the findings.

For more information, see all articles on: Corporate Governance, Research

See also:

Types of Foundations

Asset Turnover

Using Pension Disclosures to Understand the Underlying Economic Position

Adjusting Net Income to Reflect Economic Pension Expense

Income Statement Accounting for Pension Expense: An Overview