Academic journal article Journal of Risk and Insurance

Do Markets like Frozen Defined Benefit Pensions? an Event Study

Academic journal article Journal of Risk and Insurance

Do Markets like Frozen Defined Benefit Pensions? an Event Study

Article excerpt


An increasing number of North American companies are freezing or terminating their traditional defined benefit (DB) pension plans. In this article we document a positive announcement effect when a publicly traded company discloses that it has partially or fully frozen its DB plan and replaced it with--or enhanced--the 401(k) defined contribution (DC) plan. This positive risk-adjusted return is greater for firms with higher beta and/or lower return on equity (ROE) prior to the freeze. In other words the positive impact is more pronounced for firms that are likely to face financial distress if they maintain their traditional pension plan and the associated long-term promises.

"At present, the only way a company can manage the risk of long-lived workers is to work them so hard that they die within a few years of retirement; this is not a good way to retain staff."

Financial Times, editorial, September 30, 2006


On Tuesday March 7, 2006, General Motors Corporation (GM) issued a press release and announced that all new salaried employees hired by GM after January 1, 2007 would no longer be allowed to join the company's defined benefit (DB) pension plan but rather would be enrolled in the company's 401(k), which is a defined contribution (DC) plan. Employees would now have a portion of their savings and contributions matched by GM, and they would be given the ability to manage their investments across a wide range of choices within the 401(k). Included in the press release was the statement that these changes would help GM reduce its 2006 pension liability by $1.6 billion. GM's stock, which before the announcement on Monday afternoon was trading around $19.80 per share, jumped on the news and by the end of trading on Wednesday it settled at almost $21.30 per share. The 8 percent move over the course of 2 days exceeded the S&P 500 return during the same time. (1)

GM is not the only widely held publicly traded company that has taken this course of action. Well-known household names such as Lockheed (October 2005), Whirlpool (November 2006), IBM (January 2006), Dupont (August 2006), Motorola (December 2005), Sprint Nextel (January 2006), NCR (September 2006), Verizon (December 2005), and Citigroup (November 2006) have all partially or fully frozen their plans over the last few years. (2) In fact, according to statistics compiled by Watson Wyatt, of the 100 largest and most prestigious employers in the United States, 89 offered a DB pension plan to new employees in 1985, but less than 25 offered DB plans to new employees in 2008.

Furthermore--and just to provide some background context as of April 2009--the unprecedented decline in equity market values during the last 18 months has pushed the aggregate position of S&P 500 corporate DB plans from a surplus of approximately US$70 billion in late 2007, to a deficit of over US$350 billion in early 2009. This pension deficit, which is the difference between the current (actuarial) value of assets and the discounted (actuarial) value of liabilities, is the largest it has ever been (Wall Street Journal, February 12, 2009). In fact, many of these company sponsors have applied to pension regulators (the U.S. Treasury, the Pension Benefit Guaranty Corporation [PBGC]) seeking additional relief from onerous pension funding requirements, given their limited access to free cash flow. See Bodie, Marcus, and Merton (1988) for an in-depth discussion of the economic distinction between DB and DC plans.

Motivated by all of this renewed interest and concern surrounding pensions in the current article we seek to answer a very basic question that has yet to be fully and properly explored in the scholarly literature. How does the stock market react when a company freezes or eliminates its DB pension plan and what are the firm-specific financial and accounting factors that impact this reaction? …

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