Academic journal article Accounting & Taxation

When Do Companies Fund Their Defined Benefit Pension Plans?

Academic journal article Accounting & Taxation

When Do Companies Fund Their Defined Benefit Pension Plans?

Article excerpt

ABSTRACT

This paper extends the accounting academic literature on pension funding strategy by looking at a more recent data set, directly examining contributions to defined benefit pension plans, and considering the effect of changing economic conditions over time on pension plan funding. I find that the average funded status of defined benefit pension plans has changed over time in response to changing market conditions. In addition, managers respond to these changes differently depending on firm specific incentives to make contributions to their pension plans. I find that companies that have employees protected by unions, more costly plans, higher levels of cash from operations, higher levels of plan underfunding, tax incentives, and debt contracting incentives contribute more to their pension plans. In contrast, I find that companies with other investment opportunities for their free cash, and companies with pension plans assets earning higher returns contribute less to their pension plans. This paper has implications for regulators and standard setters considering how to deal with pension funding shortfalls, accounting professionals auditing companies with pension plans, CFOs determining their company 's pension funding strategy, and investors and creditors evaluating the risks that companies with defined benefit pension plans are taking on.

JEL: J32, M41, M59

KEYWORDS: Accounting for Defined Benefit Pension Plans, Pension Plan Funded Status

(ProQuest: ... denotes formulae omitted.)

INTRODUCTION

There has been a growing concern about the ability of corporations to provide retirement benefits to their employees. In recent years, there has been a shift away from the generous retirement benefits packages of the 1970s and 1980s towards defined contribution plans, such as 401(k) plans (Munnell and Soto 2007). However, some companies are still providing defined benefit pension plans (hereafter pension plans), which are more expensive on average, to their employees. In addition, companies that have reduced retirement benefits or closed participation in pension plans to new employees still face the costs of funding the plans for retirees whose benefits were protected from plan changes.

Companies regularly lobby Congress for pension funding relief. As an example, in 2004 Congress responded to pressure from large corporations with unfunded pension plans and changed the way that companies calculate the pension obligation for purposes of the legal funding requirements (Walsh 2004). More recently, AT&T has requested approval to contribute preferred equity to its pension plan in lieu of a cash contribution (Chasan 2013) and a coalition of companies and labor unions is petitioning Congress to change the law to allow the benefits of retired employees to be cut (Hicken 2013). This paper examines two related research questions about the funding of pension plans. First, how has the average funded status of the pension plans of U.S. publicly traded companies varied over time in response to changing market conditions? Second, what are the determinants of companies' pension plan funding strategies?

I first evaluate the average pension plan funded status for all U.S. publicly traded companies with pension plans during the period 1998 to 2006. The funded status of most pension plans should reflect current economic conditions because the benefit obligation should be measured using the yield on high quality corporate bonds, and pension assets are largely comprised of stocks and bonds. As expected, I find that pension plans were overfunded on average in the late 1990s when the stock market was doing well, and became underfunded on average when the stock market declined in 2000, 2001, and 2002. To make up for this decline, companies have tripled their level of contributions over the 1998 to 2006 time period.

I next investigate the determinants of pension plan contributions. Based on a review of the literature, I identify several incentives that managers have to make or withhold contributions to their pension plans. …

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