Strategic Bankruptcy and Private Pension Default

By Orr, Douglas V. | Journal of Economic Issues, September 1998 | Go to article overview

Strategic Bankruptcy and Private Pension Default


Orr, Douglas V., Journal of Economic Issues


A rapidly growing literature focuses on potential problems for both private pension plans and the Social Security system. Almost all of the literature addressing private sector pensions assumes that the firm promising to pay the pension has the desire to fulfill this promise and provides suggestions as to how potential problems can be eliminated or minimized. Proposed solutions range from expanding the tax write-offs allowed for sponsoring firms to privatizing the insuring of pension promises. This paper argues that the basic assumption underlying this literature, when applied to private pensions, may be incorrect. It argues that sponsoring firms may not have a desire to fulfill their promise, and in fact, there may be a strong desire to default on these promises. It also describes the evolving interpretations of existing laws that may provide firms with a mechanism to default on their pension promises. This mechanism is called strategic bankruptcy.

The primary goal of all true pension plans is to provide a stable level of consumption during retirement. Regardless of how pension plans are structured, they share the common characteristic that they shift some amount of current production to those who are no longer involved in the process of production. Thus, pensions are an inherently social institution that link one generation of workers to another and, as a result, elevate the common welfare above the concept of individual gain. Private firm-sponsored pensions are a long-term social contract between workers and firms that belies the neoclassical notion of an impersonal labor market.

Recently, some economists have incorrectly described pension plans as nothing more than a contractual savings plan in which each person sets aside her or his own individual saving today to provide for individual retirement consumption in the future. These economists reduce what is in fact a social relationship to an isolated individual act [Hayden 1989]. However, current saving provides for retirement consumption only to the extent that it allows the real output of society to grow. The purchase of financial assets with currently saved income provides a particular social/legal mechanism for claiming a share of output at some point in the future and nothing more. It is a mechanism that defines a social relationship as a financial one [Lawson and Lawson 1990]. When a claim is made by a pensioner, it will be a claim on then current output.

If current financial saving is put into real productive investment, the total amount of output in future years will grow. Thus, the financial claims will effectively be claims on real output. However, if current saving is channeled into nonproductive speculative activities that do not increase real output, the financial claims will be "hollow," and the amount of real output transferred to retirees will be less than expected.

The role pension plans play in creating power for firms is also obscured in much of the literature on pensions. Richard Ippolito [1985] correctly suggests that pensions constitute a form of deferred compensation. Workers provide effort today with the understanding that they will receive a stable level of income, provided by the firm, in retirement. He goes on to argue that it is rational for firms to not pre-fund this pension promise. Unfunded pension promises act as "performance bonds" to ensure that workers do not organize to "overly exploit" the firm. If the workers exert too much of their power, the firm will fail, and the workers will lose their deferred compensation. This analysis ignores the concept of power, except for that of organized labor, and is part of the conventional denial of the power exercised by the corporate sector [Munkirs and Knoedler 1987]. However, as the discussion below indicates, the firm's control over this pool of deferred compensation provides the firm increased bargaining power over current wages and benefits and the power to affect the mobility decisions of workers. …

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