Portrait of a Company: Defined Benefit Pension Plan Sponsors

By Castro-González, Karen C. | Accounting & Taxation, January 1, 2012 | Go to article overview

Portrait of a Company: Defined Benefit Pension Plan Sponsors


Castro-González, Karen C., Accounting & Taxation


ABSTRACT

This study describes firms that sponsor defined benefit pension plans (DBPP) based on firm specific characteristics, financial and operating performance. Firms are classified into portfolios based on their funding levels and described accordingly. The results suggest that firms in the most underfunded portfolio are on average smaller and value firms, with negative stock returns, poor financial and operating performance, lower profitability, invest smaller amounts in advertising, research and development and capital assets and are more indebted with higher probabilities of bankruptcy. The opposite is seen for the least and overfunded firms. The portrayal of these characteristics can help regulators in the effective identification of firms that may confront funding problems before it is too late. The detection of risk behavior or tendencies in terms of firm characteristics can help regulators in establishing policies to decelerate and improve pension plan funding levels and to protect the public interest.

JEL: G11, G23, M48

KEYWORDS - Defined benefit, pension plans, pension management, pension regulation

(ProQuest: ... denotes formulae omitted.)

INTRODUCTION

How do firms that sponsor pension plans look? Do they all look alike? Firms that sponsor pension plans can be described based on their funding levels, size, financial and operating performance, to mention a few. Most importantly, they can be described based on the type of plan they sponsor. A pension plan is defined as an arrangement whereby an employer provides benefits (payments) to retired employees for services provided in their working years. Employers fund pension plans by making payments to a funding agency. The two most common types of pension plans are defined contribution (DC) plans and DBPP. In a DC plan, the employer agrees to contribute to a pension trust a certain sum each period, based on a formula. A company usually turns over to an independent third-party trustee the amounts originally contributed. The trustee, acting on behalf of the beneficiaries, assumes ownership of the pension assets and is accountable for their investment and distribution. The trust is separate and distinct from the employer. In terms of risk, the employee gets the benefit of gain (or the risk of loss) from the assets contributed to the plan.

In contrast, DBPP delineates the benefits that employees will receive when they retire. To meet the DB commitments that will start at retirement, a company must determine what the contribution should be today. Companies may use many different contribution approaches. However, the funding method should provide enough money at retirement to meet the benefits defined by the plan. The employees are the beneficiaries of a DC trust, but the employer is the beneficiary of a DB trust. Under a DB plan, the trust's primary purpose is to preserve and invest assets so that there will be enough to pay the employer's commitment to employees. The trust is a separate entity but the trust assets and the liabilities belong to the employer. That is, as long as the plan continues, the employer is responsible for the payment of the defined benefits (DB) (without regard to what happens in the trust). The employer must make up any deficit in the accumulated assets held by the trust. On the other hand, the employer can recapture any excess accumulated in the trust, either through reduced future funding or through a reversion of funds. For years, firms that sponsor DBPP have been hard-pressed by regulators, government and employees to meet their pension funding obligations. As a result of these pressures, laws and regulations have arisen in past years. For an employer the cost of sponsoring retirement benefits sometimes is steep. The need to properly administer and account for pension funds becomes apparent when the size of these funds is understood. For example, consider General Motors Corporation. The size of the pension fund for 2004 is $99,909 million, the pension expense is $2,456 per employee and its pension expense as a percentage of pre-tax income is 52. …

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