Optimal Corporate Pension Policy for Defined Benefit Plans in the Presence of PBGC Insurance

Abstract:     
This paper develops a general continuous-time framework for defining the optimal corporate pension policy for defined benefit (DB) plans in the presence of PBGC insurance. Interactions between the firm's optimal investment and financing policies and the optimal portfolio strategy for DB plans are studied. In normal, non-distressed times, the optimal pension portfolio rule from the equityholders' ’perspective is acceptable to both the participants and PBGC. However, this is no longer the case when the firm approaches financial distress. The PBGC put then emerges in the consolidated balance sheet, and the firm's optimal portfolio behavior becomes more aggressive. We recommend that the PBGC obtain a control right on pension decisions made by sponsoring companies near distress.

Number of Pages in PDF File: 36

Keywords: optimal corporate pension policy, defined benefit pension plans, optimal portfolio, PBGC insurance, financial distress

JEL Classification: C61, D92, G11, G22, G23, G31, G32

working papers series