Should Risky Firms Offer Risk-Free DB Pensions?
40 Pages Posted: 1 Apr 2009 Last revised: 5 Apr 2009
Date Written: April 2, 2009
We develop a simple model of pension financing to study the effects of pension risk on shareholder value. In the model, firms minimize costs, total compensation must clear the labor market, and a government pension insurer guarantees a portion of promised benefits. We find that in the absence of mispriced pension insurance, the optimal pension strategy under most specifications is to immunize all sources of market risk. Mispriced pension insurance, however, gives firms the incentive to introduce risk into their pension promises, offering an explanation for some of the observed prevalence of risky pensions in the real world.
Keywords: pensions, bankruptcy, risk, portfolio choice
JEL Classification: G11, G23, G32
Suggested Citation: Suggested Citation