Should Risky Firms Offer Risk-Free DB Pensions?

40 Pages Posted: 1 Apr 2009 Last revised: 5 Apr 2009

See all articles by David A. Love

David A. Love

Williams College - Department of Economics

Paul A. Smith

Federal Reserve Board of Governors

David W. Wilcox

Federal Reserve Board - Division of Research and Statistics

Date Written: April 2, 2009

Abstract

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

Love, David A. and Smith, Paul A. and Wilcox, David W., Should Risky Firms Offer Risk-Free DB Pensions? (April 2, 2009). Available at SSRN: https://ssrn.com/abstract=1371211 or http://dx.doi.org/10.2139/ssrn.1371211

David A. Love

Williams College - Department of Economics ( email )

South Academic Building, RM 202
Williamstown, MA 01267
United States

Paul A. Smith (Contact Author)

Federal Reserve Board of Governors ( email )

20th and C Streets, NW
Washington, DC 20551
United States

David W. Wilcox

Federal Reserve Board - Division of Research and Statistics ( email )

20th and C Streets, NW
Mailstop 153
Washington, DC 20551
United States

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