Testing Moral Hazard and Tax Benefit Hypotheses: Evidence from Corporate Pension Contributions and Investment Risk

47 Pages Posted: 4 Aug 2010

See all articles by Tong Yu

Tong Yu

University of Cincinnati - Department of Finance - Real Estate

Ting Zhang

University of Dayton - School of Business Administration

Date Written: May 1, 2010

Abstract

We jointly test moral hazard and tax benefit hypotheses related to the defined benefit pension plan funding and investment risk-taking decisions by incorporating the pension plan termination probabilities. We hypothesize that sponsors with different plan termination probabilities are dominated by different incentives. In particular, sponsors are dominated by the moral hazard incentive when they face high plan termination probabilities, as the put option derived from the Pension Benefit Guaranty Corporation (PBGC) guarantee has the greatest value. In contrast, the tax benefit incentive dominates if sponsors have low termination probabilities. As the value of the PBGC put option is low, maximizing tax benefits associated with pension contributions and investment earnings becomes a dictating incentive. The findings based on sponsors’ voluntary contributions strongly support our hypotheses after controlling for endogeneity issue. However, in examining sponsors’ investment risk-taking incentives, the results based on pension beta and asset allocation do not support either of the hypotheses.

Keywords: Moral Hazard, Tax Benefit, Plan Contributions, Pension Beta, Asset Allocation, Pension Plan Termination Probabilities

JEL Classification: G11, G23, G33

Suggested Citation

Yu, Tong and Zhang, Ting, Testing Moral Hazard and Tax Benefit Hypotheses: Evidence from Corporate Pension Contributions and Investment Risk (May 1, 2010). Netspar Discussion Paper No. 05/2010-025, Available at SSRN: https://ssrn.com/abstract=1653341 or http://dx.doi.org/10.2139/ssrn.1653341

Tong Yu

University of Cincinnati - Department of Finance - Real Estate ( email )

College of Business Administration
Cincinnati, OH 45221
United States
4019548606 (Phone)
4019548606 (Fax)

Ting Zhang (Contact Author)

University of Dayton - School of Business Administration ( email )

300 College Park
Dayton, OH 45469
United States

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