Financing Constraints and the Cost of Capital: Evidence from the Funding of Corporate Pension Plans

Review of Financial Studies, Vol. 25, No. 3, pp. 868-912

Posted: 22 Aug 2011 Last revised: 4 Mar 2012

See all articles by John L. Campbell

John L. Campbell

University of Georgia - J.M. Tull School of Accounting

Dan S. Dhaliwal

University of Arizona - Department of Accounting (deceased)

William C. Schwartz

Oklahoma State University

Multiple version iconThere are 2 versions of this paper

Date Written: August 21, 2011

Abstract

We investigate the relation between firms' weighted average cost of capital and internal financial resources, using mandatory pension contributions as a proxy for internal financial resources. Rauh (2006) documents a negative association between mandatory pension contributions and capital expenditures. We find that an increase in mandatory pension contributions increases the cost of capital, but only for firms facing greater external financing constraints. Our results suggest that firms’ cost of capital is an intervening variable that can explain Rauh’s finding that mandatory pension contributions (i.e. internal financing constraints) result in foregone investment. We also find that, consistent with their view that mandatory pension contributions are a credit neutral event, Moody’s does not incorporate mandatory pension contributions into their credit ratings. Our evidence suggests this view is appropriate for firms that are not financially constrained but is inappropriate for firms that are more financially constrained. Overall, we provide evidence consistent with recent studies (Rauh 2006; Almeida and Campello 2007) that conclude that financial market frictions affect real economic activity, and in particular, corporate investment.

Keywords: financing constraints, investment, cost of capital, defined benefit pension plans

JEL Classification: G23, G30, G31, G32

Suggested Citation

Campbell, John L. and Dhaliwal, Dan S. and Schwartz, William C, Financing Constraints and the Cost of Capital: Evidence from the Funding of Corporate Pension Plans (August 21, 2011). Review of Financial Studies, Vol. 25, No. 3, pp. 868-912, Available at SSRN: https://ssrn.com/abstract=1913900

John L. Campbell

University of Georgia - J.M. Tull School of Accounting ( email )

Athens, GA 30602
United States
706.542.3595 (Phone)
706.542.3630 (Fax)

Dan S. Dhaliwal

University of Arizona - Department of Accounting (deceased)

William C Schwartz (Contact Author)

Oklahoma State University ( email )

201 Business
Stillwater, OK 74078-0555
United States
918-594-8168 (Phone)
918-594-8281 (Fax)

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