Pension Funds & The Value of Equities

Posted: 11 Jun 2013

See all articles by Martin S. Feldstein

Martin S. Feldstein

National Bureau of Economic Research (NBER) (deceased); Harvard University (deceased)

Randall Morck

University of Alberta - Department of Finance and Statistical Analysis; National Bureau of Economic Research (NBER); European Corporate Governence Institute; Asian Bureau of Finance and Economic Research

Date Written: October 10, 1982

Abstract

The value of reported vested pension obligations depends critically on the interest rate a firm uses to discount future benefit obligations. Firms with substantial benefit obligations relative to existing pension assets tend to reduce the reported present value of their obligations by using a high interest rate assumption. Conversely, firms with substantial pension assets relative to benefit obligations tend to choose low interest rate assumptions in order to increase the present value of their pension obligations so that they may take advantage of the tax benefits of early funding. The financial market appears to see through this manipulation of pension liabilities, using a common average rate to discount pension obligations. Market values correlate more closely with pension obligations when those obligations are valued at an average of the rates actually used by firms than when they are valued at those actual rates. This average rate is significantly below the long-term rate prevailing in the market. Pension liabilities are thus overemphasized by the market. Furthermore, there is some indication that the market gives more weight to pension liabilities than to pension assets; that is, each dollar increase in pension liabilities tends to translate into a dollar decrease in market value, whereas the same increase in pension assets increases firm value by less than a dollar. This may be because the market views a substantial increase in pension assets as an indication that the firm expects a corresponding increase in future pension liabilities. In any event, the fact that the market overemphasizes pension liabilities and may underestimate pension assets suggests that the growth of the private pension system may increase savings by investors and firms.

Suggested Citation

Feldstein, Martin S. and Morck, Randall K., Pension Funds & The Value of Equities (October 10, 1982). Financial Analysts Journal, Vol. 39, No. 5, 1983; University of Alberta School of Business Research Paper No. 2013-904. Available at SSRN: https://ssrn.com/abstract=2277193

Martin S. Feldstein (Contact Author)

National Bureau of Economic Research (NBER) (deceased)

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Harvard University (deceased)

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Randall K. Morck

University of Alberta - Department of Finance and Statistical Analysis ( email )

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National Bureau of Economic Research (NBER)

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European Corporate Governence Institute ( email )

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Asian Bureau of Finance and Economic Research ( email )

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Singapore

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