Managerial Risk Taking Incentives and Corporate Pension Policy

64 Pages Posted: 3 Jul 2013 Last revised: 4 Oct 2013

See all articles by Divya Anantharaman

Divya Anantharaman

Rutgers, The State University of New Jersey - Accounting & Information Systems

Yong Gyu Lee

Seoul National University

Date Written: July 2, 2013

Abstract

Theory predicts that stockholders of firms with defined-benefit pension plans will engage in risk-shifting by underfunding plans and investing plan assets in risky securities, as their firms approach distress. The empirical evidence so far has, however, been consistent more with risk-management than risk-shifting. We test whether the compensation incentives of top management affect the extent of risk-shifting versus risk-management behavior in pension plans. We find that risk-shifting through pension underfunding is stronger with compensation structures that create high wealth-risk sensitivity (vega), and weaker with high wealth-price sensitivity (delta). These relationships hold across firms and within firms and managers over time. We find consistent but weaker results with risk-shifting through pension asset allocation to risky securities. While both CEO and CFO incentives affect pension strategy, CFO incentives dominate, suggesting that pension decisions fall within the CFO’s domain. We find also that risk-shifting through pension underfunding is lower when CFOs’ own pensions are larger. Overall, these findings show that top managers’ compensation structure is an important driver of corporate pension policy; they also highlight firms within which the moral hazard concerns fueled by Pension Benefit Guaranty Corporation insurance are most relevant.

Keywords: defined-benefit pensions, risk-shifting, executive compensation, incentives

Suggested Citation

Anantharaman, Divya and Lee, Yong Gyu, Managerial Risk Taking Incentives and Corporate Pension Policy (July 2, 2013). Journal of Financial Economics (JFE), Forthcoming, Available at SSRN: https://ssrn.com/abstract=2288948

Divya Anantharaman (Contact Author)

Rutgers, The State University of New Jersey - Accounting & Information Systems ( email )

1 Washington Park
#916
Newark, NJ 07102
United States

Yong Gyu Lee

Seoul National University ( email )

Kwanak-gu
Seoul, 151-742
Korea, Republic of (South Korea)

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