Optimal Risk-Taking in Corporate Defined Benefit Plans under Risk-Shifting

Managerial Finance, (2019) Vol. 45 No. 8, pp. 1076-1091.

Doi: 10.1108/MF-01-2019-0016

Posted: 23 Jun 2020

See all articles by Tomoki Kitamura

Tomoki Kitamura

Tohoku Gakuin University; NLI Research Institute, Finance Research Group

Kozo Omori

Osaka University of Economics, Faculty of Business Administration

Date Written: August 12, 2019

Abstract

Purpose: The purpose of this paper is to theoretically examine the risk-taking decision of corporate defined benefits (DB) plans. The equity holders’ investment problem that is represented by the position of a vulnerable option is solved.

Design/methodology/approach: The simple traditional contingent claim approach is applied, which considers only the distributions of corporate cash flow, without the model expansions, such as market imperfections, needed to explain the firms’ behavior for DB plans in previous studies.

Findings: The authors find that the optimal solution to the equity holders’ DB investment problem is not an extreme corner solution such as 100 percent investment in equity funds as in the literature. Rather, the solution lies in the middle range, as is commonly observed in real-world economies.

Originality/value: The major value of this study is that it develops a clear mechanism for obtaining an internal solution for the equity holders’ DB investment problem and it provides the understanding that the base for corporate investment behavior for DB plans should incorporate the fact that in some cases the optimal solution is in the middle range. Therefore, the corporate risk-taking behavior of DB plans is harder to identify than the results of the empirical literature have predicted.

Keywords: Risk-taking, Corporate defined benefit (DB) pension plans, Optimal portfolio selection, Risk-shifting, Vulnerable option

JEL Classification: G32, G11

Suggested Citation

Kitamura, Tomoki and Omori, Kozo, Optimal Risk-Taking in Corporate Defined Benefit Plans under Risk-Shifting (August 12, 2019). Managerial Finance, (2019) Vol. 45 No. 8, pp. 1076-1091., Doi: 10.1108/MF-01-2019-0016 , Available at SSRN: https://ssrn.com/abstract=3614615

Tomoki Kitamura (Contact Author)

Tohoku Gakuin University ( email )

1-3-1 Tsuchitoi Aoba-ku
Sendai, 980-8511
Japan

NLI Research Institute, Finance Research Group ( email )

4-1-7, Kudankita
Chiyoda-ku
Tokyo, 102-0073
Japan
+81-3-3512-1854 (Phone)
+81-3-5211-1082 (Fax)

HOME PAGE: http://www.nli-research.co.jp

Kozo Omori

Osaka University of Economics, Faculty of Business Administration ( email )

2-2-8 Osumi
Higashiyokogawa-ku
Osaka
Japan

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