Do Pensions have Real Teeth? Evidence from the State Government Borrowing Costs

46 Pages Posted: 3 Feb 2022 Last revised: 11 Oct 2022

See all articles by Sumit Agarwal

Sumit Agarwal

National University of Singapore

Chunlin Liu

University of Nevada, Reno - College of Business

Qiyuan Peng

University of Dayton - School of Business Administration

Qun Wu

U of Nevada, Reno

Ting Zhang

University of Dayton - School of Business Administration

Date Written: December 28, 2021

Abstract

Yes, they do. State governments with risky defined benefit pension plans have higher borrowing costs, as measured by larger bond offering yield spreads. To control for the potential endogenous issue, we utilize the instruments of actuarial firms’ reputation, and direct flight between the state capital and actuarial firm headquarter. We further identify the relation between pension plan investment risks and borrowing costs using two quasi-experimental shocks: the introduction of a defined contribution plan or a hybrid plan, and state political regime shift. The effect of pension investment risk becomes stronger for the states with a large variation of pension contributions and greater financial constraints. Our results indicate that pension investment risks trigger subsequent unexpected pension contributions and cash flow shocks for state governments, which are the potential drivers of state borrowing costs. Additional tests show a stronger association between pension fund investment risks and state municipal finance for states with larger union membership and better pension law protection, as well as for general obligation bonds.

Keywords: Pension funds, Funding shortfalls, Investment risks, Municipal bonds

JEL Classification: G23, G11, H70

Suggested Citation

Agarwal, Sumit and Liu, Chunlin and Peng, Qiyuan and Wu, Qun and Zhang, Ting, Do Pensions have Real Teeth? Evidence from the State Government Borrowing Costs (December 28, 2021). Available at SSRN: https://ssrn.com/abstract=4024651 or http://dx.doi.org/10.2139/ssrn.4024651

Sumit Agarwal (Contact Author)

National University of Singapore ( email )

15 Kent Ridge Drive
Singapore, 117592
Singapore
8118 9025 (Phone)

HOME PAGE: http://www.ushakrisna.com

Chunlin Liu

University of Nevada, Reno - College of Business ( email )

University of Nevada, Reno
Reno, NV 89557-0016
United States

Qiyuan Peng

University of Dayton - School of Business Administration ( email )

Dayton, OH 45469
United States

Qun Wu

U of Nevada, Reno ( email )

1664 N Virginia St
Reno, NV NEVADA 89557
United States
7756829173 (Phone)

Ting Zhang

University of Dayton - School of Business Administration ( email )

300 College Park
Dayton, OH 45469
United States

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