Do Pensions have Real Teeth? Evidence from the State Government Borrowing Costs
46 Pages Posted: 3 Feb 2022 Last revised: 11 Oct 2022
Date Written: December 28, 2021
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: Suggested Citation