The corporate bankruptcy narrative of ballooning pension costs driving firms to insolvency may be more myth than fact, according to a study published earlier this month.
What did increase the likelihood of future balance-sheet distress appeared on the defined contribution (DC) side, wrote finance researchers Ying Duan (University of Alberta), Edith Hotchkiss (Boston College), and Yawen Jiao (University of California Riverside).
Unlike DC plans, DB pensions rarely—if ever—double down on exposure to their plan sponsors by becoming long-term shareholders.
Plans with more than 10% of their assets in sponsor-company stock had a “significantly” higher probability of corporate defaults than those with smaller, but still existing, exposures. These firms were also more likely to seek bankruptcy protection rather than restructure debts out of court.
Finally, compounding the problem, “DC plan sponsors and participants do not actively adjust these plans’ exposures to company stock prior to defaults, and such inertia imposes significant losses on plan participants because of the value loss of company stock.”
In contrast, defined benefit (DB) pensions—as a matter of law and practice—rarely if ever double down on exposure to their plan sponsors by becoming long-term shareholders.
While both the proportion of internal stock held by DC plans and DB unfunded liabilities tended to rise as sponsors neared insolvency, the authors found no causal link between DB funding ratios and defaulting or bankruptcy.
Nearly two-thirds of DB plans are “substantially underfunded” when their sponsoring firm hit the financial wall. However, according to Duan, Hotchkiss, and Jiao, those scant assets tend to be an effect of balance sheet distress rather than a cause of it. Unlike a DC plan sponsor, corporate treasuries enjoy greater leeway to fund—or not fund—their employee retirement pools.
Still, the study determined that only 20% of bankrupt DB plan sponsors terminated their schemes by transferring the assets and liabilities (which often end up cut down) to the Pension Benefit Guaranty Corporation. Based on their data set, “the probability of a bankruptcy filing shows no significant relationship between underfunding and the likelihood of bankruptcy.”
Thus, the researchers concluded, “our findings cast doubt on the argument that defaulting firms often opt for bankruptcies to terminate underfunded pensions—a practice not allowed in out of court restructurings.”
Authors Duan, Hotchkiss, and Jiao presented their study “Corporate Pensions and Financial Distress” earlier this month at the American Economic Association’s annual meeting in Boston.
Related Content: Lessons for DC Plans from DB; The Cash-Rich Underfunded DB Plans