(September 26, 2012) – Like fat, not all debt is created equal, according to Söhnke Bartram of Warwick Business School.
Defined benefit (DB) obligations would be the olive oil of the group: still hazardous in excessive quantities, but vastly superior to regular debt.
In a research paper titled “Post-Retirement Benefit Plans, Leverage, and Real Investment,” Bartram investigated the role of pension and retiree health benefit plans on corporate capital structure and real investment. Bartram is a finance professor and, until last year, was the head of State Street’s quantitative analysis division in London.
He based his analysis on a data set comprising the financials of more than 33,000 publicly traded non-financial firms from 50 countries between 2002 and 2009.
From this sample, Bertram found DB obligations have a negative effect on corporations’ capital expenditures. Furthermore, and perhaps surprisingly, pensions have a positive effect on research and development expenses, which he uses as a proxy for real investment. The effect, he writes, “is not only statistically significant, but also economically sizable.”
For instance, a corporation with pension obligations valued at 10.5% of the firm’s total assets would enjoy, on average, 5% less capital expenditures and 12.3% more research and development than a similar corporation without a DB plan.
“To the extent that larger post-retirement obligations entail more flexibility on the financing side, it induces more flexibility and optionality on the asset side, by creating more real options via R&D and by executing fewer options via capital expenditures,” Bertram writes. “Consequently, post-retirement plans are important not just for the capital structure, but also for the real operations of a company.”
His analysis also revealed that substitution between DB obligations and regular forms of corporate debt by no means operates in a one-to-one ratio. In other words, consuming two tablespoons of olive oil can’t be counted as saving two tablespoons of butter.
Read Bertram’s full paper here.