Practical analysis for investment professionals
19 November 2013

Moral Hazard and Tax Benefits as Drivers of Corporate Pension Plans (Podcast)

In the first five days of October 2008, large corporate pension funds lost more than $100 billion of pension assets. And at the end of 2011, the aggregate funding shortfall for Fortune 1000 companies amounted to $343 billion. In examining the decisions that defined benefit plan sponsors made, authors Xuanjuan Chen, Tong Yu, and Ting Zhang argue that moral hazard and tax benefits play a significant role. Their July/August 2013 Financial Analysts Journal article, “What Drives Corporate Pension Plan Contributions: Moral Hazard or Tax Benefits?,” further explores the effect of bankruptcy risk on such sponsors.

Reading this on mobile device? Click here to listen to the audio.

I got the chance to talk with Zhang about his research as part of our FAJ author interview series. He says the team found that “bankruptcy risk is a critical factor” when it comes to whether a sponsor’s strategy is driven by tax benefits or moral hazard. Specifically, sponsors with a high bankruptcy risk have a strong moral-hazard incentive, and thus they make lower voluntary contributions. But for low-bankruptcy-risk sponsors, maximizing tax benefits associated with pension contributions becomes a powerful incentive.

The authors examine several important policy implications, which Zhang discusses in our interview, and he believes their findings are critical for analysts. “For financial analysts who forecast company earnings or make stock recommendations, we suggest that they should pay more attention to firms with large, underfunded pension plans,” he says. “Some of these sponsors have high expected bankruptcy risk.”

To hear Zhang discuss the article and the practical implications of the results, listen to the full interview above or download the MP3.

CFA Institute members can access the full journal article on the CFA Publications website.

Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.

About the Author(s)
Abby Farson Pratt

Abby Farson Pratt was an assistant editor at CFA Institute. Previously, she worked at the Denver Post and the University of North Carolina Press. Pratt earned the Claritas™ Investment Certificate and holds a BA in journalism and English from the University of North Carolina at Chapel Hill.

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