Unfunded Pension Liabilities and Capital Structure Decisions: A Theoretical and Empirical Investigation
Alderson, Michael J.
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Permalink
https://hdl.handle.net/2142/71515
Description
Title
Unfunded Pension Liabilities and Capital Structure Decisions: A Theoretical and Empirical Investigation
Author(s)
Alderson, Michael J.
Issue Date
1984
Department of Study
Finance
Discipline
Finance
Degree Granting Institution
University of Illinois at Urbana-Champaign
Degree Name
Ph.D.
Degree Level
Dissertation
Keyword(s)
Economics, Finance
Abstract
In this thesis, a liability-based model of corporate pension funding policy is developed which is centered around two separate occurrences of differential taxation in the U.S. economy. The first of these concerns the FICA tax. Income received in the form of a pension is not subject to FICA withholding. Rational employees seeking to avoid this tax demand pension income from their employers. Firms are willing to supply pension income because the contributions which are required to service them are tax deductible.
Capitalists and labor are mutually exclusive groups. For this reason, employees (in effect) sell their pension claims in the capital markets. The second instance of differential taxation becomes important to the analysis at this stage. This is because the pension claims which labor sells are in essence debt securities, and as such are taxed at a higher rate than comparable equity instruments. Investors who purchase the pension claims will do so only if they are compensated for the additional tax which they pay on the debt obligation. When as in a "Debt and Taxes" world the tax disadvantage of purchasing the pension claim is passed back to the firm, the corporation finds it advantageous to supply pension income only up to the point where the net benefit of doing so is neutral. If corporations have differing amounts of non-pension tax shields, then a corporate pension policy which is unique to each firm exists in equilibrium.
A comparative statics analysis for the model produces four hypotheses which deal with the determination of the level of unfunded vested pension obligations. Three of these are empirically testable. A regression model is specified to test three of the conjected relationships.
Direct ordinary least squares estimates are computed for the regressions. Two-stage and three-stage least squares techniques and factor analysis regression are applied to deal with the problem of measurement error.
The results show that there is strong evidence to support the notion that the amount of unfunded vested pension liabilities which firms possess is inversely related to the amount of investment tax credits available. An inverse relationship between unfunded vested liabilities and the level of operating income is also identified.
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