Although a company’s pension assets and pension liabilities are not presented explicitly on financial statements, they should affect shareholder value and equity risk. Pension fund accounting rules are complex, however, and could obscure the influence of pension plan risk on equity risk. Moreover, the insuring role of the Pension Benefit Guaranty Corporation (PBGC) could cloud the relationship further.
Although a company’s pension assets and pension liabilities are not presented
explicitly on financial statements, they should affect shareholder value and equity
risk. Pension fund accounting rules are complex, however, and could obscure the
influence of pension plan risk on equity risk. Moreover, the insuring role of the
Pension Benefit Guaranty Corporation (PBGC) could cloud the relationship further.
The authors, therefore, investigate how pension plan risk influences the systematic risk
of the equity, namely, equity beta, both theoretically and empirically. They demonstrate
that estimates of operating asset beta (i.e., unlevered beta) will be upwardly biased if
the value and/or risk of the pension plan are not properly taken into account. Failing
to distinguish between operating asset risk and pension plan risk leads to discount
rates for operating projects that are substantially overestimated and has obvious
implications for net present value analysis in capital budgeting.
The authors estimate pension assets, liabilities, and risk using data derived from ERISA
Form 5500 for the years 1993 through 1998. Financial data derived from Compustat provide
information to calculate company risk (i.e., beta of the debt and equity). Consistent
with theoretical predictions, a company’s beta moves in direct relation to the
beta risk of pension assets. Depending on the assumptions, this relationship is
approximately one for one, which implies that the stock market seems to process
available pension data without bias.