In the July/August issue of this journal, Fischer Black argued that pension sponsors could take advantage of the special tax status of the pension plan to increase the value of their shares. Black’s two-step plan involves selling stocks in the pension fund and buying bonds with the proceeds, while selling bonds in the sponsoring corporation and using the proceeds to repurchase corporate stock.
Because contributions to the pension fund are tax-deductible, pension assets are worth less than their market value to the corporation’s shareholders, and by a factor equal to one minus the corporate tax rate. This fact complicates the answers to two key questions pension sponsors are likely to ask: (1) How much will the plan increase the value of our company’s shares? (2) Given the amount of equity assets in the pension fund to be exchanged for debt, what scale of share retirement in the corporation will be precisely offsetting, in the sense of preserving the present level of systematic risk in the shares of the corporation?
The author works out specific answers to these questions. He also determines the impact on share value if the sponsor elects not to offset the risk reduction in the pension fund with a share repurchase program in the corporation. Finally, he shows how early funding of the pension plan can take advantage of its tax-exempt status.