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Bridge over ocean
1 May 2004 Financial Analysts Journal Volume 60, Issue 3

Pension Deficits: An Unnecessary Evil

  1. Lawrence N. Bader

Many companies believe that underfunding pension plans is an inexpensive way to borrow from employees and that mismatching equity investments to bondlike pension promises creates shareholder value. To the contrary, financial economics calls for fully funding and immunizing accrued pensions. For nonguaranteed pensions, inadequate funding magnifies employees' exposure to their employers' financial health—exposure that they cannot diversify. Fully securing the pensions eliminates this inefficiency in employee compensation. Governmental guarantees eliminate the employees' pension risk but invite weak sponsors to extract subsidies from strong ones through underfunding. A statutory requirement of full funding and immunization would eliminate these subsidies.

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