Do Markets Like Frozen DB Pensions? An Event Study
26 Pages Posted: 31 Jan 2009
Date Written: April 15, 2008
Abstract
Using an event-study methodology, we document a positive announcement effect of 3.8% when an American company partially or fully freezes its Defined Benefit (DB) pension plan and replaces it with a Defined Contribution plan, such as a 401(k). This abnormal return is greater for firms with higher stock market beta, higher pension cost, lower historical stock returns and lower return on equity (ROE); all in the years prior to the announcement. In other words, the effect is more pronounced for firms that are more likely to face financial distress. We argue that the phenomenon can be explained by the longevity risk that upon closure is implicitly shifted from corporations to employees. In other words, shareholders cheer because the company is reducing a potentially unquantifiable liability: the risk of pensioners who live for ever.
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