Defined Benefit Pension Plans and Cost of Equity

• In Event: Pension Plans, Derivatives, & Clawback Provisions

Abstract

This paper extends prior research on defined benefit plans by investigating the effect of pension risk on a firm’s cost of equity. In particular, this study evaluates how pension intensity influences a defined benefit plan firm’s implied cost of equity. Using proxies to measure pension intensity, and audit quality, we document that a defined benefit plan’s cost of equity increases with the scaled magnitude of the firm’s pension intensity risk, but that audit quality moderates this relation. We rationalize these findings by asserting that the positive relation between a sponsoring firm’s cost of equity and pension intensity reflects increased financial risk associated with higher pension obligations, but that the quality of the auditor reduces this risk. This study also documents a post-SFAS 158 decrease in the cost of equity, suggesting that investors require lower returns due to the effect of more transparent accounting for defined benefit plans, including the recognition of defined pension obligations.

Authors

• Robert Houmes, Jacksonville University

• Daphne Wang, Jacksonville University

• Thanh N. Ngo, East Carolina University

• Ruth O'Keefe, Jacksonville University