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The Role of CEO Inside Debt Holdings in Corporate Pension Funding Status

Thu, March 13, 8:30 to 10:00am, Sheraton Dallas Hotel, TBA

Abstract

A vast literature following Jensen and Meckling (1976) examine inside debt, including pension benefit and deferred compensation, as a part of the managerial compensation motivate CEOs’ incentives to align with those of debt holders and mitigate the agency costs of debt and its consequences. Recent evidence shows that CEOs with higher inside debt are more conservative in adopting financial and investment policies that minimize risk seeking behavior. Defined benefit pension plan funding status is important since it matters to employees, the Pension Benefit Guaranty Corporation (PBGC) and the U.S. economy. However, its determination is very complex. Beyond the accounting and economic factors that affect actuarial assumptions, pension asset return and voluntary contribution, empirical evidence also suggests that managerial ownership is associated with pension plan funding position. We argue that firms with their CEOs holding higher inside debt are more likely to have higher financial slack and lower financial constraint, due to their CEOs’ conservative nature and lower risk appetite. We also examine whether maintaining a status of excess pension funding a way to store financial slack for those CEOs. We design a two-stage least square method to control for the endogeneity problems that drive both CEO inside debt and firms’ funding strategy and our empirical results are, in general, consistent with the predictions. We provide further evidence that other investment activities decrease during the same period because pension contribution competes with the use of cash in other operating and investing opportunities.

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