Corporate Finance and Pension Schemes

The presence of pensions schemes, particularly defined benefit (DB) pension schemes, creates a range of two-way interactions between the sponsor and the scheme, and these are considered in this chapter. First, it is established that the sponsor and its DB scheme should be analysed as a single economic entity. Next, the effects of sponsoring a DB pension scheme on the firm’s leverage are considered, followed by an examination of the liquidity effects on the sponsor of making contributions to the scheme. There is then a discussion of the quantification of the sponsor’s asset beta allowing for the risk of the pension scheme, followed by coverage of the effects of having a DB scheme on a wide range of issues. These include mergers and acquisitions, the sponsor’s credit risk and share price, and the effects of the sponsor’s default risk on the scheme’s asset allocation. This is followed by models of the interaction between a scheme’s asset allocation, funding ratio and default insurance. Risk sharing between the sponsor and the members is then introduced into these models, followed by an analysis of the scope for tax arbitrage involving DB pension schemes. Finally, models of the effects of default insurance, risk sharing and tax arbitrage on the scheme’s asset allocation and funding ratio are presented.