Risk Shifting versus Risk Management: Investment Policy in Corporate Pension Plans

Risk Shifting versus Risk Management: Investment Policy in Corporate Pension Plans

The Review of Financial Studies. July
1, 2009, Vol. 22, Issue 7, Pages 2687-2733

The asset allocation of defined benefit pension plans is a setting where both risk-shifting and risk-management incentives are likely be present. Empirically, firms with poorly funded pension plans and weak credit ratings allocate a greater share of pension fund assets to safer securities such as government debt and cash, whereas firms with well-funded pension plans and strong credit ratings invest more heavily in equity. These relations hold both in pooled regressions and within firms and plans over time. The incentive to limit costly financial distress plays a considerably larger role than risk shifting in explaining variation in pension fund investment policy among firms in the United States.