Management Survival Strategies and the Decision to Reduce Pension Plan Funding: An Empirical Test (Tax)

Abstract

Many firms have reduced funding of defined benefit pension plans by either contracting or terminating the plans. These actions have raised both accounting and regulatory concerns. From an accounting standpoint, the nature of the transaction must be reported in a fair and representationally faithful manner. Regulators wish to ensure that firms are not exploiting either workers or the tax code. However, before accountants and regulators can make informed decisions, they need better insights into the motivation for funding reductions. Therefore, this study provides a comprehensive empirical analysis of the motivational factors leading to reductions in pension plan funding. Sample firms are classified into three groups, terminators (firms terminating pension plans), contractors (firms reducing funding by more than 40% through changes in actuarial assumptions), and maintainers (firms not terminating plans or reducing funding by more than 40%). Trichotomous logit models are estimated with and without consideration of state-based sampling. Both versions of the logit model show that funding reductions are directly related to poor financial health, susceptibility to takeover, and degree of overfunding. The firm cash tax rate is negatively related to plan reductions, while overall cost of capital is not significantly related. In addition, the research shows that a trichotomous model predicts terminators better than a dichotomous model which combines contractors with maintainers.