Hostname: page-component-7dd5485656-zlgnt Total loading time: 0 Render date: 2025-10-30T23:49:01.277Z Has data issue: false hasContentIssue false
  • English
  • Français

Pension Deficits and the Design of Private Debt Contracts

Published online by Cambridge University Press:  14 September 2018

Balasingham Balachandran Open the ORCID record for Balasingham Balachandran [Opens in a new window] ,
Huu Nhan Duong Open the ORCID record for Huu Nhan Duong [Opens in a new window]  and
Van Hoang Vu
Get access Rights & Permissions [Opens in a new window]

Abstract

We find a positive relation between the amount of pension deficits and the cost of bank loans. The effect of pension deficits on the cost of bank loans is driven by financial constraints, information-asymmetry problems, and higher pension-investment risk. Banks tighten lending terms for firms with larger pension deficits by requiring collateral, increasing the number of loan covenants, and shortening loan maturity. Borrowers with larger pension deficits are also more likely to violate covenants in the future. Collectively, these findings indicate that pension deficits represent an additional source of risk priced by banks.

Information

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 54 , Issue 4 , August 2019 , pp. 1821 - 1854
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2018 

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

Article purchase

Temporarily unavailable

Footnotes

1

We gratefully acknowledge helpful comments from Joao Cocco (the referee), Vidhan Goyal, Iftekhar Hasan, Paul Malatesta (the editor), Nadia Massoud, Phong Ngo, Shams Pathan, and Ghon Rhee; participants at the 2015 International Finance and Banking Society (IFABS) Conference, the 2016 Financial Research Network (FIRN) Banking and Financial Stability Meeting, and the 2017 FIRN Corporate Finance Meeting; and seminar participants at the University of Hawaii and Newcastle University seminar series. Vu is grateful to the IFABS for the Young Researcher Travel Grant (IFABS-OXFCONF-1503).

References

Almeida, H.; Campello, M.; and Weisbach, M. S.. “The Cash Flow Sensitivity of Cash.” Journal of Finance, 59 (2004), 1777–1804.Google Scholar
An, H.; Lee, Y. W.; and Zhang, T.. “Do Corporations Manage Earnings to Meet/Exceed Analyst Forecasts? Evidence from Pension Plan Assumption Changes.” Review of Accounting Studies, 19 (2014), 698–735.Google Scholar
Anantharaman, D.; Fang, V. W.; and Gong, G.. “Inside Debt and the Design of Corporate Debt Contracts.” Management Science, 60 (2013), 1260–1280.Google Scholar
Anantharaman, D., and Lee, Y. G.. “Managerial Risk Taking Incentives and Corporate Pension Policy.” Journal of Financial Economics, 111 (2014), 328–351.Google Scholar
Armstrong, C. S.; Guay, W. R.; and Weber, J. P.. “The Role of Information and Financial Reporting in Corporate Governance and Debt Contracting.” Journal of Accounting and Economics, 50 (2010), 179–234.Google Scholar
Asthana, S.“Determinants of Funding Strategies and Actuarial Choices for Defined-Benefit Pension Plans.” Contemporary Accounting Research, 16 (1999), 39–74.Google Scholar
Atanasova, C., and Gatev, E.. “Pension Plan Risk-Taking: Does It Matter If the Sponsor Is Publicly-Traded? ” Journal of Pension Economics and Finance, 12 (2013), 218–249.Google Scholar
Bae, K.-H., and Goyal, V. K.. “Creditor Rights, Enforcement, and Bank Loans.” Journal of Finance, 64 (2009), 823–860.Google Scholar
Bartram, S. M.“Corporate Post-Retirement Benefit Plans and Leverage.” Review of Finance, 20 (2016), 575–629.Google Scholar
Bergstresser, D.; Desai, M.; and Rauh, J.. “Earnings Manipulation, Pension Assumptions, and Managerial Investment Decisions.” Quarterly Journal of Economics, 121 (2006), 157–195.Google Scholar
Bharath, S. T.; Dahiya, S.; Saunders, A.; and Srinivasan, A.. “Lending Relationships and Loan Contract Terms.” Review of Financial Studies, 24 (2011), 1141–1203.Google Scholar
Bharath, S. T.; Sunder, J.; and Sunder, S. V.. “Accounting Quality and Debt Contracting.” Accounting Review, 83 (2008), 1–28.Google Scholar
Billett, M. T.; King, T.-H. D.; and Mauer, D. C.. “Growth Opportunities and the Choice of Leverage, Debt Maturity, and Covenants.” Journal of Finance, 62 (2007), 697–730.Google Scholar
Bodie, Z.; Light, J. O.; and Morck, R.. “Funding and Asset Allocation in Corporate Pension Plans: An Empirical Investigation.” In Issues in Pension Economics, Bodie, Z., Shoven, J. B., and Wise, D. A., eds. Chicago, IL: University of Chicago Press (1987).Google Scholar
Boot, A. W. A., and Thakor, A. V.. “Can Relationship Banking Survive Competition? ” Journal of Finance, 55 (2000), 679–713.Google Scholar
Bradley, M., and Roberts, M. R.. “The Structure and Pricing of Corporate Debt Covenants.” Quarterly Journal of Finance, 5 (2015), 1550001‐1–1550001‐37.Google Scholar
Brown, S., and Hillegeist, S. A.. “How Disclosure Quality Affects the Level of Information Asymmetry.” Review of Accounting Studies, 12 (2007), 443–477.Google Scholar
Campbell, J. L.; Dhaliwal, D. S.; and Schwartz, W. C. J.. “Financing Constraints and the Cost of Capital: Evidence from the Funding of Corporate Pension Plans.” Review of Financial Studies, 25 (2012), 868–912.Google Scholar
Campello, M.; Graham, J. R.; and Harvey, C. R.. “The Real Effects of Financial Constraints: Evidence from a Financial Crisis.” Journal of Financial Economics, 97 (2010), 470–487.Google Scholar
Chang, X.; Kang, J.-K.; and Zhang, W.. “Employees as Creditors: The Disciplinary Role of Pension Deficits in the Market for Corporate Control.” Working Paper, Chinese University of Hong Kong (2012).Google Scholar
Chava, S.; Livdan, D.; and Purnanandam, A.. “Do Shareholder Rights Affect the Cost of Bank Loans? ” Review of Financial Studies, 22 (2009), 2973–3004.Google Scholar
Chava, S., and Roberts, M. R.. “How Does Financing Impact Investment? The Role of Debt Covenants.” Journal of Finance, 63 (2008), 2085–2121.Google Scholar
Chen, X.; Yao, T.; Yu, T.; and Zhang, T.. “Learning and Incentive: A Study on Analyst Response to Pension Underfunding.” Journal of Banking and Finance, 45 (2014), 26–42.Google Scholar
Choy, H.; Lin, J.; and Officer, M. S.. “Does Freezing a Defined Benefit Pension Plan Affect Firm Risk? ” Journal of Accounting and Economics, 57 (2014), 1–21.Google Scholar
Christensen, H. B., and Nikolaev, V. V.. “Capital versus Performance Covenants in Debt Contracts.” Journal of Accounting Research, 50 (2012), 75–116.Google Scholar
Cocco, J. F.“Corporate Pension Plans.” Annual Review of Financial Economics, 6 (2014), 163–184.Google Scholar
Cocco, J. F., and Volpin, P. F.. “Corporate Pension Plans as Takeover Deterrents.” Journal of Financial and Quantitative Analysis, 48 (2013), 1119–1144.Google Scholar
Comprix, J., and Muller, K. A.. “Pension Plan Accounting Estimates and the Freezing of Defined Benefit Pension Plans.” Journal of Accounting and Economics, 51 (2011), 115–133.Google Scholar
Demerjian, P. R., and Owens, E. L.. “Measuring the Probability of Financial Covenant Violation in Private Debt Contracts.” Journal of Accounting and Economics, 61 (2016), 433–447.Google Scholar
Dennis, S., and Mullineaux, D. J.. “Syndicated Loans.” Journal of Financial Intermediation, 9 (2000), 404–426.Google Scholar
Dennis, S.; Nandy, D.; and Sharpe, I. G.. “The Determinants of Contract Terms in Bank Revolving Credit Agreements.” Journal of Financial and Quantitative Analysis, 35 (2000), 87–110.Google Scholar
Diamond, D. W.“Financial Intermediation and Delegated Monitoring.” Review of Economic Studies, 51 (1984), 393–414.Google Scholar
Diamond, D. W.“Debt Maturity Structure and Liquidity Risk.” Quarterly Journal of Economics, 106 (1991a), 709–737.Google Scholar
Diamond, D. W.“Monitoring and Reputation: The Choice between Bank Loans and Directly Placed Debt.” Journal of Political Economy, 99 (1991b), 689–721.Google Scholar
Diamond, D. W.“Seniority and Maturity of Debt Contracts.” Journal of Financial Economics, 33 (1993), 341–368.Google Scholar
Dichev, I. D., and Skinner, D. J.. “Large-Sample Evidence on the Debt Covenant Hypothesis.” Journal of Accounting Research, 40 (2002), 1091–1123.Google Scholar
Easley, D.; Kiefer, N.; O’Hara, M.; and Paperman, J.. “Liquidity, Information and Infrequently Traded Stocks.” Journal of Finance, 51 (1996), 1405–1436.Google Scholar
Easley, D.; Kiefer, N.; and O’Hara, M.. “One Day in the Life of a Common Stock.” Review of Financial Studies, 10 (1997), 805–835.Google Scholar
Edmans, A., and Liu, Q.. “Inside Debt.” Review of Finance, 15 (2011), 75–102.Google Scholar
Ertugrul, M.; Lei, J.; Qiu, J.; and Wan, C.. “Annual Report Readability, Tone Ambiguity, and the Cost of Borrowing.” Journal of Financial and Quantitative Analysis, 52 (2017), 811–836.Google Scholar
Falato, A., and Liang, N.. “Do Creditor Rights Increase Employment Risk? Evidence from Loan Covenants.” Journal of Finance, 71 (2016), 2545–2590.Google Scholar
Fama, E. F.“What’s Different about Banks? ” Journal of Monetary Economics, 15 (1985), 29–39.Google Scholar
Faulkender, M., and Wang, R.. “Corporate Financial Policy and the Value of Cash.” Journal of Finance, 61 (2006), 1957–1990.Google Scholar
Franzoni, F.“Underinvestment vs. Overinvestment: Evidence from Price Reactions to Pension Contributions.” Journal of Financial Economics, 92 (2009), 491–518.Google Scholar
Franzoni, F., and Marin, J. M.. “Pension Plan Funding and Stock Market Efficiency.” Journal of Finance, 61 (2006), 921–956.Google Scholar
Graham, J. R.; Li, S.; and Qiu, J.. “Corporate Misreporting and Bank Loan Contracting.” Journal of Financial Economics, 89 (2008), 44–61.Google Scholar
Hadlock, C. J., and Pierce, J. R.. “New Evidence on Measuring Financial Constraints: Moving beyond the KZ Index.” Review of Financial Studies, 23 (2010), 1909–1940.Google Scholar
Hasan, I.; Hoi, C. K.; Wu, Q.; and Zhang, H.. “Beauty Is in the Eye of the Beholder: The Effect of Corporate Tax Avoidance on the Cost of Bank Loans.” Journal of Financial Economics, 113 (2014), 109–130.Google Scholar
Hasan, I.; Hoi, C. K.; Wu, Q.; and Zhang, H.. “Social Capital and Debt Contracting: Evidence from Bank Loans and Public Bonds.” Journal of Financial and Quantitative Analysis, 52 (2017), 1017–1047.Google Scholar
Hirsch, B. T., and Macpherson, D. A.. “Union Membership and Coverage Database from the Current Population Survey: Note.” Industrial and Labor Relations Review, 56 (2003), 349–354.Google Scholar
Hollander, S., and Verriest, A.. “Bridging the Gap: The Design of Bank Loan Contracts and Distance.” Journal of Financial Economics, 119 (2016), 399–419.Google Scholar
Ippolito, R. A.“The Economic Function of Underfunded Pension Plan.” Journal of Law and Economics, 28 (1985), 611–651.Google Scholar
Ivashina, V.“Asymmetric Information Effects on Loan Spreads.” Journal of Financial Economics, 92 (2009), 300–319.Google Scholar
Ivashina, V., and Sun, Z.. “Institutional Stock Trading on Loan Market Information.” Journal of Financial Economics, 100 (2011), 284–303.Google Scholar
James, C., and Kizilaslan, A.. “Asset Specificity, Industry-Driven Recovery Risk, and Loan Pricing.” Journal of Financial and Quantitative Analysis, 49 (2014), 599–631.Google Scholar
Jensen, M. C., and Meckling, W. H.. “Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure.” Journal of Financial Economics, 3 (1976), 305–360.Google Scholar
Jin, L.; Merton, R. C.; and Bodie, Z.. “Do a Firm’s Equity Returns Reflect the Risk of Its Pension Plan? ” Journal of Financial Economics, 81 (2006), 1–26.Google Scholar
Kahle, K. M., and Stulz, R. M.. “Access to Capital, Investment, and the Financial Crisis.” Journal of Financial Economics, 110 (2013), 280–299.Google Scholar
Kaplan, S. N., and Zingales, L.. “Do Investment-Cash Flow Sensitivities Provide Useful Measures of Financing Constraints? ” Quarterly Journal of Economics, 112 (1997), 169–215.Google Scholar
Kaplan, S. N., and Zingales, L.. “Investment-Cash Flow Sensitivities Are Not Valid Measures of Financing Constraints.” Quarterly Journal of Economics, 115 (2000), 707–712.Google Scholar
Kim, J.-B.; Li, L.; Lu, L. Y.; and Yu, Y.. “Financial Statement Comparability and Expected Crash Risk.” Journal of Accounting and Economics, 61 (2016), 294–312.Google Scholar
Lin, C.; Ma, Y.; Malatesta, P.; and Xuan, Y.. “Ownership Structure and the Cost of Corporate Borrowing.” Journal of Financial Economics, 100 (2011), 1–23.Google Scholar
Lin, C.; Ma, Y.; Malatesta, P.; and Xuan, Y.. “Corporate Ownership Structure and Bank Loan Syndicate Structure.” Journal of Financial Economics, 104 (2012), 1–22.Google Scholar
Lin, C.; Ma, Y.; and Xuan, Y.. “Ownership Structure and Financial Constraints: Evidence from a Structural Estimation.” Journal of Financial Economics, 102 (2011), 416–431.Google Scholar
Love, D. A.; Smith, P. A.; and Wilcox, D. W.. “The Effect of Regulation on Optimal Corporate Pension Risk.” Journal of Financial Economics, 101 (2011), 18–35.Google Scholar
Matsa, D. A.“Capital Structure as a Strategic Variable: Evidence from Collective Bargaining.” Journal of Finance, 65 (2010), 1197–1232.Google Scholar
Myers, S. C.“Determinants of Corporate Borrowing.” Journal of Financial Economics, 5 (1977), 147–175.Google Scholar
Qian, J., and Strahan, P. E.. “How Laws and Institutions Shape Financial Contracts: The Case of Bank Loans.” Journal of Finance, 62 (2007), 2803–2834.Google Scholar
Rajan, R., and Winton, A.. “Covenants and Collateral as Incentives to Monitor.” Journal of Finance, 50 (1995), 1113–1146.Google Scholar
Rauh, J. D.“Investment and Financing Constraints: Evidence from the Funding of Corporate Pension Plans.” Journal of Finance, 61 (2006), 33–71.Google Scholar
Rauh, J. D.“Risk Shifting versus Risk Management: Investment Policy in Corporate Pension Plans.” Review of Financial Studies, 22 (2009), 2687–2733.Google Scholar
Shivdasani, A., and Stefanescu, I.. “How Do Pensions Affect Corporate Capital Structure Decisions? ” Review of Financial Studies, 23 (2010), 1287–1323.Google Scholar
Smith, C. W. J., and Warner, J. B.. “On Financial Contracting: An Analysis of Bond Covenants.” Journal of Financial Economics, 7 (1979), 117–161.Google Scholar
Stock, J. H., and Yogo, M.. “Testing for Weak Instruments in Linear IV Regression.” In Identification and Inference for Econometric Models: Essays in Honor of Thomas Rothenberg, Andrews, D. W. and Stock, J. H., eds. New York, NY: Cambridge University Press (2005).Google Scholar
Sufi, A.“Information Asymmetry and Financing Arrangements: Evidence from Syndicated Loans.” Journal of Finance, 62 (2007), 629–668.Google Scholar
Sufi, A.“Bank Lines of Credit in Corporate Finance: An Empirical Analysis.” Review of Financial Studies, 22 (2009), 1057–1088.Google Scholar
Valta, P.“Competition and the Cost of Debt.” Journal of Financial Economics, 105 (2012), 661–682.Google Scholar
Yu, F.“Analyst Coverage and Earnings Management.” Journal of Financial Economics, 88 (2008), 245–271.Google Scholar
Supplementary material: File

Balachandran et al. supplementary material

Internet Appendix

Download Balachandran et al. supplementary material(File)
File 37 KB