Pension plan funding, risk sharing and technology choice

David C. Webb

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: This paper presents a general equilibrium analysis on the interactions between pension plan funding, capital structure, technology choice and the equity premium. The paper shows that economies with large funded defined pension schemes may be biased towards safe production. The pricipal results derive from the existence of borrowing and short sales constraints. In the first scenario workers are constrained in the capital market and debt is risk-free. If pension benefits are sufficiently high, then the capital market constraint may be binding. Then, leveraging the risky technology gives workers an adjustment channel through which they may undo an over-exposure to risk-free investment. This results in more risky production and a fall in the equity premium. In the second scenario workers are constrained in the capital market and debt is subject to default risk. If the level of the resulting pension plan shortfall risk is low and if pension benefits are sufficiently high, then the previous is at work. If the level of shortfall risk is high, workers hedge themselves by holding risk-free assets and the constraint in the capital market is no longer binding. Then the risky firm does not benefit from leveraging and there is more safe production in the economy.

JEL-codes: G11 G23 G31 G32 (search for similar items in EconPapers)
Pages: 37 pages
Date: 2007-11-28
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Persistent link: https://EconPapers.repec.org/RePEc:ehl:lserod:24641

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