Effect of debt tax benefits on corporate pension funding and risk-taking

Abstract

Purpose

This study theoretically investigates the impacts of tax benefits on funding level and risk-taking of a corporate defined benefit (DB) pension plan.

Design/methodology/approach

The present value of the future tax benefits is maximized while the stockholders determine the funding level and investment risk-taking in DB plans. As a feature of DB plans, this study considers pension benefits to be pre-determined. Further, the pension beneficiary has a priority over the sponsor company's creditors for the pension reserve fund. These are seldom considered in previous studies.

Findings

It is desirable to decrease the funding level of DB plans to increase tax benefits. This is because the effect of tax exemption for the pension fund's investment income is eliminated by the change in the contribution arising from the investment's result. The optimal investment risk-taking depends on the funding level.

Originality/value

The impact of tax benefits on decision-making for DB plans is significantly different from that stated by previous studies, that is, an increase in pension funds will reduce the corporate debt. To explain corporate behavior, this study's results—derived from the essential feature of DB plans, which could not have been included in previous studies—should be considered.

Citation

Omori, K. and Kitamura, T. (2020), "Effect of debt tax benefits on corporate pension funding and risk-taking", Journal of Economic Studies, Vol. 47 No. 6, pp. 1327-1337. https://doi.org/10.1108/JES-04-2019-0188