Securities market response to legislated changes in the pension plan reversion excise tax

Frank Lee Heflin, Purdue University

Abstract

This study examines stock returns around legislative events concerning the passage of, and subsequent increase in, the excise tax on overfunded pension plan reversions. Tests are conducted to determine (1) whether those events are associated with downward revaluations of firms sponsoring defined benefit plans (DB firms) relative to firms not sponsoring defined benefit plans (NDB) firms and (2) whether the event period returns for DB firms were related to the funding levels of their pension plans. These tests provide evidence about whether or not the option to revert excess pension assets has value. Implicit contract interpretations of reversions specify that the firm enters into implicit contracts with employees that promise part or all of excess pension assets to employees, and that capital market participants recognize and expect firms to honor those implicit contracts. Additionally, if reversions represent wealth transfers from workers, potentially resultant adverse labor cost effects may mean that reversions are not equity value increasing events, especially if managements do not invest the reverted assets in positive net present value projects. This implicit contract interpretation of reversions, then, potentially implies that the option to revert is not valued by shareholders. If the option to revert is not valued, the passage/increase of a reversion excise tax would not be expected to affect firm value. However, firms legally have the option to terminate overfunded pension plans and revert excess pension assets. These reversions may represent liquidations of valuable financial slack in the Myers and Majluf (1984) sense. If the option to revert excess pension assets has value, then the passage/increase in the reversion excise tax would be expected to affect the prices of firms sponsoring defined benefit plans. The results are, in general, weakly consistent with the hypothesis that legislative events concerning the passage and subsequent increase in the reversion excise tax affected the values of DB firms in a manner congruous with shareholders valuing the option to revert excess pension assets.

Degree

Ph.D.

Advisors

Kross, Purdue University.

Subject Area

Accounting

COinS