The Effect of Voluntary Termination of Overfunded Pension Plans on Shareholder Wealth

Abstract

This paper examines abnormal returns of the common stock of firms with excess assets in their defined benefit pension plans around the time the sponsors announce their intention to terminate the plan. Previous research in this area has developed several economic reasons for a sponsor to terminate voluntarily an overfunded pension plan. The implications of each theory for stock prices are discussed and hypotheses for testing the managerial incentive theories are developed. Two types of analyses are performed on the sample: (1) a series of tests suggested by Dodd et al [12] to study the information content of a financial disclosure, and (2) multiple regression analysis to examine the explanatory power of the managerial incentive hypotheses. The findings suggest that the sample of firms experienced a statistically significant positive abnormal return around the time of the termination announcement, although the abnormal performance varies with the disclosed reason for termination and the type of successor pension plan adopted. Results for the multiple regression tests are consistent with the theory that stockholders will experience positive abnormal returns if the termination is a result of (1) a renegotiation of the wage contract by financially troubled firms or (2) an optimal borrowing strategy from the pension plan.

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