There equal to the market value of the

There are two types of pension
plans: Defined benefits (DB) plans and defined contribution (DC) plans. In DB,
the employer promises to pay a certain amount of benefits. This amount is
determined by the number of years of service the employee has at his retirement
and also the history of salary over the employment period. In DC, the employer
only contributes a certain amount during each period to the employee’s pension.
The value of a DC plan is equal to the market value of the portfolio held by
the fiduciary on behalf of the employee (Sundaresan and Zapatero, 1997)Further elaborate on who bears the risk in DB and DC and
specify that DB is the focus here since companies bear the risk and have to
match assets with liabilities. Now that we know in what different ways
liabilities can be perceived (in contribution paid today or benefits paid
later) it is also important to consider which perspectives a company has on its
pension plan. A study by Bodie, Light, Morck and Taggart (1987) identifies two
important perspectives: The traditional perspective and the corporate financial
perspective. The former means that pension funds are entirely separate from the
corporation and its shareholder and should be managed without regard to either
corporate financial policy or the interests of the corporation and its
shareholders. In the latter pension decisions are viewed as an integral part of
overall corporate financial policy. From this perspective, defined benefit
liabilities are just one more set of fixed financial liabilities of the firm. The
concern now is how to manage the firm’s extended balance sheet, including both
its normal assets and liabilities and its pension assets and liabilities, in
the best interests of the shareholders. Black (1980) and Tepper (1981) explain
that the tax effects are the first and they argued that the unique feature from
this integrated perspective is their role as tax shelter. That is why Black and
Tepper further point out that pension funds should be invested in more heavily
taxed assets such as bonds instead of equity, real estate or other assets that
are taxed with a lower marginal tax rate. Bodie, Light, Morck and Taggart
(1987) conclude their research by stating that they found strong evidence for a
significant tax effect which means that the corporate financial perspective is