There are two types of pensionplans: Defined benefits (DB) plans and defined contribution (DC) plans. In DB,the employer promises to pay a certain amount of benefits. This amount isdetermined by the number of years of service the employee has at his retirementand also the history of salary over the employment period. In DC, the employeronly 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 bythe fiduciary on behalf of the employee (Sundaresan and Zapatero, 1997)Further elaborate on who bears the risk in DB and DC andspecify that DB is the focus here since companies bear the risk and have tomatch assets with liabilities. Now that we know in what different waysliabilities can be perceived (in contribution paid today or benefits paidlater) it is also important to consider which perspectives a company has on itspension plan. A study by Bodie, Light, Morck and Taggart (1987) identifies twoimportant perspectives: The traditional perspective and the corporate financialperspective. The former means that pension funds are entirely separate from thecorporation and its shareholder and should be managed without regard to eithercorporate financial policy or the interests of the corporation and itsshareholders.
In the latter pension decisions are viewed as an integral part ofoverall corporate financial policy. From this perspective, defined benefitliabilities are just one more set of fixed financial liabilities of the firm. Theconcern now is how to manage the firm’s extended balance sheet, including bothits normal assets and liabilities and its pension assets and liabilities, inthe best interests of the shareholders. Black (1980) and Tepper (1981) explainthat the tax effects are the first and they argued that the unique feature fromthis integrated perspective is their role as tax shelter. That is why Black andTepper further point out that pension funds should be invested in more heavilytaxed assets such as bonds instead of equity, real estate or other assets thatare taxed with a lower marginal tax rate. Bodie, Light, Morck and Taggart(1987) conclude their research by stating that they found strong evidence for asignificant tax effect which means that the corporate financial perspective isapplicable.