The Effect of Regulatory Change on Pension Funding Determinants

Pension theory suggests and empirical tests indicate that optimal funding levels for defined benefit plans are determined on the basis of risk, taxes, and capital availability. This study examines whether federal pension and tax legislation enacted in 1986 and 1987 significantly altered the role of risk, taxes, and capital availability as determinants of corporate pension funding policy. Regression tests relating funding levels to these variables were conducted on a sample of pension plans, separately, for each of the reporting years, 1985 (before enactment of the legislation) and 1989 (after enactment of the legislation). Pension risk and tax exposure variables, significant in explaining funding levels in 1985, were not significant in 1989. Pension risk and tax factors under this new regime play a significantly diminished role, if any, in determining funding level policy for defined benefit plans. Evidence is provided that current pension funding is dependent upon the variability of common equity returns, and thus indicate that the pension funding decision is made in the same context as any other capital allocation decision.