PENSION FUNDING POLICY AND CORPORATE FINANCE (BUSINESS, EMPLOYEE BENEFITS, JOB TENURE)

The Employee Retirement and Income Security Act of 1974 (ERISA) moved private pensions to the forefront of public policy; it attempted to correct defects in the private pension system by regulations.;Underfunding is widespread because firms use pension funding activities for other corporate objectives. This hypothesis is supported by data from the Financial Accounting Standards Board. Pension funding can provide a convenient and economic source of capital; it can also smooth corporate earnings in order to satisfy the financial market's preference for earnings stability.;The downside risk of this underfunding is passed on to the Pension Guarantee Benefit Corporation (PBGC) created by ERISA. PBGC is now floundering because of an inadequate and inequitable premium structure and exploitative termination rules. Without direct government subsidy, a system of inadequately funded pension plans insured by a bankrupt insurance agency will never achieve the retirement income security envisioned by ERISA.;Current proposals to reform PBGC include risk-based premiums to encourage adequate funding and stringent termination rules to eliminate flagrant abuses. These proposals, however, face insurmountable technical difficulties and administrative obstacles.;This paper uses a new revaluation procedure to show that funding inadequacy is a serious problem. The problem stems from permissive and ineffective ERISA regulations that allow firms to use unrealistic actuarial assumptions, while ignoring future wage increases and exaggerating future returns on pension fund investments.;By focusing on PGBC's problems, current proposals neglect ERISA's fundamental social objective. One alternative is to give pensions a first claim on corporate assets, which are more than adequate to protect retirement income. This proposal relies on the financial markets to assign pension risk and to allocate the cost. Pension funding will then be internally optimal for the firm and externally efficient for the economy. As a result, the present bulky regulatory apparatus could be substantially streamlined.