The Association between Board Composition and Corporate Pension Policies

Published date01 November 2016
Date01 November 2016
The Financial Review 51 (2016) 481–506
The Association between Board
Composition and Corporate Pension
Nikos Vafeas
University of Cyprus
Adamos Vlittis
Cyprus Institute of Marketing
This study examines the role of board composition in the determination of pension
policies. The results suggest that the proportion of outside directors serving on the board
is positively related with pension plan funding levels. In addition, the proportion of outside
directors mitigates the relation between financial distress risk and plan underfunding. Last, as
firms approach distress, boards with a greater proportion of outside directors tend to allocate
a lower fraction of plan assets to riskier securities. Together, our findings suggest that outside
directors are mindful of their obligations toward pension plan beneficiaries.
Keywords: board of directors, pension policies, defined benefit pension plans
JEL Classifications: G32, G34
Corresponding author: School of Economics and Management, University of Cyprus, Kallipoleos 75,
Nicosia 20537, Cyprus; Phone: +357-22893601; Fax: +357-22895475; E-mail:
We have benefited from comments and suggestions by two anonymous reviewers, seminar participants
at the University of Edinburgh and the Cyprus University of Technology, and in particular from input
by Stergios Leventis, Alex Michaelides, Andreas Milidonis, Lenos Trigeorgis, Martin Walker and Dave
Yermack. We thank John Graham for providing the corporate marginal tax rates data and Beryl Pittman
for editorial input. Nikos Vafeasacknowledges research support from the University of Cyprus. Theodora
Papanastasiou provided competent research assistance.
C2016 The Eastern Finance Association 481
482 N. Vafeasand A. Vlittis/ The Financial Review51 (2016) 481–506
1. Introduction
This study extends prior research on the relation between corporate governance
mechanisms and pension policies (e.g., Cocco and Volpin, 2007; Phan and Hegde,
2013; Anantharaman and Lee, 2014) by examining the role of board composition in
pension plan funding and asset allocation decisions. The board of directors, and in
particular its outside directors, has a potentially important monitoring role to play in
the determination of pension policies given that shareholders and plan beneficiaries,
who are a pension plan’s primary stakeholders, are not well positioned to impose
effective governance. Drawing from the board literature (e.g., Adams, Hermalin and
Weisbach, 2010), we study how outside directors help to shape corporate pension
policies. The primary tension motivating our investigationis provided by the conflict-
ing interests of shareholders and pension plan beneficiaries, and the pension-related
fiduciary responsibility bestowed on directors by regulators. It is a priori unclear how
outside directors behave toward these different constituents in the contextof pension
plans. The present study addresses this issue empirically.
Before we proceed to assess the importance of board composition, we should
review the nature of competing interests in the determination of pension policies
necessitating the enforcement of proper monitoring mechanisms. The institutional
structure of defined benefit (DB) plans in the United States creates an agency conflict
that is similar to the conflict between equity- and debtholders as a firm approaches
financial distress (Jensen and Meckling, 1976; Myers, 1977). If we view the DB
plan as corporate debt, limited downside risk constrains shareholder losses in the
case of failure but awards shareholders the full benefits when the fund performs
well. Therefore, shareholders of firms approaching distress have risk-shifting in-
centives that manifest in incentives to underfund their pension plans and to invest
plan assets in risky securities (Sharpe, 1976; Treynor, 1977).1The empirical evi-
dence on the risk-shifting hypothesis, however, is weak. While some studies find
evidence of risk shifting with regard to the funding decision (e.g., Bodie, Light,
Morck and Taggard, 1985; Coronado and Liang, 2005; Bereskin, 2011), the ma-
jority of prior studies find evidence consistent with a competing risk-management
explanation especially when it comes to the asset allocation decisions (e.g., Fried-
man, 1983; Francis and Reiter, 1987; Petersen, 1996; Amir and Benartzi, 1999).
The risk-management explanation suggests that incentives stemming from manda-
tory pension contributions increase liquidity constraints and financial distress costs,
leading financially weaker firms to select more conservative investment strategies
(Rauh, 2009).
Anatharamam and Lee (2014) propose the shareholder–manager conflict on risk
as an additional explanation to the weak empirical evidence on risk shifting. While
1This conflict is exacerbated by the insurance provided by the Pension Benefit Guaranty Corporation
(PBGC). The PBGC insurance shifts the loss away from plan beneficiaries to the PBGC and reduces the
incentives of plan beneficiaries to monitor management of their plan.

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