Although a company’s pension assets and pension liabilities are not presented explicitly on financial statements, they should affect shareholder value and equity risk. Pension fund accounting rules are complex, however, and could obscure the influence of pension plan risk on equity risk. Moreover, the insuring role of the Pension Benefit Guaranty Corporation (PBGC) could cloud the relationship further.

The authors, therefore, investigate how pension plan risk influences the systematic risk of the equity, namely, equity beta, both theoretically and empirically. They demonstrate that estimates of operating asset beta (i.e., unlevered beta) will be upwardly biased if the value and/or risk of the pension plan are not properly taken into account. Failing to distinguish between operating asset risk and pension plan risk leads to discount rates for operating projects that are substantially overestimated and has obvious implications for net present value analysis in capital budgeting.

The authors estimate pension assets, liabilities, and risk using data derived from ERISA Form 5500 for the years 1993 through 1998. Financial data derived from Compustat provide information to calculate company risk (i.e., beta of the debt and equity). Consistent with theoretical predictions, a company’s beta moves in direct relation to the beta risk of pension assets. Depending on the assumptions, this relationship is approximately one for one, which implies that the stock market seems to process available pension data without bias.