Evidence on the Timing and Determinants
of Overfunded Pension Plan Termination
College of Business, San Francisco State University, San Francisco, CA 94132
KENNETH R. FERRIS
American Graduate School of International Management, Glendale, Arizona 85306
ANDREW H. CHEN
Cox School of Business, Southern Methodist University, Dallas, Texas 75275-0333
Abstract. This paper examines the factors associated with the timing of overfunded pension plan termination.
From a survey of corporate executives from plan terminating firms, four factors are identified as key determi-
nants in the termination decision: (1) the type, quality, and appropriateness of employee benefits; (2) merger or
takeover; (3) financial health; and (4) tax considerations. A logit analysis involving 172 terminations from the
period 1980 to 1989 was then conducted to empirically investigate the financial determinants of plan termina-
tion, after excluding merger or takeover-related terminations. The findings indicate that for both financially-dis-
tressed and less financially distressed firms, the decision to terminate an overfunded plan and the timing of that
decision are linked to the corporate need for cash resources to cover short-term obligations and to the amount of
available excess pension assets. No evidence was found to link an earnings shortfall with the termination deci-
sion for either the financially-distressed or less financially-distressed groups. In addition, evidence indicates that
for the financially-distressed group, it is more likely for companies to terminate an overfunded plan when avail-
able resources for capital projects have declined significantly, suggesting that reverted pension assets may be
used for these purposes. No evidence was observed to support a tax-motivated termination decision.
Keywords: Overfunded plan termination, Pension Asset Reversion, Financially—distressed firm
According to the Pension Benefit Guaranty Corporation (PBGC), approximately $21 bil-
lion was reverted from private pension plans to corporate treasuries during the period 1980
to 1989. In an effort to discourage pension asset reversions, the U.S. Congress passed leg-
islation imposing an excise tax (currently 20 percent
) on the value of any reverted assets.
Nevertheless, despite the fact that pension asset reversions are now more costly to corpo-
rate sponsors, plan terminations have continued, but at a substantially declining rate.
The purpose of this paper is twofold: (1) to report the results of a survey of factors lead-
ing to overfunded plan termination; and (2) to report the results of an empirical investiga-
tion of the factors associated with the timing of plan termination (i.e., when is the optimal
year to terminate an overfunded pension plan). Because the underlying reasons for plan
termination may differ across firms as a function of financial health, the sample of plan-
sponsors investigated was segmented into financially-distressed and less financially-dis-
tressed subgroups. In general, the empirical results indicate that it is more likely for both
financially-distressed and less financially-distressed sponsors to terminate an overfunded
plan in a year when the net reverted pension assets are large or when cash needs to meet
Review of Quantitative Finance and Accounting, 8 (1997): 129–150
© 1997 Kluwer Academic Publishers, Boston. Manufactured in The Netherlands.