PENSION BENEFITS EFFECTS ON CAPITAL-MARKET EQUILIBRIUM, FIRM VALUE, AND FINANCING DECISIONS

The implications of the impact of pension benefits for capital market equilibrium, investment, induced retirement, and the firm's value and financing decisions are analyzed. A static utility-maximization model is proposed. The model implies a new return-risk equation that explicitly incorporates the effect of pension compensations and is compared with the standard equation. The new model more adequately describes the return-risk relationship of a capital asset than the traditional model and implies that the program of pension benefits has a significant influence on the movement of stock prices. The model further implies that the firm's value is affected by a change in pension benefits and increases as its leverage increases, and that while the Modigliani-Miller first proposition is not affected by the leverage of the pension fundings, it is no longer valid in the presence of corporate income taxes. A special form of the Modigliani-Miller second proposition is also derived from the model.