Investment and financing constraints: Evidence from the funding of corporate pension plans

I exploit sharply nonlinear funding rules for defined benefit pension plans in order to identify the dependence of corporate investment on internal financial resources in a large sample. Capital expenditures decline with mandatory contributions to DB pen-sion plans, even when controlling for correlations between the pension funding status itself and the firm’s unobserved investment opportunities. The effect is particularly evident among firms that face financing constraints based on observable variables such as credit ratings. Investment also displays strong negative correlations with the part of mandatory contributions resulting solely from unexpected asset market movements. Companies cannot commit to building new plants, launching new research projects or hiring new employees if that cash is needed to fund pensions. —Glen A. Barton, Chairman and Chief Executive of Caterpillar Inc. (New York Times, 22 June 2003). Firms that sponsor defined benefit (DB) pension plans must make financial contributions to their pension funds according to legally specified formulas. These contributions have a direct impact on a company’s internal financial resources. If a firm is financially constrained, contribution requirements may also affect its ability to invest in new capital, conduct research and development (R&D), and make acquisitions. To the extent that required contributions can be separated from the firm’s investment opportunities, they are useful instru-ments in identifying the response of corporate capital expenditures to changes in internal financial resources. This paper investigates the response of corpo-rate expenditures—primarily on capital but also on R&D and acquisitions—t