Mercer: Beware of Subbing Stock for Cash in Pension Payments
A research paper by Mercer Investment Consulting notes that a host of fiduciary issues are associated with having company stock in a pension plan, including the fact that any part of management that also acts as a plan fiduciary is exposed to potential conflict-of-interest problems.
Nevertheless, said research paper author and Mercer consultant Louis Finney, it might be a valuable option for the short term.
“Stock contributions are a helpful option for
cash-strapped companies, and one that healthy companies may
occasionally consider,” said Finney in a statement. “But
company stock doesn’t improve the risk and return profile
of the pension plan. Moreover, it increases the
fiduciary burdens of trustees, who must then manage the
allocation and determine the role of the company as
essentially an asset of the plan as well as a payer of
future contributions.”
Short-term benefits aside, the risks are real, said Mercer
consultant David Cantor. Possible implications for the
company include:
- Increased investment risk in the pension plan due to lower diversification, higher linkage of company and plan performance, and leverage of the company. This increased risk may lead to increased volatility of funded status, contributions, and earnings.
- Increased fiduciary risks to management and an additional burden placed on fiduciaries to manage the allocation of company stock in the portfolio. Participant concern and litigation risk may also be increased.
- The increase in company stock could increase shareholder equity and/or dilute shareholder value. By tying the company and pension plan closer together, increases in company stock in the pension plans probably will bring heightened scrutiny by participants and an increase in litigation risk.
Times to Make the Move
According to Mercer, there are four major rationales for making contributions to a pension plan in company stock rather than cash:
- If a company is under stress and strapped for cash but must still make a minimum funding contribution, contributing company stock will allow the company to conserve cash.
- Management might believe that the company is presently undervalued and could appreciate significantly in the short-term. In this case, a cash-rich company might contribute stock as a short-term bet on the company price. Management should be aware, however, that once stock is placed in the pension plan, the trustees may decide to diversify the risks, Mercer said.
- Contributions of company stock increase management control. Treasury stock does not have any voting or dividend rights; by transferring company stock from treasury stock to the pension plan, the voting and dividend rights are reactivated. If the trustees of the plan vote the shares in management interests, then management can achieve greater voting power. However, the fiduciary responsibility of plan trustees may require them to diverge from management’s interests.
- While the liquidity of a company could be increased if the contribution comes from treasury stock or new issuance and the fiduciaries then sell the shares in the open market, this is not a “given,” according to Mercer.
For more information about the Mercer research, go to http://www.merceric.com/knowledgecenter/reportsummary.jhtml?idContent=1095905 (free registration required).