Pension Plan Contributions, Free Cash Flows and Financial Slack



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Calculating pension plan cash flows using financial statement information



Derivation of Contributions and Benefits Paid


Included in the provisions of the recently released SFAS No. 132 [FASB, 1998], “Employers’ Disclosures about Pensions and Other Postretirement Benefits“, is the requirement to disclose cash flows associated with pension plans; i.e. contributions (CONTA) made by the firm to the pension plan and benefits (BENA) paid by the plan to retirees. These disclosures were not provided under SFAS 87, the accounting standard in effect for the sample of firms we examined. However, these cash flows can be estimated (albeit with some measurement error14). In order to analyze the relationship between contributions and firms’ funding status, one must derive them from the given SFAS 87 disclosures.

Estimating Contributions


The pension amount shown on the balance sheet, the accrued pension liability (prepaid pension cost), reflects the difference between the plan assets and PBO less any unrecorded plan assets/ liabilities. Each year, the balance sheet liability is increased by the amount of the net periodic (smoothed) pension expense recognized under SFAS 87 and reduced by employer pension contributions made during the year.

Using the given balance sheet amounts and the reported pension cost, the unknown variable "Contributions", can be derived as:



Contributions = Pension expense -  accrued pension liability.

Minimum Liability Adjustment


The above estimate will be incorrect if the firm is subject to the accrual of a minimum pension adjustment. The FASB required firms with pension plans in which the ABO is greater than plan assets to record on the balance sheet a minimum pension liability equal to the difference between the two. Thus, the minimum liability adjustment (required to effect this liability) also affects the opening or closing balance of the accrued pension liability, although it is not included in net pension cost. Thus, in the estimation of the contribution, the minimum liability adjustment needs to be removed from the opening and closing balances of the accrued pension liability.

Estimating Benefits


To estimate the cash benefits paid to retirees in the current period, the following information is required:

  • opening and ending balances of the pension plan assets,

  • actual return on plan assets (PENROA), and

  • pension plan contributions as estimated above.

Given these items, cash benefits paid to current retirees can be estimated as
Benefits paid to retirees = Contributions + PENROA -  plan assets



EXHIBIT 1

SUMMARY STATISTICS





Variable

Mean

Minimum

25%

Median

75%

Maximum




UNSCALED






















Contributions

11.8

0.0

0.0

0.4

3.4

7760.0




PBO

359.2

0.0

0.0

18.6

119.2

82027.0




Pension assets

361.1

0.0

0.0

17.3

119.4

77210.0




Net funding

1.8

-22264.0

-3.1

0.0

1.3

10435.0




Free cash flow

61.3

-17513.0

-1.5

1.0

27.2

10715.0




Benefits

28.1

0.0

0.0

1.0

7.4

6637.7




Tax rate

22.2

0.0

0.0

23.1

36.6

60.0




Total assets

3860.0

0.5

57.2

353.4

1870.3

351041.0




























SCALED BY TOTAL ASSETS






















CONTA

0.0033

0

0

0.0008

0.0044

0.0448




FUNDA

0.0001

-0.1957

-0.0074

0

0.0025

0.2329




FCFA

0.0020

-1.0243

-0.0211

0.0113

0.0547

0.4971




BENA

0.0071

0

0

0.0024

0.0085

0.1790




PENROA

0.0142

-0.0306

0.0019

0.0072

0.0188

0.2185

Notes:

  1. Contributions are estimated as the pension expense minus the change in the accrued pension liability (net of minimum liability). CONTA are contributions scaled by total assets.

  2. Net Funding is estimated as the fair market value of pension assets minus the Projected Benefit Obligation (PBO). FUNDA is net funding scaled by total assets

  3. Free cash flow is net operating cash flow minus capital expenditures. FCFA is free cash flow scaled by total assets

  4. Benefits paid are estimated as pension contributions minus (plus) increases (decreases) in the fair market value of pension plan assets plus the actual return on assets. BENA is benefits paid scaled by total assets.

  5. The Tax rate is estimated as the tax payments (or tax expense) divided by pretax income. It is winsorized to fall in the range of 0%-60%.

  6. Pension assets are plan assets at fair market value.

  7. PENROA in the actual return on plan assets (scaled by total assets).

  8. Number of observations = 8,643 firm-years made up of 1,683 firms.


EXHIBIT 2

CORRELATION MATRIX





FCFA

FUNDA

BENA

PENROA

TAX

CONTA

0.109

-0.316

0.488

0.254

0.086

FCFA




0.034

0.075

0.082

0.223

FUNDA







0.013

0.278

0.082

BENA










0.547

0.052

PENROA













-0.004

Notes:


1. CONTA is pension plan contributions divided by total assets of the firm.

2. TAX is the tax rate.

3. FCFA represents free cash flow scaled by total assets of the firm.

4. FUNDA is the net funding status scaled by total assets.

5. BENA is Benefits paid divided by total assets.

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