Ting Zhang

Learning and Incentive: A Study on Analyst Response to Pension Underfunding

There is a long-standing debate on whether sell-side analysts learn from their experience to improve earnings forecast skills. This study shows that incentive is an important factor for understanding the “learning by doing” effect by analysts. We examine analysts’ response to a complex type of information – corporate pension underfunding. Pension underfunding negatively impacts future earnings and analysts on average underreact to such information in their earnings forecasts. More importantly, when there is a strong incentive for analysts to deliver accurate forecasts, analyst learning effectively reduces their underreaction to pension underfunding information. On the other hand, when such an incentive is absent, the analyst learning effect is not discernible in the data. Further evidence suggests that analyst learning and incentive jointly reduce stock market mispricing associated with corporate pension underfunding.

What Drives Corporate Pension Plan Contributions: Moral Hazard or Tax Benefits?

In testing moral hazard and tax benefit hypotheses regarding defined benefit plan funding and contribution incentives by incorporating sponsors’ bankruptcy risk, the authors proposed that high-bankruptcy-risk sponsors have a strong moral hazard incentive because the put value of the U.S. Pension Benefit Guaranty Corporation guarantee is high. For low-bankruptcy-risk sponsors, the put value is low; maximizing tax benefits associated with pension contributions becomes a powerful incentive. Results based on sponsors’ voluntary contributions support both hypotheses. Underfunding of corporate defined benefit (DB) pension plans has become a prevalent issue among U.S. companies amid the recent financial crisis. A key question that has attracted considerable research interest is what determines a DB plan sponsor’s decisions on pension funding and contributions. Within one unified framework, the authors tested two hypotheses—one on the moral hazard incentive and the other on the tax benefit incentive—with respect to decisions on DB pension funding and contributions by incorporating sponsors’ expected bankruptcy risk, as measured by Moody’s EDF (expected default frequency). The incorporation of expected bankruptcy risk is critical in better understanding a sponsor’s incentives because it relates directly to the put option value derived from U.S. Pension Benefit Guaranty Corporation (PBGC) insurance. The authors hypothesized that sponsors with high expected bankruptcy risk are dominated by the moral hazard incentive because the put option on the PBGC guarantee has the greatest value. In contrast, for sponsors with low expected bankruptcy risk, the PBGC put option value is low; maximizing tax benefits associated with pension contributions becomes a dictating incentive. Unlike earlier researchers who used total pension contributions, the authors decomposed total pension contributions into mandatory and voluntary contributions. They used voluntary contributions as a major measure for sponsors’ incentives regarding pension funding and contributions. Using IRS Form 5500 data for 1990–2010, they calculated sponsors’ voluntary pension contributions on the basis of applicable pension laws and regulations. The results based on sponsors’ voluntary contributions are consistent with the two hypotheses after controlling for potential endogeneity. In particular, sponsors with high expected bankruptcy risk make low voluntary contributions; for those with low bankruptcy risk, voluntary contributions increase with the marginal tax rate. Using the recent financial crisis as a natural experiment on the effects of sponsors’ expected bankruptcy risk, the authors found that both moral hazard and tax benefits have intensified since the crisis. Suggesting that the existing pension regulations do not successfully reduce sponsors’ moral hazard incentive, the authors discuss three important policy implications: (1) The PBGC premium structure should fully reflect the bankruptcy risk that a plan sponsor poses to PBGC, (2) the PBGC claims on unfunded pension liabilities during corporate bankruptcy proceedings should be more strictly enforced, and (3) policymakers should address sponsors’ moral hazard incentive as a critical issue when designing pension regulations to ensure the soundness of the U.S. private pension system.

Does short selling improve stock price efficiency and liquidity? Evidence from a natural experiment in China

ABSTRACT China introduced short selling for designated stocks in March 2010. Using this important policy change as a natural experiment, we examine the effect of short selling on stock price efficiency and liquidity. We show that the introduction of short selling significantly improves price efficiency, as measured by the differences in individual stock responses to market returns and the delay in price adjustments. Short selling also enhances stock liquidity, as measured by bid-ask spread and Amihud [2002. ‘Illiquidity and Stock Returns: Cross-section and Time-series Effects.’ Journal of Financial Markets 5: 31–56] illiquidity measure; and reduces stock volatility. Overall, our results suggest that short selling helps to stabilize asset prices, provides additional liquidity and improves market quality, even in an emerging economy with a less developed stock market than that in the US and Europe.