CFOs might find they not only should invest more in capital projects, but they also would get a better bang for their buck by reducing equity exposure in the pension plan, he observed.
Lowering equity allocations will reduce expected returns, and thus increase pension contributions, Mr. Merton said in the Journal of Applied Corporate Finance.
"And that sounds like a bad thing, a value-reducing proposition — until one begins to consider the effect on risk. When you look at the whole picture, lowering the expected returns on the assets also lowers the risk of the entire firm. And by lowering risk, you create the capacity for the firm to take other risks — core operating risks, if you will, that are likely to add more value than passive equity investments in other companies," Mr. Merton said.
Explained Michael Peskin, managing director and head of Morgan Stanley's global pensions solution group, New York: "For strong companies, they're better off getting the (risk) exposure in the corporation, not in the pension plan."
Until now, how much risk to take in the pension fund was nebulous, and companies largely have stuck with high equity allocations, explained Barton Waring, managing director at Barclays Global Investors, San Francisco.
"For companies where the pension plan is dominating part of the organization, this may provide an argument (in favor of) reducing that equity exposure," he said.
"It's hard to imagine that 75% equity is comfortably within the risk tolerance of most sponsors, remembering the reaction to 2001-2002 experience," Mr. Waring said. "It would be easy to see the average dropping to 40% to 50% equities and to see more dispersion" in asset allocations, he said.