DP3955 Pension Fund Governance and the Choice Between Defined Benefit and Defined Contribution Plans

Author(s): Timothy J. Besley, Andrea Prat
Publication Date: June 2003
Keyword(s): governance, pension fund, private pension
JEL(s): G23
Programme Areas: Financial Economics, Industrial Organization, Public Policy
Link to this Page: http://www.cepr.org/pubs/dps/DP3955

Recent events in several countries have underscored the importance of good governance in private occupational pension plans. The present Paper uses contract theory to analyse the interplay of residual claims and control rights in private pensions. The residual claimant is the plan sponsor in a defined benefit (DB) plan and the pool of beneficiaries in a defined contribution (DC) plan. The main control rights we examine relate to decisions on funding, asset allocation, and asset management. Under complete contracting, governance can be shown to be neutral: DC and DB plans differ only on risk allocation. If instead contracts are incomplete, a DB (DC) plan should: (1) Assign more vigilance responsibility to the sponsor (beneficiaries); (2) Rely less (more) on trustees; (3) Tend to employ trustees that are professional experts (caring insiders); (4) Assign asset allocation rights to the sponsor (beneficiaries); (5) have strict funding requirements.