Do Firm’s Equity Return Reflect the Risk of Its Pension Plan? A Canadian Empirical Study

This paper examines whether systematic equity risk of Canadian firms as measured by beta from Capital Asset Pricing Model, reflects the risk of firm’s defined benefit pension plan. The foremost reason for this study is due to the opaque set of accounting report for pension asset, liability and expenses. Pension asset and liability are kept off balance sheet and are regarded as a separate entity from the rest of the firm. As the equity market and long term interest rate deteriorates, and longevity of people increases in past decade, the risk of pension can be detrimental to the company’s financial health as a whole. Panel based models are used in testing the relationship between the firm risk and pension risk The empirical finding in this paper highlighted a direct relationship between the two. It also shows implication for corporate finance practise in the determination of the cost of capital. The standard procedure of measure of cost of capital or for operating assets tend to overestimate the cost of capital which put upward pressure on the discount rate for capital budgeting.