23 February 2018

Bank of England: Growing pension deficits and the expenditure decisions of UK companies

Authors investigate the effects of deficits and deficit recovery plans on UK companies’ dividends, investment, wages and cash holdings. Identification is based on the close relationship between low long-term interest rates and pension deficits; and the external regulation of pension schemes by The Pensions Regulator

Since 2007 many of the 6000 DB pension schemes in the UK have experienced large and growing deficits. In aggregate, the DB deficit is estimated to have increased to around £300 billion by 2015, more than 15% of annual GDP. At the same time as deficits have risen, investment has been subdued. This is a common experience in a number of OECD countries. Using privileged access to TPR microdata, and two novel identification schemes, authors investigate how deficits and deficit recovery contributions have affected the expenditure decisions of UK companies. 

First, they verify that the widening of pension deficits and the deficit recovery contributions that firms have had to make to close those deficits have been largely exogenous to individual companies. Firms whose pension schemes were already in deficit experienced shocks to their internal finances as, firstly, lower long-term interest rates increased the size of pension deficits for schemes that were already in deficit, and then secondly, TPR placed them under a legal obligation to put a plan in place to close deficits. 

Second, while firms with larger pension deficits had an incentive but not an obligation to act in response to these deficits they paid lower dividends on average, but they did not invest less. Authors are able to isolate the effects of mandatory contributions and recovery plan lengths using data that was not available to previous authors. We show that obligations under recovery plans agreed with TPR prompted firms to adopt a different pattern of behaviour compared to their more voluntary responses to deficits. Firms making contributions to close those deficits did reduce investment and dividend payments on average. These effects were greater for firms that were financially constrained, reflecting the more limited options available to them to use external or other internal funds to smooth out their expenditures. The scale of these effects was large for many FTSE 350 companies with DB deficits, and responses to them can explain some of the weakness in aggregate dividends and investment observed since 2007. 

Third, while the effects for some firms were large, by contrast the effects at the aggregate level have been small in macroeconomic terms, and are dwarfed by the estimated positive impact of QE. QE is estimated to have boosted the level of GDP by in the region of 1½-3%, while the negative effects of deficits are only estimated to have reduced GDP by around 0.1% GDP since 2007. And given that only part of the pension effects can be attributed to QE, the adverse effects for GDP of QE via pension funds are likely to have been small and they are unlikely to have substantially reduced the effectiveness of QE. 

These findings suggest that the regulatory approach undertaken by The Pensions Regulator has balanced the need to close growing deficits with the aim of allowing businesses to continue operating in a sustainable way. They also imply that unconventional monetary policies such as QE, which were implemented by the Bank of England, are likely to have had predominantly positive effects at the macroeconomic level even after taking account of the impacts on pension funds. Their results suggest that – for the UK and other countries in similar positions – that large DB pension deficits can have significant effects on investment and other expenditure decisions at the firm-level, but for the UK at least, the macroeconomic consequences have been relatively small.

Working paper

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