Pension Fund Governance and the Choice

Recent events in several countries have underscored the importance of good governance in private occupational pension plans. The present paper uses contract theory to analyze 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. ∗We thank Michael Orszag, Ian Tonks, and audiences at the LSE, the Second Workshop of the RTN Project on Financing Retirement in Europe, and Watson Wyatt London for useful suggestions. †This work is undertaken as part of the UBS-LSE pensions program (http://www.lse.ac.uk/ubs/). ‡Address: STICERD, London School of Economics, Houghton Street, London WC2A 2AE, UK. Email: [email protected] and [email protected].