preprints.org > business, economics and management > finance > doi: 10.20944/preprints202409.2326.v1

Preprint Article Version 1 This version is not peer-reviewed

Version 1 : Received: 27 September 2024 / Approved: 29 September 2024 / Online: 30 September 2024 (03:28:38 CEST)

The consistent recognition of both explicit short term and implicit long term elements of post-retirement contracts between employees and the firm can have a significant implication for estimating a firms long term sustainable cost of capital. In this paper, we show that the significant levels of investment in company own stock by pension and post-retirement plans can effectively dilute the interest of pre-existing shareholders in the enterprise value of corporations in ways which are not revealed by a classic entity theory perspective on equity. We test the empirical implications of adopting a pre-existing shareholder model of the reporting entity to re-examine the relationship between a firm’s sustainable cost of capital and various sources of idiosyncratic risk. We find that the estimated cost of capital is sensitive to: (a) alternative explicit versus implicit definitions of pension liability; (b) the nature and scope of long-term deferred compensation arrangements; and (c) the scope and nature of investment-related risks through investment in sponsoring company stock that are associated with these pension arrangements.

pension plans; cost of capital; enterprise value

Business, Economics and Management, Finance

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