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

Recent events in several countries have underscored the importanceof good governance in private occupational pension plans. Thepresent paper uses contract theory to analyze the interplay of residualclaims and control rights in private pensions. The residual claimant isthe plan sponsor in a defined benefit (DB) plan and the pool of beneficiariesin a defined contribution (DC) plan. The main control rightswe examine relate to decisions on funding, asset allocation, and assetmanagement. Under complete contracting, governance can be shownto be neutral: DC and DB plans differ only on risk allocation. If insteadcontracts are incomplete, a DB (DC) plan should: (1) Assignmore vigilance responsibility to the sponsor (beneficiaries); (2) Relyless (more) on trustees; (3) Tend to employ trustees that are professionalexperts (caring insiders); (4) Assign asset allocation rights tothe sponsor (beneficiaries); (5) have strict funding requirements.[...]