Underinvestment vs. Overinvestment: Evidence from Price Reactions to Pension Contributions

Mandatory contributions to defined benefit pension plans provide a unique identification strategy to estimate the market's assessment of the value of internal resources controlling for investment opportunities. The drop in prices following these cash outflows is magnified for firms that appear a priori more financially constrained, consistent with a negative effect of financing frictions on investment. In contrast, price reactions to pension contributions are positive for poorly governed firms, suggesting that the managers of these companies engage in value-destroying projects. While under- and overinvestment have similar weight in a panel of large firms, the first distortion prevails in a sample that is more representative of the cross-section of listed companies.