Defined-Benefit Pension Obligations, Actuarial Risk, and Corporate Capital Structure: The Hidden Leverage of Unfunded Pension Liabilities

This paper investigates the capital structure implications of defined-benefit (DB) pension obligations, which represent a form of 'hidden leverage' that is economically equivalent to unsecured long-term debt but is often excluded from standard leverage measures. Using hand-collected pension data for 2,870 firms with DB plans across 16 countries over 2005-2024, we construct an 'augmented leverage' measure that adds the present value of net pension obligations to traditional debt. Our findings reveal that: (1) pension-augmented leverage is, on average, 7.4 percentage points higher than traditional book leverage, with the gap reaching 14.2 pp for firms in the most pension-intensive industries (automotive, airlines, steel, utilities); (2) credit markets price pension leverage as approximately 78% equivalent to financial debt: a $1 increase in net pension obligations raises credit spreads by 78% as much as a $1 increase in financial debt, confirming that pension obligations represent genuine leverage; (3) firms with large pension deficits substitute financial debt with pension debt: a one-standard-deviation increase in pension funding deficit reduces financial leverage by 2.1 pp, reflecting a 'crowding out' effect; (4) pension risk management—including liability-driven investment (LDI), pension risk transfers (buy-ins, buy-outs), and de-risking glide paths—significantly affects both pension-augmented and financial leverage: firms that complete pension risk transfers increase financial leverage by 3.4 pp within two years, as the elimination of pension risk frees debt capacity; (5) the 2022 UK gilt crisis—triggered by the LDI collateral margin calls that destabilized UK pension funds—provides a natural experiment demonstrating the systemic risk of pension-capital structure interconnections, with affected firms experiencing 2.8 pp deleveraging and 94 bps credit spread widening.