Pension Fund Governance and the Choice Between Defined Benefi ta nd Defined Contribution Plans

Recent events in several countries have underscored the impor- tance 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 benefi t( DB) plan and the pool of bene- ficiaries 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 in- stead 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 profes- sional experts (caring insiders); (4) Assign asset allocation rights to the sponsor (beneficiaries); (5) have strict funding requirements.