Pension Plan Returns and the Firm's Cost of Debt

We examine firms with defined benefit pension plans and find a positive relation between assumed rates of return on pension assets and the firm’s cost of debt. This positive relation is more pronounced in sub-samples where creditors' potential losses due to the risk of having limited information are likely to be magnified (e.g., among firms with: poor performance, underfunded pension plans, or volatile earnings). We reject the hypothesis that riskier pension allocations explain the positive relation between assumed returns and cost of debt. The results are consistent with creditors penalizing firms for noise induced by assumed returns into financial statements.