New Paper Finds More Participant-Elected Pension Board Members Associated with Lower Bond Ratings

The board of trustees of a public pension plan has a large influence over the plan’s investments, asset allocation, actuarial assumptions, and benefit levels. Given the importance of the board, its makeup has been of great interest to researchers. However, the literature has been mixed regarding the effects of the board composition on public pension performance.

There is strong evidence that more appointed and ex-officio members (insiders) in the board tend to result in more politically influenced investment decisions, more optimistic accounting assumptions, and lower investment returns. On the other hand, there is also evidence that boards composed of participant-elected plan members (outsiders) can interfere with professional managers, leading to lower performance.

In this new paper, John Dove, Courtney Collins, and Daniel Smith contribute to the literature by using a new measure to evaluate the effects of pension board composition. Rather than looking at investment returns or funded ratios, the authors choose bond ratings as a more comprehensive indicator. Specifically, the authors rely on state pension data from 2001 to 2014 to analyze the relationship between state pension board composition and state bond ratings provided by S&P, Moody’s, and Fitch, after controlling for socioeconomic, fiscal health, and pension health factors.

The paper finds that a higher percentage of outsiders (elected board members) is associated with lower bond ratings, while a higher share of insiders (appointed and ex-officio members) is correlated with higher bond ratings. The correlation is strongest when there is a supermajority of insiders, which is associated with significantly higher bond ratings.

From the result, the authors posit that elected board members may be less financially literate than appointed and ex-officio board members, which tend to have stronger financial backgrounds and thus may be inclined to adopt sounder pension policies. This implies that it may be beneficial for public plans to have more people with financial expertise on the board.