The Potential for Inflating Earnings through the Expected Rate of Return on Defined Benefit Pension Plan Assets

2011 ◽  
Vol 25 (3) ◽  
pp. 443-464 ◽  
Author(s):  
Brian Adams ◽  
Mary Margaret Frank ◽  
Tod Perry
Keyword(s):  
Financial Reporting ◽  
Asset Allocation ◽  
Cumulative Effect ◽  
Pension Plan ◽  
Pension Plans ◽  
Rate Of Return ◽  
Defined Benefit ◽  
Operating Income ◽  
Defined Benefit Pension Plan ◽  
Reported Earnings

SYNOPSIS Using a sample of firms over the period of 1991 through 2005, we examine the opportunity that exists for firms to inflate earnings through the expected rate of return (ERR) assumption associated with defined benefit pension plans. The evidence suggests that, on average, the ERR is not overstated relative to several benchmarks, including contemporaneous actual returns, historical cumulative actual returns, and expected future returns based on asset allocation within the pension. We also find that actual changes in the ERR are infrequent and typically have less than a 1 percent impact on annual operating income. We also estimate that a 0.5 percent change (50 bps) in the ERR will result in a cumulative effect on operating income over a five-year period of approximately 0.5 percent or less for the majority of firms. When we examine firms with the highest ERRs or with the greatest opportunity to inflate earnings, again, we find that the ERR is not overstated relative to several benchmarks. Although we do not observe pervasive inflating of reported income through the ERR during our sample period, we do find that for some firms, small increases in ERR can have a material impact on reported earnings. Our results provide evidence related to the pervasiveness, materiality, and impact of overstated earnings through the ERR, which helps regulators assess the costs and benefits of eliminating this discretion in financial reporting.

Pension plans assumptions: the case of discount rate

2019 ◽  
Vol 32 (1) ◽  
pp. 36-49 ◽  
Author(s):  
Ana Isabel Morais ◽  
Inês Pinto
Keyword(s):  
Financial Reporting ◽  
Value Relevance ◽  
Pension Plan ◽  
Pension Plans ◽  
Rate Of Return ◽  
International Accounting ◽  
Defined Benefit ◽  
Accounting Standard ◽  
Content Type ◽  
Defined Benefit Plans

Purpose In 2009, the International Accounting Standards Board started revising International Accounting Standard (IAS) 19 to improve the requirements for managing the annual expense of a pension plan. The revised standard became effective in 2013. The purpose of this paper is to investigate what effect this revision had on managerial discretion. The paper also examines the implications of the revision on the value relevance of accounting information. Design/methodology/approach The authors use a sample of 72 firms listed on the FTSE 100 that have defined benefit plans for the period between 2009 and 2015. The authors use a regression discontinuity design to analyse the effect from the revision of IAS 19 on the choice of managers regarding the expected rate of return-on-plan assets. The paper also investigates whether firms with higher pension sensitivity are more likely to manage earnings upward before the revision of IAS 19. Further, the paper studies the value relevance of earnings after the revision of the accounting standard. Findings Consistent with predictions, the results show that the adoption of the revised IAS 19 limits the use of the expected rate of return on assets to manage the annual expense of defined benefit plans. This finding shows a sharp increase in the value relevance of earnings. Practical implications This finding is useful for users and preparers of financial statements and regulatory bodies as it identifies not only the influence of a change in the accounting standard for earnings management but also provides evidence on the consequences of managers’ discretion. Originality/value This paper provides direct evidence on the relationship between regulation and financial reporting discretion. It also provides evidence to accounting standard setters that the revision of IAS 19 improves the value relevance of financial information, which gives additional justification to the changes introduced by regulators.

scholarly journals The missing link: economic exposure and pension plan risk

2015 ◽  
Vol 9 (2) ◽  
pp. 290-303
Author(s):  
Paul Sweeting ◽  
Alexandre Christie ◽  
Edward Gladwyn
Keyword(s):  
Asset Allocation ◽  
Pension Plan ◽  
Asset Returns ◽  
Oil Price ◽  
Defined Benefit ◽  
Financial Health ◽  
Defined Benefit Pension Plan ◽  
Asset Class ◽  
Normal Shape ◽  
The Impact

AbstractThe funding position of a defined benefit pension plan is often closely linked to the performance of the sponsoring company’s business. For example, a plan sponsor whose financial health is dependent on high oil prices may struggle during periods of oil price weakness. If the pension plan’s assets perform poorly at this time, the ability of the sponsor to address any funding requirement could be restricted precisely when the need for funding is heightened. In this paper, we propose an approach to dealing with joint plan and sponsor risk that can provide protection against extreme adverse events for the sponsor. In particular, adopt a strategy of minimising a portfolio’s expected losses in the event of an assumed drop of x% in the oil price. Our methodology relies on an asset allocation framework that takes into account the impact of serial correlation in asset returns, as well as the negative skewness and leptokurtosis resulting from the non-normal shape of marginal distributions of historical asset returns. We also make use of copulas to measure the dependence between asset class returns.

Financial health and the valuation of corporate pension plans

2019 ◽  
Vol 19 (4) ◽  
pp. 459-490
Author(s):  
Jun Cai ◽  
Miao Luo ◽  
Alan J. Marcus
Keyword(s):  
Property Rights ◽  
Pension Plan ◽  
Pension Plans ◽  
Defined Benefit ◽  
Financial Health ◽  
Valuation Effects ◽  
Defined Benefit Pension Plan ◽  
Corporate Pension ◽  
Standing Question

AbstractWe return to the long-standing question ‘Who owns the assets in a defined benefit pension plan?’ Unlike earlier studies, we condition the market's assessment of implicit property rights on the sponsoring firm's financial health. Valuations of financially strong firms, and those that are strengthening, are more responsive to pension plan funding. For these firms, each extra dollar of net plan assets is valued at between $0.50 and $1.00. In contrast, for weak and weakening firms, valuation effects are statistically indistinguishable from zero. This result is consistent with the higher likelihood that they will renege on their pension obligations.

scholarly journals Pension Funding and the Actuarial Assumption Concerning Investment Returns

2003 ◽  
Vol 33 (02) ◽  
pp. 289-312 ◽  
Author(s):  
M. Iqbal Owadally
Keyword(s):  
Discount Rate ◽  
Asset Allocation ◽  
Pension Plan ◽  
Pension Plans ◽  
Defined Benefit ◽  
Return On Assets ◽  
Investment Return ◽  
Investment Returns ◽  
Pension Liabilities

An assumption concerning the long-term rate of return on assets is made by actuaries when they value defined-benefit pension plans. There is a distinction between this assumption and the discount rate used to value pension liabilities, as the value placed on liabilities does not depend on asset allocation in the pension fund. The more conservative the investment return assumption is, the larger planned initial contributions are, and the faster benefits are funded. A conservative investment return assumption, however, also leads to long-term surpluses in the plan, as is shown for two practical actuarial funding methods. Long-term deficits result from an optimistic assumption. Neither outcome is desirable as, in the long term, pension plan assets should be accumulated to meet the pension liabilities valued at a suitable discount rate. A third method is devised that avoids such persistent surpluses and deficits regardless of conservatism or optimism in the assumed investment return.

scholarly journals Corporate Pension Plans as Takeover Deterrents

2013 ◽  
Vol 48 (4) ◽  
pp. 1119-1144 ◽  
Author(s):  
João F. Cocco ◽  
Paolo F. Volpin
Keyword(s):  
Pension Plan ◽  
Pension Plans ◽  
Defined Benefit ◽  
Announcement Effects ◽  
Defined Benefit Pension Plan ◽  
Corporate Pension ◽  
Pension Liabilities

AbstractWe use UK data to show that firms that sponsor a defined-benefit pension plan are less likely to be targeted in an acquisition and, conditional on an attempted takeover, they are less likely to be acquired. Our explanation is that the uncertainty in the value of pension liabilities is a source of risk for acquirers of the firm's shares, which works as a takeover deterrent. In support of this explanation we find that these same firms are more likely to use cash when acquiring other firms, and that the announcement of a cash acquisition is associated with positive announcement effects.

Expected Benefit Payments and Asset Allocation in Defined Benefit Plans Post-SFAS 132(R)

2018 ◽  
Vol 32 (3) ◽  
pp. 71-82
Author(s):  
Alan I. Blankley ◽  
Philip Keejae Hong ◽  
Kristin C. Roland
Keyword(s):  
Asset Allocation ◽  
Investment Decisions ◽  
Pension Plan ◽  
Pension Benefit ◽  
Defined Benefit ◽  
Defined Benefit Pension Plan ◽  
Defined Benefit Plans ◽  
Pension Asset ◽  
Short Horizon ◽  
Reporting Environment

SYNOPSIS We contribute to the literature examining defined benefit pension plan asset allocation in the post-SFAS 132(R) reporting environment. SFAS 132(R) requires firms to disclose the expected annual pension benefit payments, thus providing a direct way to measure pension plan payout horizon. Controlling for previously documented determinants of pension asset allocation, we find evidence that a payout horizon measure constructed from SFAS 132(R) disclosures is associated with the firm's pension investment decisions. Specifically, we document that firms with a greater proportion of pension obligations due in the short horizon allocate a smaller portion of their plan assets to equity investments. Additionally, we provide evidence that our proposed measure explains asset allocation over and above previously used proxies representing plan horizon, confirming the usefulness of the 132(R) mandated disclosures.

scholarly journals Teaching The Interrelationships Among Costs, Expense, And Liability Of A Defined Benefit Pension Plan

2008 ◽  
Vol 5 (2) ◽  
Author(s):  
Arlette C. Wilson ◽  
Norman H. Godwin
Keyword(s):  
Balance Sheet ◽  
Accounting Standards ◽  
Pension Plan ◽  
Financial Accounting ◽  
Defined Benefit ◽  
Financial Accounting Standards Board ◽  
Operating Income ◽  
Defined Benefit Pension Plan ◽  
Other Comprehensive Income ◽  
Representational Faithfulness

The Financial Accounting Standards Board (FASB) recently issued Statement of Financial Accounting Standards No. 158 “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans” (SFAS #158).  Their intent is to comprehensively reconsider the accounting for postretirement benefit plans in phases.  The first phase was to provide timely and significant improvements and resulted in SFAS #158.  The object of this Statement is to improve the understandability and representational faithfulness of the amounts reported in the employer’s statement of financial position by recognizing as an asset or liability the overfunded or underfunded status of a defined benefit postretirement plan.  The purpose of this paper is to provide a logical approach for teaching accounting for a defined benefit pension plan.  This objective will be accomplished by providing a discussion with detailed illustrations of the interrelationships of the effects on income (both operating income and other comprehensive income) and the amount reported on the balance sheet.

scholarly journals Pension Funding and the Actuarial Assumption Concerning Investment Returns

2003 ◽  
Vol 33 (2) ◽  
pp. 289-312 ◽  
Author(s):  
M. Iqbal Owadally
Keyword(s):  
Discount Rate ◽  
Asset Allocation ◽  
Pension Plan ◽  
Pension Plans ◽  
Defined Benefit ◽  
Return On Assets ◽  
Investment Return ◽  
Investment Returns ◽  
Pension Liabilities

An assumption concerning the long-term rate of return on assets is made by actuaries when they value defined-benefit pension plans. There is a distinction between this assumption and the discount rate used to value pension liabilities, as the value placed on liabilities does not depend on asset allocation in the pension fund. The more conservative the investment return assumption is, the larger planned initial contributions are, and the faster benefits are funded. A conservative investment return assumption, however, also leads to long-term surpluses in the plan, as is shown for two practical actuarial funding methods. Long-term deficits result from an optimistic assumption. Neither outcome is desirable as, in the long term, pension plan assets should be accumulated to meet the pension liabilities valued at a suitable discount rate. A third method is devised that avoids such persistent surpluses and deficits regardless of conservatism or optimism in the assumed investment return.

Sign in / Sign up

Export Citation Format

Share Document