Does Mandatory Recognition of Off-Balance Sheet Liabilities Affect Capital Structure Choice? Evidence from SFAS 158

Abstract

We investigate whether mandatory recognition of previously disclosed off-balance sheet liabilities affects corporate capital structure decisions. Specifically, we use the introduction of the Statement of Financial Accounting Standards No. 158 as a quasi-exogenous shock to financial reporting decisions as it requires sponsors of defined benefit (DB) pension plans to recognize the level of pension and healthcare plan funding explicitly on the balance sheet. Our findings show that DB plan sponsors with high off-balance sheet liabilities decrease financial leverage following the new accounting standard. Debt contracting considerations likely explain the result, since the reduction in financial leverage is concentrated among DB plan sponsors with high off-balance sheet liabilities and tight financial covenants that are based on a floating interpretation of U.S. GAAP. Thus, the mandatory financial statement recognition was sufficiently costly to warrant a change in corporate funding decisions.

Keywords: SFAS 158, Off-Balance-Sheet Items, Defined Benefit Pension Plan, Leverage, Recognition, Disclosure, Pension Accounting, Capital Structure

JEL Classification: G32, G39, M40, M41, M48