Location, location, location! Real effects from the mandated removal of pension expected return from operating income

46 Pages Posted: 23 Feb 2021

See all articles by Divya Anantharaman

Divya Anantharaman

Rutgers, The State University of New Jersey - Accounting & Information Systems

Elizabeth Chuk

University of California, Irvine - Paul Merage School of Business

Saipriya Kamath

London School of Economics & Political Science (LSE) - Department of Accounting and Finance

Date Written: February 19, 2021

Abstract

The accounting for defined-benefit (DB) pension expense in U.S. GAAP involves offsetting pension costs against an expected (rather than actual) return on pension assets. Pensions commentators argue that this expensing model tilts pension portfolios towards riskier assets – as sponsoring firms can benefit from assuming higher expected rates of return on riskier assets (which reduce pension expense and boost reported income), without bearing the cost of higher volatility in reported income. We examine a recent regulatory change in U.S. GAAP, which mandates the relocation of the expected return on pension assets from “above the line” of to “below the line” of operating income. Consistent with this change reducing the financial reporting incentives for risk-taking, we predict and find that a sample of U.S. firms subject to this mandate reduces risk-taking in pension assets following the change, relative to a control sample of Canadian firms not subject to the change. In cross-sectional tests, we find that the reduction in risk-taking is more pronounced in (1) firms where the financial reporting incentives for risk-taking were stronger in the pre-period, and in (2) firms where the regulatory change particularly reduced those benefits. Our findings imply that managers are willing to undertake real actions (i.e., invest in riskier assets) to report favorable operating income, and that these incentives are incremental to the incentives to report favorable net income. They also provide evidence that financial reporting incentives serve as a driver of pension asset allocation decisions.

Keywords: Accounting regulation, standard-setting, defined benefit pension, operating income, Accounting Standards Update No. 2017-07

JEL Classification: M40, M41, M48

Suggested Citation

Anantharaman, Divya and Chuk, Elizabeth and Kamath, Saipriya, Location, location, location! Real effects from the mandated removal of pension expected return from operating income (February 19, 2021). Available at SSRN: https://ssrn.com/abstract=3789464 or http://dx.doi.org/10.2139/ssrn.3789464

Divya Anantharaman

Rutgers, The State University of New Jersey - Accounting & Information Systems ( email )

1 Washington Park
#916
Newark, NJ 07102
United States

Elizabeth Chuk (Contact Author)

University of California, Irvine - Paul Merage School of Business ( email )

University of California, Irvine
Irvine, CA California 92697-3125
United States

Saipriya Kamath

London School of Economics & Political Science (LSE) - Department of Accounting and Finance ( email )

United Kingdom

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
70
Abstract Views
409
rank
442,856
PlumX Metrics