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ItemReal effects from the mandated removal of pension expected return from operating income( 2021)The accounting for defined benefit (DB) pension expense in US GAAP involves offsetting pension costs against an expected (rather than actual) return on pension assets. Pension 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 US GAAP, which mandates that the expected return on pension assets be disaggregated from service cost and relocated from “above the line” 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 US firms subject to this mandate reduces investment in riskier 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 the financial reporting benefits. Our findings provide evidence that financial statement presentation – the level of aggregation of expenses and their location – can have real economic consequences.
ItemHow do investors respond to targets' interim earnings?( 2021)Fundamental to the accounting literature is that firms’ stock prices relate positively to their earnings news. We examine a setting where investors may be unsure to which firm the announced earnings accrue: earnings announced by acquisition targets between the announcement and completion of the acquisition. We find that targets’ stock prices relate positively to their unexpected earnings during this interim period, but only for unsuccessful deals. For completed deals, we fail to find evidence that the target’s or acquirer’s stock prices respond to the target’s unexpected interim earnings at the time of announcement. However, we find that targets’ interim earnings predict future abnormal returns of the combined firm following deal completion. These returns are economically significant as a trading strategy based on targets’ interim earnings produces annualized abnormal returns of 8.3%. Our findings suggest that investors respond inefficiently to the earnings that targets announce between announcement and completion of acquisitions.