Real effects from the mandated removal of pension expected return from operating income

Anantharaman, Divya
Chuk, Elizabeth
Kamath, Saipriya
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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.
Accounting regulation, standard-setting, defined benefit pension, operating income, Accounting Standards Update No. 2017-07
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