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Earnings management, expected returns on pension assets, and resource allocation decisions

Published online by Cambridge University Press:  16 November 2007

SHARAD ASTHANA
SHARAD ASTHANA
Affiliation:
Department of Accounting, College of Business, University of Texas at San Antonio One UTSA Circle, San Antonio, TX, USA78249 (e-mail: [email protected])
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Abstract

This paper empirically examines the role of expected rate of return on pension assets reported under SFAS 87 as a tool for meeting and beating earnings targets and its effect on firm value. Results suggest that managers may use this pension assumption to inflate earnings per share (eps) when they are going to miss the earnings expectations. The earnings inflation is directly related to the amount by which earnings will miss the target and to earning sensitivity to expected return on pension asset assumption. The results are robust to two different measures of earnings inflation and two of earnings expectations.

The market behaves semi-efficiently and appears to adjust the firm value for large earnings inflations and in situations where firms have incentives to manipulate earnings or earnings are highly sensitive to expected rate of return on pension assets. However, this adjustment is not complete and post-announcement returns continue to depend on the inflated component of earnings, confirming that resource allocation decisions are based on managed earnings. Additional disclosure requirements to make pension assumptions more transparent are also discussed in the paper. Such disclosures could enhance the efficient use of the information by market participants.

Type
Articles
Information
Journal of Pension Economics & Finance , Volume 7 , Issue 2 , July 2008 , pp. 199 - 220
Copyright
Copyright © 2007 Cambridge University Press

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