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

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  • ASTHANA, SHARAD

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.

Suggested Citation

  • Asthana, Sharad, 2008. "Earnings management, expected returns on pension assets, and resource allocation decisions," Journal of Pension Economics and Finance, Cambridge University Press, vol. 7(2), pages 199-220, July.
    • Handle: RePEc:cup:jpenef:v:7:y:2008:i:02:p:199-220_00
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    Cited by:

    1. Shaw, Kenneth W. & Whitworth, James D., 2022. "Client importance and unconditional conservatism in complex accounting estimates," Advances in accounting, Elsevier, vol. 58(C).
    2. Masaki KUSANO, 2022. "Recognition versus Disclosure and Managerial Discretion: Evidence from Japanese Pension Accounting," Discussion papers e-22-008, Graduate School of Economics , Kyoto University.
    3. Karen C. Castro-González, 2012. "Information Content Of Changes In Pension Plan Funding Status And Long-Term Debt," The International Journal of Business and Finance Research, The Institute for Business and Finance Research, vol. 6(1), pages 1-14.
    4. Martin Glaum & Tobias Keller & Donna L. Street, 2018. "Discretionary accounting choices: the case of IAS 19 pension accounting," Accounting and Business Research, Taylor & Francis Journals, vol. 48(2), pages 139-170, February.
    5. Blankley, Alan I. & Comprix, Joseph & Hong, Keejae P., 2013. "Earnings management and the allocation of net periodic pension costs to interim periods," Advances in accounting, Elsevier, vol. 29(1), pages 27-35.
    6. Hsieh, Su-Jane & Liu, Shuming, 2021. "The cost-of-equity implications of off-balance sheet pension liabilities," Journal of Contemporary Accounting and Economics, Elsevier, vol. 17(1).
    7. Doyle, Joanne M., 2017. "Persistence in the long-run expected rate of return for corporate pension plans," The Quarterly Review of Economics and Finance, Elsevier, vol. 63(C), pages 271-277.

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