The cost-of-equity implications of off-balance sheet pension liabilities

We use ex ante measures of cost of equity to examine: 1) whether the market assimilates off-balance sheet pension liabilities in assessing cost of equity, 2) whether off-balance sheet pension liabilities explain cost of equity in a similar manner as those reported on the balance sheet, and 3) the incremental explanatory power of Statement of Financial Accounting Standards (SFAS) 158 (FASB 2006) on cost of equity. We find that off-balance sheet pension liabilities are significantly positively associated with ex ante cost of equity in the pre- and post-SFAS 158 periods, suggesting that investors incorporate off-balance sheet pension liabilities in assessing cost of equity. However, recognized pension liabilities are more associated with cost of equity than off-balance sheet pension liabilities in both pre- and post-SFAS 158 periods. Furthermore, we find that the implementation of SFAS 158 significantly increases the explanatory power of previously disclosed pension liabilities (e.g., unrecognized prior service costs) on cost of equity, suggesting that SFAS 158 is effective in improving the cost-of-equity implications of pension liabilities.