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Assessing Mark-to-Market Accounting for Pensions

Research from Simon Business School Explores Why Firms Opt To Change Their Accounting Policy

ROCHESTER, N.Y., Oct. 25, 2016 /PRNewswire/ — Since the beginning of 2010, many large companies including Verizon Communications Inc. and Honeywell International Inc. voluntarily adopted mark-to-market valuation of their pension plans.

This change from the historical accounting method of smoothing or leveling out pension plan losses and gains over several years enabled these companies to avoid reporting past losses in current and future financial statements, which would drag down corporate income.

But, how do firms decide whether to change their accounting policy?

Experts from Simon Business School at the University of Rochester developed and tested predictions of the economic determinants of firms’ decisions to voluntary adopt mark-to-market for the pension-related actuarial gains and losses.

The research titled, “Economic Determinants of the Decision to Voluntarily Adopt Mark-to-Market Accounting for Pension Gains and Losses,” (co-authored by Simon School Professors, Jaewoo Kim, Charles Wasley, and Joanna Wu) revealed that while both enhancing transparency in financial reporting as well as opportunistic managerial behavior are useful in explaining cross-sectional variation in mark-to-market adoption decisions, the weight of the evidence tends to favor the opportunistic manager hypothesis.

Simply put, managers opportunistically use mark-to-market adoption to take a “big bath” to get bad news/large accumulated pension actuarial losses behind them. Additionally, after implementing mark-to-market pension accounting, managers emphasize non-GAAP (generally accepting accounting principles) earnings disclosures, which exclude mark-to-market pension adjustments presumably in order to weaken the adverse impacts of immediately recognizing unrealized gains or losses in net income.

Two common explanations for making this decision are the information perspective and managerial opportunism...

“Two common explanations for making this decision are the information perspective and managerial opportunism,” said Jaewoo Kim, assistant professor at Simon Business School and co-author of the study. “A key difference between the two explanations is that under the transparency explanation, managers’ choice of accounting policies is motivated by the desire to maximize firm value, whereas under the opportunism explanation managers’ choice is designed to maximize their wealth, which may reduce, rather than increase firm value.”

In order to test the predictions of the economic determinants of firms’ voluntary choice of mark-to-market accounting and to assess the resulting consequences of that choice, the researchers conducted the following three tests:

  • First, a logistical regression model to identify the economic factors that explain firms’ adoption of mark-to-market pension accounting
  • Second, explicitly test the opportunistic explanation to analyze the relation between CEO cash compensation and pre-adoption period pension expense, and post-adoption period mark-to-market pension adjustments
  • Third, test the transparency explanation to compare the firms’ earnings response coefficients before and after adoption of mark-to-market reporting

The results of the research are consistent with financial reporting method choices, in particular mark-to-market accounting choices, and voluntary disclosure of non-GAAP earnings being interconnected to each other. This research offers the first evidence of an important recent development in accounting method choice involving MTM pension accounting.




About Simon Business School
The Simon Business School is currently ranked among the leading graduate business schools in the world in rankings published by the popular press, including Bloomberg Businessweek, U.S. News & World Report, and the Financial Times. The Financial Times recently rated the School No. 9 in the world for finance. More information about Simon Business School is available here.