The Economic Consequences of Accounting Standards: Evidence from Risk-Taking in Pension Plans

Abstract

Pension experts have long conjectured that pension accounting rules encourage firms to invest pension assets in risky asset classes (Zion and Carcache 2003, Gold 2005). The recent passage of IAS 19 Employee Benefits (Revised) (hereafter, “IAS 19R”) marks a fundamental shift in pension accounting, by removing from pension expense the use of a managerial estimate that is directly tied to the riskiness of plan assets (i.e., the expected rate of return (ERR) on plan assets), and replacing it with a managerial estimate that is unrelated to plan asset riskiness (i.e., the discount rate). The use of the ERR creates a financial reporting benefit for risk-taking, where sponsors recognize in reported income the benefits of risk-taking (via a higher ERR, which reduces pension expense), but not the costs of risk-taking (i.e., higher volatility in actual returns). Exploiting the quasi-experimental setting created by this shift in a difference-in-differences research design, we demonstrate that a sample of Canadian firms affected by IAS 19R reduces risk-taking in pension investments post-IAS 19R, compared to a control sample of US firms unaffected by IAS 19R. These findings provide some of the first empirical evidence on the economic consequences of the IAS 19R mandate eliminating the ERR-based pension accounting model, which still applies to US GAAP.

Keywords: Pension accounting, pension smoothing, pension asset allocation, IAS 19

JEL Classification: M40, M41