Accounting Observer > Public Blog - Suspicions Confirmed: Making Earnings With Pension Assumptions

The AAO Weblog covers accounting issues and current events as they relate the practice of investment analysis. All posts prior to September, 2007 are in the public domain, but after September 4, only subscribers to The Analyst's Accounting Observer will see all posts going forward. Only selected, occasional posts will be released to the public domain from September 4 forward.

Subscriptions to full posts available for $500 annually.

Suspicions Confirmed: Making Earnings With Pension Assumptions

Location: Blogs AAO Weblog (Public)
Posted by: Jack Ciesielski	1/28/2005 9:11 AM
In the last few years, there's a condition that's afflicted many analysts and investors: its acronym is PDHD, standing for "Pension Deficit Hyperactivity Disorder." Those afflicted with it often foam at the mouth, moaning loudly and frequently upon realizing that firms they're interested in might be forced to fork over cash to fund underfunded defined benefit pension plans. It's a serious condition for both the firm and its investors. Do not confuse this condition with PPHD: Padded Pension Hyperactivity Disorder. The symptoms are similar - foamy oral orifice, loud moaning - but you must pay attention to the moaned message to distinguish PPHD from PDHD. With PPHD, investors and analysts find themselves out of sorts because a firm has an overfunded pension plan that contributes non-cash earnings in the consolidated earnings picture, and more commonly, are concerned about the effects of cheery pension asset earnings assumptions on consolidated earnings. (I speak from experience: I've had both. I've always handled it by spending more time with stock option disclosures. But that leads to other conditions, whose symptoms can be worse.) Investors and analysts afflicted with these conditions are not necessarily hypochondriacs. And now, there's some solid empirical evidence that those afflicted with PPHD are really fairly accurate in their perceptions of the world. It's not light reading, but if you suffer from PPHD, it's worth downloading "Earnings Manipulation, Pension Assumptions and Managerial Investment Decisions." Authored by Daniel Bergstresser, Mihir Desai, (both of Harvard) and Josua Rauh (MIT), the study shows that: "Managers appear to manipulate firm earnings when they characterize pension assets to capital markets and alter investment decisions to justify, and capitalize on, these manipulations. Managers are more aggressive with assumed long-term rates of return when their assumptions have a greater impact on reported earnings. Managers also increase assumed rates of return as they prepare to acquire other firms and as they exercise stock options, further confirming the opportunistic nature of these increases ... Taken together, these results suggest that opportunistic earnings manipulation influences significant managerial investment decisions." (From the abstract) The methodology is perhaps more than you'd care to hack through - but suffice it to say, it was not based on a spurious selection of limited data. There was interesting focus on IBM during the Lou Gerstner years in the paper, as well. The author's findings should at least make those suffering from PPHD confident that the problem is not all in their heads.

Permalink \| Trackback