Discretion in accounting for pensions under IAS 19: using the ‘magic telescope’?

Abstract

We use a panel data set of UK-listed companies over the period 2005 to 2009 to analyse the actuarial assumptions used to value pension plan liabilities under IAS 19. The valuation process requires companies to make assumptions about financial and demographic variables, notably discount rate, price inflation, salary inflation, and mortality/life expectancy of plan members/beneficiaries.We use regression analysis to analyse the relationships between these key assumptions (except mortality, where disclosures are limited) and companyspecific factors such as the pension plan funding position and duration of pension liabilities. We find evidence of selective 'management' of the three assumptions investigated, although the nature of this appears to differ from the findings of US authors. We conclude that IAS 19 does not prevent the use of managerial discretion, particularly by companies whose pension plan funding positions are weak, thereby reducing the representational faithfulness of the reported pension figures. We also highlight that the degree of discretion used reflects the extent to which IAS 19 defines how the assumptions are to be determined. We therefore suggest that companies should be encouraged to justify more explicitly their choice of assumptions.

Pension Funding Regulations and Actuarial Gains and Losses

“…Billings et al. (2017) examine the effect of funding status on the opportunistic use of managerial discretion over the choice of actuarial assumptions in the UK. These studies focus on the levels of primary actuarial assumptions rather than the changes in all actuarial assumptions together.…”

“…Many prior studies examine the effect of the pension funding ratio on the opportunistic use of managerial discretion regarding actuarial assumptions, but only a few studies analyse the effect of firm efforts to improve their funding status through cash contributions on assumption choices (Asthana 1999; Billings et al. 2017). For example, Asthana (1999) argues that firms are incentivised to make liberal actuarial assumption choices to reduce contributions to plan assets.…”

“…Billings et al. (2017) show that firms may adjust their assumptions in response to their pension funding positions. These studies view the contribution ratio as a financial pressure rather than firms’ efforts to raise funding status.…”

Executive compensation and cash contributions to defined benefit pension plans

“…Comprix and Muller (2006) find that firms use higher expected rate of returns for pension assets to increase reported earnings in order to increase executive compensation. Billings, O'Brien, Woods, and Vencappa (2017) provide international evidence that UK companies exploit discretion in actuarial assumptions, particularly when the pension plan funding positions are weak. Sithole, Haberman, and Verrall (2011) observe systematic differences across countries in life expectancy assumptions as inputs to pension liabilities calculations.…”

Compliance with pension‐related mandatory disclosures and debt financing

“…While firms are expected to comply with these disclosures, prior studies document a substantial variation between firms in the level of compliance with mandatory disclosures, including those related to pensions obligations (see Tsalavoutas, Tsoligkas, & Evans, 2020 for a review). There is also evidence of selective management of relevant key assumptions when these are disclosed (Billings, O'Brien, Woods, & Vencappa, 2017).…”