Does pension plan reporting readability affect earnings volatility?

Abstract

Purpose The purpose of this study is to explore whether pension plan reporting readability affects earnings volatility. Moreover, as SFAS 158 requires firms to fully recognize their funded status on the balance sheet, the firms’ pension liabilities (inside debts) and financing ability have the corresponding change. This study further investigates whether pension plan reporting readability affects earnings volatility from the SFAS 158 and funded status perspectives. Design/methodology/approach This study follows Li (2008), Lehavy et al. (2011) and Rennekamp (2012) to use the FOG and SMOG variables as the readability proxies and investigates whether pension plan reporting readability affects earnings volatility from the perspectives of inside debts and SFAS 158 by using a sample of 3,077 American firms from the year 2006 to 2009. Findings Empirical results of this study show that firms with low readability of pension plan reporting have high earnings volatility, revealing that less readable pension plan reporting increases the assessed variance of a firm’s inside debts, financing flexibility, investment ability and therefore profitability. In addition, the implement of SFAS 158 enhances the effect of pension plan reporting readability on earnings volatility. Moreover, the authors also find that the funded status plays a moderating role for the effect of pension plan reporting readability on earnings volatility. Finally, the results are robust to endogeneity issue. Research limitations/implications Earnings stability measures how consistently earnings have been generated over time, and its importance has been acknowledged by most firms. For example, prior literature has documented that manipulating financial reporting to smooth earnings is becoming a business common practice (Burgstahler et al., 2006; Liu and Espahbodi, 2014). The empirical results suggest that pension plan reporting readability is a significant determinant of earnings volatility. Practical implications As a practical implication, this study points out that manipulations of the pension reporting readability are not costless. It incurs the costs of earnings instability. Social implications This study indicates that the issuance of SFAS 158 makes firms more likely to engage in pension plan readability manipulation. As a result, it has policy implication that the regulator should consider how the policy change alters the firm financial reporting behavior. Originality/value The empirical results suggest that firms may be more likely to engage in obfuscating pension plan disclosure after FASB’s issuance of SFAS 158. This would further increase outside investors’ assessed variance for inside debts and earnings volatilities. When policymakers require firms to recognize their funded status in statement of financial position, they should consider the costs or benefits that the firm manager face and, therefore, how this policy change alter the firm financial reporting behavior.

The impact of strategic emphasis on the readability of narrative information in annual reports

“…They find that an abnormal positive tone is higher when firms achieve reporting profits rather than losses leading to misinform investors. However, poor readability is costly because unintelligible pension plan reporting increases the assessed variance of firms’ inside debts and results in earnings instability (Lin et al , 2019). According to the obfuscation explanation, this extra amount of explanation can be used to mask poor performance as a tool used by management, which exercises a certain level of discretion in its choices.…”

The fog index in accounting research: contributions and challenges

“…The Accounting Review (Bens et al, 2016;Bowen et al, 2014;Bozanic et al, 2019;Brochet et al, 2019;Brochet et al, 2016;D'Augusta & DeAngelis, 2020;Goodman et al, 2014;Hoitash & Hoitash, 2018;Kim et al, 2013;Kubick et al, 2020;Lehavy et al, 2011;Li, 2016;Schloetzer et al, 2020;Asay et al, 2017) 18 2 Journal of Accounting and Economics (Arif et al, 2019;Asay et al, 2018;Berger, 2011;Frankel et al, 2016;Heese et al, 2017;Lang & Stice-Lawrence, 2015;Lawrence, 2013;Li, 2008;Miller, 2017) 2 17 3 Review of Accounting Studies (Arora et al, 2014;Bhattacharya et al, 2020;Blankespoor et al, 2014; Bonsall 2 4 Contemporary Accounting Research (Bao et al, 2018;Beatty et al, 2019;Bova et al, 2015;Bozanic & Thevenot, 2015;Chen et al, 2019;Filzen & Peterson, 2015;Heese, 2019;Lee, 2012;Lin et al, 2019) 13 5 Journal of Accounting Research (Allee et al, 2018;Allee & Deangelis, 2015;Blankespoor, 2019;Brown et al, 2020;Cascino et al, 2019;Chen et al, 2015;…”