Factors in Managing Actuarial Assumptions for Pension Fair Value: Implications for IAS 19

Abstract

Corporate managers make several discretionary assumptions (i.e., the rate of salary growth and assumed return rate of pension plan assets) in calculating the fair value of pension assets and value of pension liabilities. In this study, we examine the factors that can induce managers to increase (decrease) fair value of pension assets (liabilities) through pension assumptions. We use the Taiwan setting as a natural experiment because Taiwan is planning to adopt IFRS from 2013 on. The estimation of pension asset (liability) value is similar between Taiwan accounting standards (i.e., TFAS 18) and international accounting standards (IAS 19); however, fair value is only disclosed in the financial statements under TFAS 18, but is required to be recognized in the balance sheet under IAS 19. The findings under TFAS 18 can provide important implications for future adoption of IAS 19. Using two key inputs for pension pricing model, this study finds that companies are inclined to increase (decrease) the value of pension assets (liabilities) by rising (lowering) the assumed expected rate of asset returns (expected salary growth). The manipulation is more pronounced for firms with high distress risk and complex ownership structure. Prior studies find that once firms are required to recognize the fair value (i.e., adopting IAS 19) as opposed to disclose the information (i.e., TFAS 18), firms have higher incentives to manipulate the model inputs. This suggests that the regulator needs to specify the authoritative enforcement rules regarding fair value estimation, and provides more insights on firms with high distress risk and complex ownership structure.

Determinants of Expected Returns at Public Defined-Benefit Pension Plans

“…Indeed, Hsu, Wu and Lin (2013) affirm that private firms adjust ERRs in order to change the actuarial values of pension assets and liabilities (also see Asthana (1999)). …”

Discretion in the accounting for defined benefit obligations – an empirical analysis of German IFRS statements

“…While Bergstresser et al (2006) and Asthana (2008) find that managers may manipulate earnings through their characterizations of pension assets and through the expected return on plan assets, Adams et al (2011) come to the result that the expected rate of return on pension assets is not overstated relative to several benchmarks. However, further support on the view that the expected rate of return is subject to managerial manipulation is provided by Hsu et al (2013) who show that companies with distress risk and complex ownership structure tend to increase the value of plan assets by rising the expected rate of asset returns.…”

Disclosure-Derived Financial Statement Adjustments in Equity Valuation

“…For example, firms reaching on-balance-sheet debt capacity may be likelier to increase leverage through off-balance-sheet or hybrid financing structures (Mills and Newberry, 2005). Firms in financial distress, with high on-balance-sheet leverage, may also opportunistically manage pension assumptions, which may require analyst adjustments (Hsu et al, 2013). Firms may have low or high reported operating profitability (inclusive of one-time items) due to transitory gain or loss items, leading to correlations between reported operating profitability and non-recurring item adjustments.…”