The effect of GAAP conformity on pension underfunding

Abstract

Purpose The purpose of this paper is to examine the association between conformity with generally accepted accounting principles (GAAP) indicated by Governmental Accounting Standards Board (GASB) 34 presentation and pension underfunding in Illinois. Design/methodology/approach The authors used a fixed effects regression and employed a sample of Illinois municipalities (n=2,565 municipal-year observations) over the period 2009–2014. Findings The findings show that GAAP is inversely associated with pension underfunding, but only among the subsample of municipalities that are within the healthy pension funding range, i.e., above 80 percent funded. These municipalities may be in a better position to increase pension funding in response to the disciplining effect of broad GAAP conformity. Research limitations/implications The paper focuses solely on one state and one multi-employer plan. Future studies should consider assessing the applicability of the results to other states and plan settings. Social implications The results inform the standard-setting process, particularly as the implementation of the new GASB standards is evaluated and as GASB 34 is reexamined. Originality/value Despite concerns associated with state and local pension underfunding, academic studies examining its determinants are few. The sample setting is representative of municipal pension plans in the USA (with a comparable average pension funding ratio of 74.2 percent) and provides variability in GAAP conformity (the state encourages, but does not require, financial statement presentation consistent with GASB 34), as well as homogeneity in actuarial assumptions across observations (all sample municipalities participate in a large multi-employer municipal pension plan). The sample period immediately precedes the implementation of GASB Statements Nos 67 and 68, which increase the scope of pension reporting, providing the opportunity to consider the effects of broad GAAP conformity and a baseline for subsequent consideration of the effects of the new standards.

Defined Benefit Public Pension Funding Determinants and Consequences: A Review of the Literature

“…The key determinant of interest (GAAP conformance) falls within the governance and reporting category, while control variables in the fiscal environment and plan characteristics and member demographics were also modeled. The results in Davidyan & Waymire (2018) suggest GAAP conformance is inversely associated with pension underfunding in the subsample of the healthy funded plans (above 80% funding ratio).…”

“…The only three, true empirical works noted in this setting are a working paper by Bagchi (2016), a study by Faulk, Hicks, & Killian (2016), and a study by Davidyan & Waymire (2018). Bagchi (2016) is examining political competition and its effects on pension funding in the context of 2,000 municipal pension plans in the state of Pennsylvania, using biennial data between 1985 and 2009.…”

“…This finding is consistent with the association noted at the state plans level by Marks et al (1988) discussed in the previous section, but where the model provides a different directional relationship, having pension funding as the dependent variable (exploring determinants of underfunding) and financial disclosure the independent one. A more recent paper by Davidyan & Waymire (2018) studied the association of GASB Statement number 34 conformance (i.e., governmental financial reporting model) and pension underfunding, noting positive association of conformance with higher pension funding ratios (i.e., lower underfunding) within the subsample of healthyfunded plans (80% and higher).…”

“…Finally, Davidyan & Waymire (2018) explore the association of conformity with GAAP and pension underfunding in a large sample of municipalities participating in the Illinois Municipal Retirement Fund (a multi-employer DB plan in the State of Illinois), in the period from 2009 to 2014. In this study, GAAP conformity is indicated by GASB statement number 34 presentation in the plan's financial statements.…”