NCPA - National Center for Policy Analysis


March 24, 2005

Companies with large pensions can boost earnings quite easily: manipulate the assumed rates of return on the firm's pension assets, according to Matt Nesvisky (National Bureau of Economic Research).

He finds that many firms have pension plans that are large enough to allow them to substantially increase reported earnings in the short run by changing the assumed long-term rate of return. This in turn boosts the firms' stock price and the companies' overall valuation. For example:

  • A firm whose pension assets are twice as large relative to its operating income makes a long-term rate of return assumption 10 basis points larger than the median company.
  • Companies that are very sensitive to the rate of return make assumptions 40 basis points higher than firms less sensitive to the rate of return.
  • Assumed long-term rates of return are approximately 30 basis points higher for firms that are acquiring other firms.

Nesvisky also notes that managers who are the least constrained by their shareholders appear to be the most aggressive with their rate of return assumptions. Additionally, despite the boost in stock price, the evidence suggests that earnings manipulations do not benefit shareholders.

Source: Matt Nesvisky, "Pension Assumptions and Earnings Manipulation," NBER Digest, December 2004; based upon: Daniel Bergstresser, Mihir Desai and Joshua Rauh, "Earnings Manipulation and Managerial Investment Decisions: Evidence from Sponsored Pension Plans," National Bureau of Economic Research, Working Paper No. 10543, June 2004.

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