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Did Pension Plan Accounting Contribute to a Stock Market Bubble?

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Author Info
Julia Lynn Coronado (Federal Reserve Board)
Steven A. Sharpe (Federal Reserve Board)

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Abstract

During the 1990s the assets of corporate defined-benefit pension plans ballooned with the booming stock market. Under current accounting guidelines, the result was a substantial but stealthy boost to sponsoring firms' profits. This study assesses the extent to which investors were fooled by pension accounting. It finds that stock prices reflected not the fair market value of sponsoring firms' net pension assets, as reported in the footnotes to their financial statements, but rather some capitalization rate on pension cost accruals in the income statement. Additional tests indicate that the market values a firm's pension earnings no differently from its core earnings, suggesting that pension earnings are often overvalued. This failure to differentiate induces large valuation errors for many firms, although this does not seem to translate into aggregate overvaluation, at least not before 2001, when falling stock prices and interest rates slashed pension net asset values but not pension earnings.

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File URL: http://www.brookings.edu/press/Books/2003/bpea20031.aspx
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Publisher Info
Article provided by Economic Studies Program, The Brookings Institution in its journal Brookings Papers on Economic Activity.

Volume (Year): 34 (2003)
Issue (Month): 2003-1 ()
Pages: 323-371
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Handle: RePEc:bin:bpeajo:v:34:y:2003:i:2003-1:p:323-371

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Related research
Keywords: macroeconomics; Pension Plan Accounting; Stock Market Bubble;

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Jeremy I. Bulow & Randall Morck & Lawrence H. Summers, 1987. "How Does the Market Value Unfunded Pension Liabilities?," NBER Working Papers 1602, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  2. Irwin Tepper, 1981. "Taxation and Corporate Pension Policy," NBER Working Papers 0661, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  3. Sharpe, William F., 1976. "Corporate pension funding policy," Journal of Financial Economics, Elsevier, vol. 3(3), pages 183-193, June. [Downloadable!] (restricted)
  4. Davidson, Russell & MacKinnon, James G, 1981. "Several Tests for Model Specification in the Presence of Alternative Hypotheses," Econometrica, Econometric Society, vol. 49(3), pages 781-93, May. [Downloadable!] (restricted)
    Other versions:
  5. Tepper, Irwin, 1981. "Taxation and Corporate Pension Policy," Journal of Finance, American Finance Association, vol. 36(1), pages 1-13, March. [Downloadable!] (restricted)
  6. Alicia H. Munnell & Nicole Ernsberger (assistant), 1987. "Pension contributions and the stock market," New England Economic Review, Federal Reserve Bank of Boston, issue Nov, pages 3-14.
  7. Alan L. Gustman & Thomas L. Steinmeier & Olivia Mitchell, 1994. "The role of pensions in the labor market: A survey of the literature," Industrial and Labor Relations Review, ILR Review, ILR School, Cornell University, vol. 47(3), pages 417-438, April.
  8. Barth, Mary E. & Beaver, William H. & Landsman, Wayne R., 1992. "The market valuation implications of net periodic pension cost components," Journal of Accounting and Economics, Elsevier, vol. 15(1), pages 27-62, March. [Downloadable!] (restricted)
  9. Zvi Bodie & Jay O.. Light & Randall Morck, 1987. "Funding and Asset Allocation in Corporate Pension Plans: An Empirical Investigation," NBER Chapters, in: Issues in Pension Economics, pages 15-48 National Bureau of Economic Research, Inc. [Downloadable!]
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  10. Steven A. Sharpe, 2002. "How does the market interpret analysts' long-term growth forecasts?," Finance and Economics Discussion Series 2002-7, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. David A. Love & Paul A. Smith & David Wilcox, 2009. "Should risky firms offer risk-free DB pensions?," Finance and Economics Discussion Series 2009-20, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  2. Enrica Detragiache, 2003. "Company Pension Plans, Stock Market Returns, and Labor Demand," IMF Working Papers 03/222, International Monetary Fund. [Downloadable!]
  3. Jeffrey R. Brown, 2007. "Guaranteed Trouble: The Economic Effects of the Pension Benefit Guaranty Corporation," NBER Working Papers 13438, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  4. Julia Coronado & Olivia S. Mitchell & Steven A. Sharpe & S. Blake Nesbitt, 2008. "Footnotes Aren't Enough: The Impact of Pension Accounting on Stock Values," NBER Working Papers 13726, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  5. Kamakshya Trivedi & Garry Young, . "Defined benefit company pensions and corporate valuations: simulation and empirical evidence from the United Kingdom," Bank of England working papers 289, Bank of England. [Downloadable!]
  6. David Love & Paul Smith & David Wilcox, 2007. "Why Do Firms Offer Risky Defined Benefit Pension Plans?," Department of Economics Working Papers 2007-4, Department of Economics, Williams College. [Downloadable!]
    Other versions:
  7. Daniel Bergstresser & Mihir A. Desai & Joshua Rauh, 2004. "Earnings Manipulation and Managerial Investment Decisions: Evidence from Sponsored Pension Plans," NBER Working Papers 10543, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  8. Simon Kwan, 2003. "Pension accounting and reported earnings," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, issue Jul 4. [Downloadable!]
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