Pension liabilities and conservative financial reporting

We investigate the relationship between a firm’s conditional financial reporting policy and the tendency to understate pension liabilities in the statement of financial position. We focus on two primary actuarial assumptions for pension liabilities, the discount rate and the salary growth rate, because a small bias in these two actuarial assumptions has a big effect on the estimate of pension liabilities and firms have some latitude in choosing these rates. We predict and find that firms are less likely to choose an upwardly biased discount rate and/or a downwardly biased salary growth rate when their earnings reflect bad news on a timelier basis than good news. Even though the salary growth result is somewhat weak, overall results suggest that firms are less likely to understate their pension liabilities by choosing pension obligation increasing actuarial assumptions when their financial reporting is conditionally more conservative.