Did pension plan accounting contribute to a stock market bubble?
During the 1990s, the asset portfolios of defined-benefit (DB) pension plans ballooned with the booming stock market. Due to current accounting guidelines, the robust growth in pension assets resulted in a stealthy but substantial boost to the profits of sponsoring corporations. This study assesses the extent to which equity investors were fooled by pension accounting. First, we test whether stock prices reflected the fair market value of sponsoring firms' net pension assets reported in footnotes to the 10-K or, instead, some capitalization rate on the pension cost accruals embedded in the income statement. The results strongly favor the latter view. Additional tests indicate that the market does not value a firm's "pension earnings" differently from its "core earnings", suggesting that pension earnings are often overvalued. Simulations show that a failure to differentiate between core and pension earnings induces large valuation errors for many firms, although this pension effect did not materially contribute to aggregate in overvaluation 2000. However, overvaluation from pension earnings reached 5 percent in the aggregate in 2001, when the steep stock price decline and the drop in interest rates had slashed pension net asset values but not pension earnings.
|Date of creation:||2003|
|Date of revision:|
|Contact details of provider:|| Postal: |
Web page: http://www.federalreserve.gov/
More information through EDIRC
|Order Information:||Web: http://www.federalreserve.gov/pubs/feds/fedsorder.html|
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.:
- Russell Davidson & James G. MacKinnon, 1980.
"Several Tests for Model Specification in the Presence of Alternative Hypotheses,"
378, Queen's University, Department of Economics.
- 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.
- Alan L. Gustman & Olivia S. Mitchell & Thomas L. Steinmeier, 1994.
"The Role of Pensions in the Labor Market: A Survey of the Literature,"
Cornell University, ILR School, vol. 47(3), pages 417-438, April.
- 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, Cornell University, ILR School, vol. 47(3), pages 417-438, April.
- Zvi Bodie & Jay O. Light & Randall Morck & Robert A. Taggart, Jr., 1984.
"Funding and Asset Allocation in Corporate Pension Plans: An Empirical Investigation,"
NBER Working Papers
1315, National Bureau of Economic Research, Inc.
- 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.
- Sharpe, William F., 1976. "Corporate pension funding policy," Journal of Financial Economics, Elsevier, vol. 3(3), pages 183-193, June.
- Irwin Tepper, 1981. "Taxation and Corporate Pension Policy," NBER Working Papers 0661, National Bureau of Economic Research, Inc.
- Jeremy I. Bulow & Randall Morck & Lawrence H. Summers, 1987.
"How Does the Market Value Unfunded Pension Liabilities?,"
in: Issues in Pension Economics, pages 81-110
National Bureau of Economic Research, Inc.
- Jeremy I. Bulow & Randall Morck & Lawrence H. Summers, 1985. "How Does the Market Value Unfunded Pension Liabilities?," NBER Working Papers 1602, National Bureau of Economic Research, Inc.
- 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.
- Zvi Bodie & John B. Shoven, 1983. "Financial Aspects of the United States Pension System," NBER Books, National Bureau of Economic Research, Inc, number bodi83-1, October.
- 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.).
- Tepper, Irwin, 1981. "Taxation and Corporate Pension Policy," Journal of Finance, American Finance Association, vol. 36(1), pages 1-13, March.
- 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.
When requesting a correction, please mention this item's handle: RePEc:fip:fedgfe:2003-38. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Kris Vajs)
If references are entirely missing, you can add them using this form.