The impact of pension assumptions on firm valuation

This study examines the association between disclosed accounting numbers and firm market value while incorporating the effect of managerial discretion on these numbers. In particular, the study focuses on the assumptions used to compute the firm's pension liabilities and costs. I find two general forces influence managers' choice of the assumptions: (1) economic factors arising from the firm's operating environment and (2) reporting incentives associated with contracting considerations. The market appears to be aware of both forces and, conditional on the accounting numbers disclosed, values the firm accordingly. That is, where reporting incentives induce managers to choose obligation-reducing (or income-increasing) assumptions, the market places a lower value on the firm. These findings suggest that the market is able to identify when assumptions are being used that are not justified by the firm's operating environment and discounts the effect of those assumptions on the disclosed accounting numbers.