Finance and Economics Discussion Series (FEDS)
August 2003
Did Pension Plan Accounting Contribute to a Stock Market Bubble?
Julia Lynn Coronado and Steven A. Sharpe
Abstract:
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.
Keywords: Pension, accounting, firm valuation, bubble, stock market
PDF: Full Paper
Disclaimer: The economic research that is linked from this page represents the views of the authors and does not indicate concurrence either by other members of the Board's staff or by the Board of Governors. The economic research and their conclusions are often preliminary and are circulated to stimulate discussion and critical comment. The Board values having a staff that conducts research on a wide range of economic topics and that explores a diverse array of perspectives on those topics. The resulting conversations in academia, the economic policy community, and the broader public are important to sharpening our collective thinking.