The effect of GAAP conformity on pension underfunding

Abstract

Purpose The purpose of this paper is to examine the association between conformity with generally accepted accounting principles (GAAP) indicated by Governmental Accounting Standards Board (GASB) 34 presentation and pension underfunding in Illinois. Design/methodology/approach The authors used a fixed effects regression and employed a sample of Illinois municipalities (n=2,565 municipal-year observations) over the period 2009–2014. Findings The findings show that GAAP is inversely associated with pension underfunding, but only among the subsample of municipalities that are within the healthy pension funding range, i.e., above 80 percent funded. These municipalities may be in a better position to increase pension funding in response to the disciplining effect of broad GAAP conformity. Research limitations/implications The paper focuses solely on one state and one multi-employer plan. Future studies should consider assessing the applicability of the results to other states and plan settings. Social implications The results inform the standard-setting process, particularly as the implementation of the new GASB standards is evaluated and as GASB 34 is reexamined. Originality/value Despite concerns associated with state and local pension underfunding, academic studies examining its determinants are few. The sample setting is representative of municipal pension plans in the USA (with a comparable average pension funding ratio of 74.2 percent) and provides variability in GAAP conformity (the state encourages, but does not require, financial statement presentation consistent with GASB 34), as well as homogeneity in actuarial assumptions across observations (all sample municipalities participate in a large multi-employer municipal pension plan). The sample period immediately precedes the implementation of GASB Statements Nos 67 and 68, which increase the scope of pension reporting, providing the opportunity to consider the effects of broad GAAP conformity and a baseline for subsequent consideration of the effects of the new standards.