Do Managers Change Pension Plan Assumptions to Meet/Exceed Earnings Threshold? Korean Evidence

Abstract

This study examines whether managers are likely to exercise discretion in determining pension plan actuarial assumptions to meet or exceed earnings targets. According to current accounting standards, managers can exercise broad discretion in setting actuarial assumptions under a defined benefit (DB) pension plan. Existing literature documents that managers can manage earnings upward by manipulating pension plan assumptions. Based on sample firms with DB pension plans from 2011 to 2018, our results reveal the followings. First, managers tend to manipulate pension assumptions optimistically when the unmanaged earnings miss the targets. Second, investors do not recognize the effect of changing assumptions on reported earnings and thus react favorably to the overstated earnings. Third, manipulating firms under-perform in the long run compared to the control group despite favorable short-term performance, which suggests accrual reversal and managerial attribute effects.