State Pension Liabilities and Credit Assessments

Abstract

SYNOPSIS We examine the decision relevance of a commonly suggested adjustment to how state governments report governmental pension liabilities by recalculating such pension liabilities using the return on a portfolio of high-quality municipal bonds as the discount rate. Calculated as the difference between the state's expected rate of return and the municipal bond return, we find that the discount rate adjustment associates with lower credit ratings and higher interest costs. We also find that credit rating agencies are more likely to issue conflicting ratings when the calculation of the discount rate adjustment involves greater uncertainty. Overall, while financial statement users agree about the need for and the direction of a pension liability rate adjustment, there is less consensus about the proper magnitude of this adjustment, suggesting that current accounting treatment of pensions in the public sector leads to costly uncertainty among financial statement users.