Firms' Choice of Estimation Parameters: Empirical Evidence from SFAS No. 106

Abstract

This study explains the cross-sectional variation in firms' selected assumptions (discount rates and health care cost trend rates) used to measure the obligation for postretirement benefits other than pensions (PRB) under SFAS No. 106. Our aim is to examine whether managements manage the reported PRB by choosing either too conservative or too aggressive estimation parameters. In addition, we examine whether investors value the firm's equity based on the cross-section median parameters or based on each firm's selected parameters. We find that firms with relatively larger PRB obligation and more leverage tend to select more aggressive (obligation-reducing) estimation parameters. We also find that firms that amended their PRB plans and firms with extreme earnings-price ratios tend to select more conservative (obligation-increasing) estimation parameters. Finally, we find that investors value the firm's equity using reported rather than adjusted estimation parameters.