Using Earnings Management and Prospect Theory to Explain the Setting of the Expected Rate of Return on Pension Plans

摘要

We try to find out the considerations of managers when they set their assumptions of expected long term rate of return on pension plan assets (ROPA). The revision of FASB Statement 132 requires firms to disclose information on asset allocation assumptions as well as their ROPA. When we use the asset allocation assumption made by each firms’ pension fund and historical returns of assets to calculate an estimated long term rate of return (EROPA), we find there is significant difference between ROPA and EROPA. This suggests that asset allocation is not the only consideration when managers set their ROPA target. Two theories are examined in this paper to explain such difference between ROPA and EROPA: earnings management and prospect theory. We use two models to test the earnings management hypothesis, single accrual model and threshold model. We find that the intention to smooth the reported income is an important incentives for managers to manipulation their ROPA. The accrual model can partly explain the difference between ROPA and EROPA. However, we can not observe any evidence in the threshold model. We also introduce prospect theory to examine the effect of risk attitude on ROPA. We find that managers’ risk attitude provides a good explanation for the difference between ROPA and EROPA.