I test whether the introduction of a new pension standard (FRS 17) in the U.K., which virtually eliminated smoothing in pension accounting, is associated with a re-allocation of assets from equities to bonds in defined-benefit pension plans. My findings indicate that sample firms decrease their equity allocation by about 8 percentage points, on average, after the passage of FRS 17. The magnitude of the asset re-allocation depends on the financial reporting effect of FRS 17, and is positively associated with: (i) the increase in reported pension underfunding, (ii) the expected future volatility of reported actuarial gains/losses in the pension plan, and (iii) the increase in reported pension cost. I also find that the sensitivity of asset allocation to the financial reporting impact of FRS 17 depends on firm characteristics such as dividends, financial constraints, pension plan size, profitability, and shareholder governance. The systematic shift away from equities after FRS 17 indicates that smoothing encourages equity investment in pension plans by allowing firms to mitigate the financial reporting costs of equity volatility.
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