Impact of Change in Pension Accounting Is Negligible

The paper from SEI, “Considering a Switch to Mark-to-Market Accounting? An Understanding of Potential Stakeholder Reactions,” examines the impact such an accounting method might have on companies’ investors, equity research, credit ratings and management compensation programs. Twenty-three major U.S. companies that implemented mark-to-market accounting for their defined benefit plans over the past two years were reviewed for the paper. The research findings show such a switch has little substantive change on these corporate constituencies.

“While there has been much discussion in the industry regarding the pros and cons of transitioning to mark-to-market accounting for pension plans, our research suggests that the reaction by key stakeholders and the subsequent impact on corporate finances is generally negligible,” says Thomas Harvey, director of advice for SEI’s Institutional Group. “Plan sponsors that might have previously been hesitant about such a change should potentially re-evaluate their pension accounting options.”

The paper says many plan sponsors currently use a multiyear smoothing method in calculating their pension liabilities. This approach is designed to help decrease year-to-year volatility of pension expense, but can create a drag on future earnings. Mark-to-market accounting removes this smoothing method and realizes gains or losses immediately as they occur, providing a more accurate view of the current results of the organization’s pension plan. The paper notes that mark-to-market accounting is used on a more global basis by International Accounting Standards.

Other findings from the paper include:

• Returns on share price in the period surrounding the earnings announcement show no statistically significant abnormal return values;
• Financial analysts’ reports and quarterly earnings calls show very few questions and no direct criticisms of the mark-to-market implementations by companies;
• Ratings agencies such as S&P, Moody’s and Fitch already use mark-to-market accounting as part of their longstanding practices;
• Internal management receives the benefit of removing drags on earnings, while ultimately gaining more favorable earnings per share without the penalty of past poor performance; and
• Non-generally accepted accounting principles (GAAP) adjustments to earnings generally removes the mark-to-market effect in investor calls, analyst reports and management compensation programs.

The paper’s authors conclude, “Based on our research, a change to mark-to-market accounting can be made with the potential for little substantive change on the part of investors, analysts or managers as part of this implementation.”

The full text of the research paper can be found here.

SEI is a provider of investment processing, fund processing, and investment management business outsourcing solutions. Its Institutional Group provides outsourced fiduciary management investment services. The firm is based in Oaks, Pennsylvania.