The Fiction of Pension Accounting
By: Floyd Norris
Here's one explanation for the rising stock market as 2001 nears
an end: Some companies are locking in profits for next year by
buying stocks this year.
If that sounds ridiculous, it is. Whether profits will be made on
stocks bought now is unknowable. No reasonable accounting system
would let you book profits just because you bought the stocks.
But we are not dealing with a reasonable accounting system. We
are dealing with pension accounting, American style. The amount of
expense, or profit, that companies report from their pension systems
are not based on the actual profits earned by investments in the
pension fund. Instead, companies report profits as if the pension
investments earned what was assumed when the year began.
That's where the current buying comes from. Many companies assume
they will make 9 percent or more on pension investments, with some
forecasting more than 11 percent. With interest rates as low as they
are now, they clearly can't make anything like that on
investment-grade bonds, which make up a significant proportion of
most pension portfolios. Adding more stocks is the only way to make
such an optimistic number possibly believable. Otherwise, they would
have to reduce the assumption and next year's reported profits.
Whether pension plans will earn those returns over the long term
is debatable. They did better during the late 1990's bull market.
Warren E. Buffett, the chairman of Berkshire Hathaway says in the
current issued of Fortune magazine that he would love to "make
a large bet" that returns will be lower.
A survey by Bear Stearns that in 2000 the median company in the
Standard & Poor's 500-stock index assumed that its pension
assets would earn 9.2 percent, with some much higher. In fact, the
average return was 5 percent.
That means corporate profits were overstated in 2000. If
companies are assuming similar returns now, as Patricia McConnell,
the Bear Stearns accounting guru, says is likely, there are more
overstatements this year.
Over the long run, corporate books will show the reality of what
the pension plans really earn. But with the various smoothing
mechanisms built into the accounting rule, that can take decades. By
then, the bosses making the current optimistic assumptions will have
collected bonuses based on those assumptions and retired.
"It's a coming flash point in accounting," Thomas E.
Jones, the vice chairman of the International Accounting Standards
Board and a retired executive vice president of Citicorp said this
week. "We're kidding ourselves" by reporting results under
the American rule, he added.
This is a case where accounting clearly does affect behavior. In
Britain, a new accounting rule forces companies to show the actual
results of their pension plan investments. Boots, a big drugstore
chain, responded by selling all the stocks in its pension plans.
A new international rule would probably require companies to show
actual returns on their pension fund investments, although the
returns would be reported on a different line from operating
Opponents will say that would discourage stock market investments
and therefore reduce long-term returns for the funds. But if
companies believe that stocks are good investments, they should be
willing to report the real results and to explain to investors why
the risks are worth taking. There is no good reason to report
PO Box 20022, New York, NY 10025
Phone: +1 (212) 557-3163 - Fax: +1 (212) 557-3164