double (accounting) standards: a comparison of

J. OF PUBLIC BUDGETING, ACCOUNTING & FINANCIAL MANAGEMENT, 24 (2), 278-312 SUMMER 2012

DOUBLE (ACCOUNTING) STANDARDS: A COMPARISON OF PUBLIC AND PRIVATE SECTOR DEFINED BENEFIT PENSION PLANS

Kathryn E. Easterday and Tim V. Eaton*

ABSTRACT We examine and compare funding status, actuarial assumptions and asset investment allocations of defined benefit pension plans in the public and private sectors across time, using information as reported under GASB and FASB. We find that pension plans in both sectors are underfunded and that inferences about pension funding in the public sector would be different if pension assets’ fair values were required in the computation of funding status. Actuarial assumptions of public employee plans appear to be both more optimistic and less variable than those of private sector plans. Finally, we document that public sector plans allocate invested assets somewhat differently than in the private sector, although our findings do not confirm anecdotal reports of riskier pension investment strategies relative to the private sector.

INTRODUCTION

The purpose of government is significantly different from that of business entities and in many cases it is entirely appropriate that accounting and reporting rules differ between the government and the private sector (Governmental Accounting Standards Board, 2006). Various stakeholders make investment decisions, engage in discussions about resource allocations, and debate priorities and policies related to defined benefit (DB) pensions. To do so they rely on information reported according to accounting and disclosure ----------------------------------- *Kathryn E. Easterday, Ph.D., and Tim V. Eaton, Ph.D., are Assistant Professor, and Associate Professor, respectively, Department of Accountancy, Miami University. Dr. Easterday’s research interests include pension accounting, capital asset pricing and pricing anomalies. Dr. Eaton’s teaching and research interests are in the areas of financial accounting with a special focus on pension research.

Copyright © 2012 by PrAcademics Press

DOUBLE (ACCOUNTING) STANDARDS: A COMPARISON 279

requirements promulgated by the Financial Accounting Standards Board (FASB) and the Governmental Accounting Standards Board (GASB). Users should be able to clearly understand the comparative financial implications related to the funding, stability, and financial management of DB pensions. We have found that important differences in pension accounting and disclosure rules between the public and private sectors potentially make such comparisons difficult for many users.

Accounting professionals and researchers already know that accounting and reporting requirements surrounding pension plans are not entirely consistent between GASB and FASB. Many features of DB pensions are quite similar irrespective of whether they are in the public or private sector, but accounting and reporting rules for the same or similar features of DB pensions often vary significantly between GASB and FASB. Does this lead to conflicts with a fundamental objective of financial reporting, which is to provide timely, relevant information for users of the financial statements?

Recent and continuing efforts by GASB and FASB to enhance pension accounting and financial reporting suggest that both organizations see room for improvement. FASB released Statement of Financial Accounting Standards (SFAS) No. 158 Employers’ Accounting for Defined Benefit Pension and Other Postretirement Benefits in 2006 and is currently deliberating Compensation – Retirement Benefits – Multiemployer Plans (Subtopic 715-80): Disclosure about an Employer’s Participation in a Multiemployer Plan. In July 2011, GASB issued two new exposure drafts that, if implemented, would significantly impact financial reporting for pensions of state and local governments.1 GASB is also conducting research on Fiduciary Responsibilities,2 a project initiated in 2010 after questions were raised regarding proper reporting for pension trust funds.

Millions of active and retired workers are covered under DB pension plans, and future obligations are often measured in billions of dollars. Because DB pensions and their financial implications affect a wide variety of stakeholders (active workers and retirees, managers of both corporate and government entities, investors, taxpayers), research on DB pensions warrants multiple approaches. Recent studies focusing on public employee pensions rely on complex adjustments to pension assets and liabilities based on FASB

280 EASTERDAY & EATON

accounting standards and assumptions required in the private sector (Ennis, 2007). However, as acknowledged in the quotations shown below, from FASB’s Statement of Financial Accounting Concepts (SFAC) No. 1 and GASB’s Concept Statement No. 1, many users who may wish to compare characteristics of corporate DB pensions to those in the public sector – such as taxpayers, politicians, voters, or individual investors – are not “sophisticated,” although the interests they have in evaluating the comparative viability and stability of these pensions are very real.

Financial reporting should provide information that is useful to present and potential investors and creditors and other users in making rational investment, credit, and similar decisions. The information should be comprehensible to those who have a reasonable understanding of business and economic activities and are willing to study the information with reasonable diligence (FASB SFAC No. 1, par. 34, 1978).

Financial reporting helps fulfill government’s duty to be publicly accountable. Financial reporting also helps to satisfy the needs of users who have limited authority, ability, or resources to obtain information and who therefore rely on the reports as an important source of information (GASB Concepts Statement No. 1, par. 3, 1987).

These users generally rely on information as reported in financial statements and likely do not have the capacity, or access to additional information, needed to perform complicated, mathematical manipulations based on accounting rules they do not know. Therefore, we specifically have avoided making such complex adjustments for our comparisons, particularly with regard to valuation of pension obligations.

Papers by Rauh (2006), Novy-Marx and Rauh (2011), and Kozak (2008) have made significant contributions to the literature on DB plans by emphasizing economic concerns related to underfunding of DB pensions in both the public and private sectors. In particular, they have focused on differences in discount rates used to value pension liabilities between governmental and corporate entities. We contend that consideration of accounting and disclosure differences for DB pensions are important also because they determine the type and format of financial information presented to stakeholders, most of whom are not academics or skilled financiers. The motivations for


our study were to look at reported pension information through the eyes of these users, to compare selected features of DB pensions between the two sectors, and to consider the conclusions that such users might reach based on the financial reports provided to them under current accounting and disclosure requirements. We not only made statistical comparisons between the public and private sectors of several important pension features but we examined the comparisons over time. Our analysis highlights differences in accounting and disclosure rules for analogous DB pension features and points out difficulties that users of financial statements may face when attempting to make their own comparisons of DB pensions between the two sectors. Our results are consistent with previous studies, and the longitudinal aspect of our research design provides some assurance that such inferences are not by-products of short-term influences in the macroeconomic environment.

Our analysis compared reported pension data for public sector retirement systems to data reported by firms in the private sector because a retirement system and a firm each represent a reporting framework under which at least one and possibly multiple individual DB pension plans are aggregated.

We explored pension funding status, as well as actuarial assumptions and allocations of invested plan assets. We have documented that both public employee and corporate sector pension plans appear to be in general underfunded, with the pattern varying over time. Further, we show that if the funding status of public employee pensions were determined similarly to the way it is for corporations – that is, using fair values of pension assets rather than actuarial values – then inferences about public employee pension funding status may be very different. Additionally, we found that actuarial assumptions for public employee pension plans tend to be more optimistic and also more “sticky” than for corporate plans. Finally, we address anecdotal evidence suggesting that investment practices for public employee pension plans tend to be riskier than for corporate plans (Chon, 2010a; Freedberg, 2009; Walsh, 2010b). Our findings in this area are mixed. Allocations to the relatively safe category of debt are consistently and significantly lower for invested public employee pension assets compared to corporate pension assets, but equity allocations for public employee pension assets are


also lower. Whether investment strategies actually differ remains an open question which presents opportunities for future research.

The remainder of this paper proceeds as follows. In the next section we present background information. The third section presents our analysis and results. The final section concludes.

BACKGROUND

Pension Characteristics and Accounting Rules

An employer offering a DB plan compensates employees in two ways. First, employees receive current wages; second, the employer promises future payments after retirement. The employer bears both the risk for ensuring that sufficient funds are available to make promised future payments and a fiduciary responsibility to carefully manage and invest DB plan assets held in trust to meet these obligations. The employer must evaluate its ability to meet the cash payment obligations of the DB plan in the current year as well as over the long term. Because there is uncertainty about many of the factors that determine size of the ultimate pension obligation – number of employees remaining employed until retirement, years of service until retirement, wage progression during active service, life expectancy after retirement – employers utilize various accounting estimates and actuarial assumptions to assess their obligation amounts.

Corporate DB pension plans that meet specific requirements under both IRS section 401(a) and ERISA3 (“qualified plans”) are eligible for favorable tax treatment; plans that do not meet requirements (“nonqualified plans”) are not eligible. Qualification status of a DB pension plan may affect a company’s tax strategy, but does not affect the company’s reporting and disclosure requirements under US GAAP. Companies may also offer DB pension plans covering employees in other countries where they operate (foreign plans). Many firms offer multiple DB plans covering various groups of employees and a particular company may offer DB plans that are qualified, nonqualified, foreign, or some mixture of these types. Legal requirements as well as financial and/or tax incentives for funding DB pension plans differ depending on whether a DB plan is foreign or domestic, qualified or nonqualified. However, accounting and disclosure requirements under US GAAP are the same for a company


that offers DB plan(s), regardless of how those plans are categorized.4 In contrast, categorization of public employee pension plans or systems as “foreign,” “qualified,” or “non-qualified” is not applicable because the employers are domestic government entities, and as such are not subject to IRS or ERISA rules.5

FASB Accounting Standards Codification (ASC) 7156 requires balance sheet reporting of DB plan funding status, measured as the difference between the pension benefit obligation (PBO) and the fair value of plan assets. FASB requires that DB pension assets be reported at fair value. The PBO is the present value of the total future obligation reflecting a discount rate at which the obligation could effectively be settled, taking into account future compensation levels and various actuarial assumptions affecting probability of payment. The guidance suggests that employers examine rates of high-quality fixed income investments, taking into account future available reinvestment rates if necessary. It also requires that the discount rate be reevaluated each year and that it change in a manner similar to general interest rates.7 The discount rate of the pension obligation, expected rate of return (ERR) on invested plan assets, and the rate of compensation increase are among several actuarial estimates that must be disclosed. Gains and losses resulting from changes in the net pension asset and liability must be recognized in other comprehensive income.

GASB Statement No. 25 (1994a) requires statements of plan assets and changes in net assets, as well as supplemental disclosures of actuarially determined values of pension plan assets and accrued liabilities. GASB Statement No. 27 (1994b) enumerates requirements for reporting pension expenses and the related assets and liabilities. GASB Statement No. 50 (2007) requires disclosure of a pension plan’s funded status in the notes to the financial statements. GASB requirements for reporting pension plan funding status call for the use of actuarial values for both pension assets and liabilities, using methods that smooth the effects of gains and losses on invested plan assets over a period of years. There currently is no maximum number of years over which this smoothing may occur, nor is there a limit to the amount or direction by which the actuarial value of plan assets may differ from the market value of plan assets.8

Pension liabilities in the public sector are analogous to private sector PBOs in that the actuarial value of pension liabilities reported


is a discounted total future pension benefit obligation. However, GASB requires that future pension obligations be discounted at the expected rate of return on plan assets. Utilizing market-based discount methods for pension liabilities is also permitted, but it is not required under GASB and some public employee pension plan administrators actively discourage such disclosures (Biggs, 2009). Novy-Marx and Rauh (2008) provided empirical evidence that valuation methods required by GASB for reporting pension assets and obligations result in underestimates of obligations and overestimates of funding status.

Pension Underfunding

In addition to reporting on pension plan assets and obligations, employers evaluate the overall funding status of their DB plans to determine whether plan assets are adequate to pay the ultimate obligations to employees. A pension plan is determined to be fully funded when pension assets are sufficient to cover the present value of total pension obligations. If assets exceed obligations the plan is considered overfunded; if assets are insufficient to meet obligations the plan is underfunded. Underfunding is associated with substantially negative – albeit different – consequences for both corporate and governmental entities.

Pension plan underfunding is strongly discouraged in the private sector through regulatory means. ERISA, through the Pension Benefit Guaranty Corporation (PBGC),9 imposes mandatory cash contributions from the employer if a plan is severely underfunded and can enforce statutory liens if contributions are not made. As an additional measure, the Pension Protection Act of 2006 required firms to fully fund their pension obligations and to make up shortfalls over a maximum of seven years, although some temporary relief was granted in 2010 due to the US economic crisis (Chon, 2010b; Corkery, 2010). Beyond the regulatory structure, capital markets also seem to take a rather dim view of companies with underfunded DB pensions. Picconi (2006) found that pension underfunding signals potential reductions in firms’ future cash flows and earnings, while Franzoni and Marin (2006) provided evidence that firms with underfunded pension plans have poor operating performance and lower market returns than do firms with fully- or overfunded plans.


In contrast, governmental entities do not face federal legislative or regulatory constraints on plan funding. Reports in the popular press and recent academic research (Augustine, Draine, Fehr & Huh, 2010; Belkin, Etter & Brat, 2011; Bischoff, Gottschlich & Nash, 2010; Cauchon, 2006; Easterday & Easton, 2010; Rauh, 2010; Walsh, 2010a) have suggested that many state and local governments may be at risk financially due to the magnitudes of liabilities and underfunding of public employee DB pensions. In particular, Novy-Marx and Rauh (2009b) suggested that GASB accounting and disclosure rules for pensions result in significant understatements of public pension liabilities, implying that reported funding status of public employee retirement systems may be significantly overstated. The potential for misleading taxpayers and other stakeholders is deemed serious enough that the SEC recently began looking into state government financial disclosures, alleging that information regarding Illinois and New Jersey’s pension plans misled investors in those states’ municipal bond offerings (Dugan, 2010; Scannell & Neumann, 2010). Rising concern over potential economic impacts of unfunded public employee pensions was further reflected in a recent decision by Moody’s Investment Service to include unfunded pension liabilities in its ranking of state debt loads (Corkery, 2011).

Many US state and local governments face drastic budgetary consequences as a result of the recent economic downturn. Rauh (2010) projected that public employee pension liabilities demand so much in the way of financial resources that as many as 20 states could run out of money by 2025, even after assuming consistent market returns of eight percent on invested pension assets. Capital markets do not ignore effects of unfunded pension liabilities for government entities, either: Novy-Marx and Rauh (2009a) concluded that growing unfunded state liabilities (including pensions) are associated with higher state borrowing costs.

In states that do not have constitutional or legislative guarantees for public employee pension benefits, public employees may face higher costs or benefit reductions as officials attempt to rein in costs (Fleisher, 2011). State and local governments can also increase taxes in order to meet the pension obligations. Illinois offers an example. In early 2011 the Illinois state legislature passed a 67% increase in the individual state income tax and a 45% increase in the state corporate tax in an attempt to meet significant budgetary and


pension funding shortfalls (Belkin et al., 2011; Bunch, 2010; Chon, 2010c). Raising taxes, reducing pension benefits and shifting monies from other budget priorities to cover pension obligations all entail political risks (Cooper, 2011; Neumann, 2010), and some state and local government officials deal with budget pressures by making only partial contributions or no payments at all to fund public employees’ pension plans (Chong, 2010c). Bankruptcy options exist for municipal but not for state governments, although in the future some comparable mechanism may be developed for state governments as well (Walsh, 2011).

Actuarial Assumptions

DB pensions are essentially promises to pay compensation in the future and there may be substantial uncertainty surrounding the present magnitude of the ultimate liability, its growth rate over time, and whether existing pension assets will be sufficient to meet future needs. Employers make numerous choices regarding actuarial methods and assumptions and these choices are of interest to users of financial statements trying to form opinions about the viability of DB pensions. Numerous academic studies provide evidence that various pension-related actuarial assumptions may be opportunistically manipulated by managers in the presence of financial constraints or other incentives for misreporting (Asthana, 1999; Bergstresser, Mihir & Rauth, 2006; Chaney, Copely & Stone, 2002; Comprix & Muller III, 2011, Eaton & Nofsinger, 2004; Ennis, 2007; Mitchell & Smith, 1994; Peng, 2008).

We compared three actuarial assumptions for corporate and public employee pensions: ERR, discount rate for determining the present value of the pension obligation, and rate of compensation increase.

Expected Rate of Return on Invested Plan Assets

Under FASB rules, ERR is a component in the calculation of pension expense. There is incentive for optimism in estimating ERR for companies because as ERR increases, pension expense decreases; even a small change in ERR can greatly impact pension expense (Amir & Benartzi, 1998; Blankley & Swanson, 1995).

Strikingly different from FASB rules is the GASB requirement that public employee retirement systems use ERR as the discount rate for


determining the present value of pension obligations. For governments a higher ERR provides double benefits. First, the expected growth of plan assets is reported to be better, possibly providing justification to make lower (or no) cash contributions to pension funds (Ennis, 2007). There is evidence in several studies that optimistic ERRs may provide a welcome means for cash-strapped state and local governments to reduce or delay making contributions to pension funds in order to address other important budget priorities (Chaney et al., 2002; Eaton & Nofsinger, 2004; Mitchell & Smith, 1994; Peng, 2008). Second, the present value of the reported obligation is lowered when a higher discount rate is used.

Discount Rate of Pension Obligation

We also compare the discount rates used to determine reported pension liabilities. As described above, pension liabilities for public pensions use the ERR of their invested plan assets as the liability discount rate. Novy-Marx and Rauh (2009b, 2011) argued that ERR is too high a rate for discounting public pension obligations and that the resulting underestimation of pension liabilities caused by this requirement can contribute to distorted decision making by government managers.10 In contrast, FASB requires that corporate plans value pension liabilities at the market discount rate of the liabilities, not at the investment return rate for assets used to fund them.

Rate of Compensation Increase

Generally, inflation is expected to be the primary driver of wage increases over time for public employees.11 In contrast, companies operate in the competitive market and the reported rate of compensation increase should reflect expectations about factors that exert both upward and downward pressure on wages over time (e.g., inflation, real productivity growth, competitive pressure to reduce production costs, labor market competition, etc.). The assumed rate of compensation increase is a required disclosure for private sector entities;12 however, GASB does not require a similar disclosure – other than assumed inflation rate – for governmental entities. Whether the rate of compensation increase reported by companies is larger or smaller than assumed inflation rates for public sector pensions is an empirical question, and we believe appropriate to our investigation by providing another meaningful comparison of pension


accounting and reporting practices between companies and governmental entities.

Asset Allocations

Amir and Bernartzi (1998) found that ERR is a relatively poor predictor of actual returns for corporate pensions; Eaton and Nofsinger (2001) found similar results in the public sector. Both papers found that investment allocations are better predictors of actual returns than is ERR. But investment allocations are a potential source of pension underfunding when allocation choices are sub-optimal, leading to slower-than-expected growth or even losses – particularly when risky investment strategies are pursued. In bull markets it is especially tempting to allocate higher percentages of pension assets to equities, taking advantage of high market returns to improve plan funding status while reducing or eliminating the need for cash contributions. However, such a strategy involves considerable risk in that it exacerbates underfunding during market downturns (Peng, 2008). In the corporate sector, risk appetites should be somewhat restrained by the FASB, which requires that pension funding status be determined and reported using market values of pension assets; and similarly restrained by ERISA and the PBGC.

Public employee retirement systems determine funding status and report pension assets based on actuarial rather than market values, but this masks the effects of poor (good) investment performance and the consequent reductions (growth) in pension assets. Anecdotal evidence (Freedberg, 2009; Walsh, 2010b) and empirical research (Novy-Marx & Rauth, 2009a; Stalebrink, Kriz, & Guo, 2010) suggest that public sector pensions pursue relatively risky investment strategies. We examined the comparative appetite for investment risk between public employee retirement systems and corporate pension plans by testing whether their investment allocations differ.

ANALYSIS

Data Sample

Our public employee pension data comes from The Public Fund Survey (PFS), which is sponsored by the National Association of State


Retirement Administrators and the National Council on Teacher Retirement. PFS is an annual summary of approximately 100 state and local public employee retirement systems and represents roughly 85% of the total assets and members in such retirement systems each year.13 Public employee retirement systems represent at least one (and possibly multiple) individual DB retirement plans covering various groups of state and municipal employees.14 PFS data items are provided at the plan level and are aggregated to the system level for comparative analyses using plan-system identifier codes provided by PFS. We deleted plans for which sufficient data is not present. Our final public sector sample consists of 701 system-years representing 869 plan-years ranging from 2001 to 2008.15 Fair values for pension assets are included in our public employee pension sample starting in 2005; there are 347 system-years for which the fair value of pension assets is available. Variable names, definitions, and availability effects on sample size are shown in Table 1, Panel A.

We obtained corporate sector data from the Compustat Pension and Fundamentals datasets. Compustat pension data is aggregated at the firm level.16 Our initial sample consists of 12,561 firm-years for publicly traded US firms with DB plans in fiscal years 2001 through 2008, but variable availability reduces our sample size. Variable names, definitions, and availability effects on sample size

TABLE 1 Variable Definitions and Sample Makeup

Panel A: Public Fund Survey Variable Names and Definitions for Public Sector Pension Plan Data

PFS Variables Variable Definition

Number of Observations Remaining in

Sample ACTLIABS Actuarial value of liabilities > 0

($millions) 892

ACTASSETS Actuarial value of assets > 0 ($millions)

892

INVRETURNASSUMP Assumed rate of return on retirement plan assets > 0

890

INFLATIONASSUMP Assumed rate of inflation 869 ASSETMARKETVALUE Market value of retirement plan

assets 436


TABLE 1 (Continued)

Panel B: Compustat Variable Names and Definitions for Private Sector Pension Plan Data

Compustat Variables Name Variable Definition

Number of Observations Remaining in

Sample PCPPAO Funded status of plan ($millions) 12,561 PPLAO Pension plan assets > 0 ($millions) 12,376 PBPRO Projected benefit obligation > 0

($millions) 12,373

PBARR Discount rate used to estimate the present value of the projected benefit obligation

11,706

PPROR Expected rate of return on pension plan assets

10,208

PPRCI Estimated rate of employees’ compensation increase

8,596

AT Total assets > 0 ($millions) 8,596 REVT Total revenues > 0 ($millions) 8,588 MKTV_F Market value at fiscal yearend > 0

($millions) 7,385

PRCC_F Closing share price at end of fiscal year, > $1 and < $500 ($/share)

7,225

are shown in Table 1, Panel B. The final corporate sector sample consists of 7,225 firm-years during the sample period of 2001 to 2008. Summary statistics for the firms in our corporate sample are shown in Table 2.

Table 3, Panel A shows mean (median) PBOs and pension assets for each firm in our private sector sample from 2001 through 2008. PBOs increased each year throughout the sample period; pension assets increased through 2007, then dropped sharply in 2008. Mean PBOs exceeded mean plan assets in all years except 2001 and 2007.

Table 3, Panel B shows mean (median) reported pension liabilities and assets for the public retirement systems in our sample over the time period of study. Similar to the data we observed for companies’ PBOs in Panel A, the mean actuarial retirement system liabilities increased every year from 2001 through 2008. Actuarial


TABLE 2 Summary Statistics for Firms in the Private Sector Sample:

2001 – 2008

Year

Number of Firms in Sample

Mean (Median) Market Cap

(In $ Millions)

Revenues (In $ Millions)

Total Assets (In $

Millions) Share Price (in Dollars)

2001 766 5,936.3 (795.3)

4,409.2 (970.9)

12,933.1 (1,538.1)

29.02 (24.47)

2002 904 6,474.4 (870.0)

5,460.9 (1,076.8)

16,879.7 (1,834.6)

26.74 (23.18)

2003 921 7,907.7 (1,244.3)

5,916.4 (1,220.8)

18,675.5 (2,081.8)

32.53 (28.31)

2004 953 8,546.1 (1,456.9)

6,413.8 (1,282.1)

19,271.5 (2,156.3)

34.39 (29.96)

2005 969 8,847.5 (1,611.2)

7,093.6 (1,443.6)

19,821.8 (2,229.2)

34.71 (29.22)

2006 960 9,939.7 (2,025.5)

7,633.4 (1,763.3)

18,611.1 (2,414.9)

36.86 (31.83)

2007 917 10,317.0 (2,004.2)

7,967.3 (2,012.1)

17,947.8 (2,751.8)

36.86 (29.77)

2008 835 7,571.9 (1,617.0)

9,182.9 (2,467.1)

26,471.4 (3,489.7)

26.20 (21.77)

TABLE 3 Summary Statistics for Corporate and Public Sector Pensions:

2001 – 2008 Panel A: Corporate pension benefit obligation and assets1

Year Mean (median) PBO,

$millions Mean (median) pension assets,

$millions 2001 837.1 (111.4) 857.6 (91.9) 2002 1,260.3 (134.9) 1,003.5 (93.7) 2003 1,427.9 (162.0) 1,217.3 (121.9) 2004 1,533.3 (176.6) 1,325.2 (134.1) 2005 1,612.5 (196.9) 1,427.3 (150.4) 2006 1,685.5 (203.6) 1,615.7 (164.4) 2007 1,718.7 (228.5) 1,770.2 (196.2) 2008 1,771.1 (247.2) 1,357.4 (176.5)


TABLE 3 (Continued)

Panel B: Public employee retirement system liabilities and assets2

Year

Num

ber

of

syst

ems

Num

ber o

f pla

ns

Mea

n (m

edia

n)

actu

aria

l val

ue

of p

ensi

on

liabi

litie

s,

$m

illio

ns

Mea

n (m

edia

n)

actu

aria

l val

ue

of p

ensi

on

asse

ts,

$m

illio

ns

Mea

n (m

edia

n)

fair

valu

e of

pe

nsio

n as

sets

, $

mill

ions

2001 76 93 20,274.6 (10,511.0)

20,718.5 (9,720.5)

Not available

2002 91 111 21,850.6 (11,764.4)

21,364.9 (9,962.9)

Not available

2003 94 115 22,828.3 (11,938.6)

20,915.5 (9,394.2)

Not available

2004 93 114 24,182.5 (12,271.3)

21,395.1 (9,846.7)

Not available

2005 92 113 25,732.7 (13,404.3)

22,324.4 (10,078.8)

18,102.0 (8,048.6)

2006 91 114 27,958.6 (14,661.4)

23,941.6 (10,948.0)

23,531.6 (11,175.8)

2007 89 112 29,373.4 (14,885.2)

25,305.8 (11,781.3)

27,651.7 (12,228.0)

2008 75 97 35,091.9 (20,455.0)

30,236.7 (14,586.3)

27,094.4 (10,646.6)

Notes: 1 Pension assets are reported at fair market value, as required by FASB. PBO is the present value of the total pension benefit obligation. 2Actuarial value of pension liabilities is the total pension benefit obligation, discounted at the expected rate of return on invested plan assets as required by GASB. Actuarial values of pension assets are determined using methods that smooth investment gains and losses over a period of years. Smoothing methods and lengths of time over which smoothing occurs are at the discretion of pension administrators. Reporting of pension assets at fair value is permitted but not required by GASB. Fair value data for assets of public employee plans in our sample is available starting in 2005.

values of assets also increased every year, and quite significantly even at the end because the smoothing mechanism continued to factor in growth that occurred during the market boom of the mid-2000s while delaying the full effect of the market downturn in 2008.


Fair values of pension assets are available in our sample for the years 2005–2008. They are shown in the last column of Panel B and are lower than actuarial liabilities in every year shown. Mean actuarial liabilities also exceeded mean actuarial assets in every year except 2001. Given previous results obtained by Novy-Marx and Rauh (2009b), it is likely that the reported public employee actuarial pension liabilities understate the magnitude of these obligations’ present values.

Clearly, the sheer size of public employee pension obligations compared to those in the corporate setting is noteworthy. Unscaled, the mean actuarial values of public sector pension assets and liabilities range from approximately 15 to 24 times the magnitudes of those reported by corporate entities. In Figure 1 we scale pension liabilities by entity resource inflows for both corporate and public employee plans, using annual firm revenues for corporate plans and annual state revenues for public employee plans.17 While some may contend that firm revenues are not identical to state revenues, we argue that they both represent inflows of resources available for use in meeting an entity’s obligations, including pension obligations. Figure 1 shows that for companies, pension obligations average approximately 20% of annual revenues, while public employee actuarial pension liabilities are approximately 180% of state revenues.

Pension Funding Status

We compared funding status between the public and private sectors using a computed funding ratio (FR), dividing pension plan

assets by obligations:_ _ ($)

_ _ ($)

pension plan assetsFR

pension plan obligations .

Underfunded plans have 0 <FR< 1, while fully- or overfunded plans have FR> 1.

Figure 2 shows annual mean funding ratios over time for both corporate and public employee pensions in our sample, computed using reported values for pension assets and liabilities as required under FASB and GASB. Mean corporate funding ratios generally follow US market trends. In contrast, the public sector pension funding ratio line drops dropped gently over the entire sample period


FIGURE 1 Comparison of Reported Private and Public Sector Pension

Obligations, Scaled by Annual Resource Inflows

Notes: Pension liabilities in the public sector are similar to private sector

PBOs in that the actuarial value of pension liabilities is the discounted total of pension benefit obligations. Firm revenue data comes from Compustat. State revenue data comes from The Fiscal Survey of States (2002 – 2009).

– a feature of the smoothing methodology which also suggests that on average, growth in actuarially valued obligations is outstripping growth in actuarially valued plan assets. Funding ratios based on GASB reporting requirements for public employee pensions were consistently higher on average than corporate pension funding ratios over the years 2001 through 2005.

We used t-tests to evaluate differences in funding ratios, applying the Satterthwaite approximation because our public and private sector samples are unequal in size and variance.18 Table 4, Panel A shows that differences depicted graphically in Figure 2 were statistically significant for all years, 2001–2008. In only two years (2006 and 2007) were mean funding ratios based on required reported values for pension assets and liabilities higher in the private sector than in public sector.

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

4.50

5.00

rati

o of

pen

sion

liab

iliti

es to

ann

ual r

esou

rce

infl

ows

year

Private sector: mean PBOs scaled by annual firm revenues

Public sector: mean pension liabilities scaled by annual state revenues


FIGURE 2 Comparison of Mean Funding Ratios Based on Reported Values, By

Sector Type

Notes: Funding ratio is equal to pension assets divided by plan obligations:

.

Public employee retirement systems’ funding ratios are computed using the actuarial value of assets and actuarial value of pension obligations, as reported in accordance with GASB. Corporate sector pension funding ratios are computed using pension assets’ fair values and PBO, as reported in accordance with FASB.

We also compared funding ratios based on actuarial values of pension assets in public employee retirement systems with those based on fair values for 2005–2008, the years in which asset fair value data are available for public employee retirement systems in our sample. Figure 3 provides a visual comparison. Not surprisingly, the more volatile funding ratios using assets’ fair values fluctuate around the actuarial method line. Mean corporate pension funding ratios from Figure 2 are also shown for comparison. “Fair value asset” funding ratios for public sector pensions closely mirror those in the corporate sector – again, not surprising. Both show abrupt drops

0.60

0.65

0.70

0.75

0.80

0.85

0.90

0.95

1.00

1.05

mea

n fu

ndin

g ra

tio

year

Corporate sector pensions

Public employee pensions

_ _ ($)

_ _ ($)


pension plan obligations


FIGURE 3 Public Pension Funding Ratios Based on Asset Actuarial vs. Fair

Values

Notes: Funding ratio is equal to pension assets divided by plan obligations:

.

For public employee retirement systems, funding ratios are computed two ways: 1) using fair value pension assets (permitted but not required to be reported by GASB) and actuarial value of pension obligations; 2) using the actuarial value of assets and actuarial value of pension obligations, as reported in accordance with GASB. Corporate sector pension funding ratios from Figure 2 are shown as a benchmark for comparison.

in 2008, no doubt a reflection of the general crisis in US financial markets. Table 4, Panel B shows the results of statistical tests of equality for public pension funding ratios computed under the different asset valuation assumptions.

Finally, we tested differences in funding ratios between public and private sector pensions using fair valuation for assets and actuarial liabilities (PBO) to determine the respective funding ratios. Results are shown in Table 4, Panel C. Funding ratio differences were

0.60

0.65

0.70

0.75

0.80

0.85

0.90

0.95

mea

n fu

ndin

g ra

tio

year

Funding ratio using fair value pension assets

Funding ratio using actuarial value pension assets

Corporate sector funding ratios

_ _ ($)

_ _ ($)


pension plan obligations


TABLE 4 Comparisons of Mean Funding Ratios in the Private and Public Sectors

Panel A: Differences in Mean Funding Ratios Using Asset Valuations as Required under GASB and FASB, 2001 – 20081

Year Public sector: mean pension funding ratio

Corporate sector: mean pension funding ratio

Difference Corporate-Public

2001 0.986 0.920 0.066** 2002 0.931 0.754 0.177*** 2003 0.876 0.793 0.083*** 2004 0.847 0.796 0.051** 2005 0.826 0.788 0.038* 2006 0.820 0.852 -0.032* 2007 0.834 0.902 -0.068*** 2008 0.825 0.703 0.122***

Panel B: Differences in Mean Funding Ratios for Public Retirement Systems Using Actuarial vs. Fair Valuations for Pension Assets, 2005 – 20082

Year Mean funding ratio (actuarial value)

Mean funding ratio (fair value)

Difference (actuarial – fair)

2005 0.826 0.725 0.101** 2006 0.820 0.840 - 0.020 2007 0.834 0.906 - 0.072** 2008 0.825 0.693 0.132** Panel C: Differences in Mean Pension Funding Ratios Using Fair Values for Pension Assets in Both the Corporate and Public Sectors, 2005 – 2008

Year Public retirement systems Corporate pensions

Difference Corporate-Public

2005 0.725 0.788 0.063 † 2006 0.840 0.852 0.012 2007 0.906 0.902 -0.004 2008 0.693 0.703 0.010

Notes: † significant at α < 0.10; * significant at α < 0.05; ** significant at α < 0.01; *** significant at α < 0.0001.

1 Funding ratio is equal to pension assets divided by plan obligations. For public employee retirement systems, funding ratios are computed using the actuarial value of assets and actuarial value of pension obligations, calculated and reported in accordance with GASB. Corporate sector pension funding ratios in Panels A and C are computed using pension assets’ fair values and PBO, calculated and reported in accordance with FASB. T-tests of mean differences in all three panels employ Satterthwaite’s approximation for samples with unequal variances.

2 Disclosing the fair value of pension assets is permitted but not required by GASB. Fair value data is available in our sample for 2005 and after.


marginally significant in 2005 (α < 0.10) but otherwise not distinct from zero. Although previous academic studies have undertaken complex computations necessary to estimate public pension liabilities using FASB rules, we did not pursue that line of inquiry here because of our focus on users who are unlikely to have the capacity, or access to information, to do so.19

In summary, our funding ratio analyses show that both corporate and public employee pensions are in general underfunded despite legislative oversight of corporate pensions and regardless of how the ratios for public employee retirement systems are computed. Even during the bull market conditions of the mid-2000s funding ratios using fair values peaked at only about 90% in both sectors. Using actuarial (fair) asset valuation required under GASB (FASB), public retirement system pensions appear to be on average better funded than pensions in the private sector but when using assets’ fair values to compute public sector pension funding ratios the differences disappear. Our analysis highlights an important way in which different pension accounting and reporting rules for government versus corporate entities complicates efforts by taxpayers or other stakeholders to make sense of pension funding as it compares between the two sectors, without resorting to complex analyses requiring information they are not likely to have.

Actuarial Assumptions

Table 5, Panels A, B and C tabulate our findings in comparing ERRs, pension liability discount rates, and compensation growth rates. Panel A shows an annual comparison of ERRs. Mean corporate ERRs decreased monotonically from 2001 through 2008, hinting that corporate managers generally revised their estimates downward over this time. Mean ERRs for public retirement systems hovered steadily around eight percent and appear “stickier” than for corporate plans, dropping only 0.078% over the eight-year period versus the corporate mean drop of 1.020%. With the exception of the year 2005, public retirement system ERRs differed significantly from corporate ERRs.

Table 5, Panel B documents our comparison of the discount rate used to determine the present value of pension liabilities. As described previously, the public retirement system pension liability discount rate is required by GASB to be equal to ERR; the values in


the third column of Panel B are the same as in the third column of Panel A. Not surprisingly we find that the risk-adjusted market discount rates used for corporate pensions are on average approximately two percent lower than the rates (ERRs) used by public employee plans. Figure 4 is a graphical representation of the data shown in Panel B, and a line showing corporate sector ERRs is included in this graph for comparison. It emphasizes both that corporations apply substantially higher rates to invested pension assets than to the liabilities, and that there is a substantial spread in pension liability discount rates between public retirement systems and companies. By adding a focus on different accounting and reporting rules between the public and private sectors and their effects for users dependent on the information reported in the

FIGURE 4 Comparison of Discount Rates for Pension Liabilities for Corporate

Pensions and Public Employee Retirement Systems

Notes: Public employee retirement systems are required by GASB to use a discount rate for pension obligations that is equal to the expected long term rate of return on invested plan assets, whereas corporate plans are required by FASB to use risk-adjusted market rates to discount their future obligations. Corporate sector ERRs from Figure 4 are also shown as a benchmark for comparison.

0.04

0.05

0.06

0.07

0.08

0.09

0.10

inte

rest

rat

e

year

Corporate sector discount rates

Public retirement system discount rates (and ERRs)

Corporate sector ERRs


financial statements, our analyses complement the work of Ennis (2007) and Novy-Marx and Rauh (2009b, 2011), who concentrated primarily on economic effects of actuarial assumptions.

Panel C of Table 5 compares the assumed compensation increase rate reported by firms with the assumed rates of inflation reported by public employee retirement systems. As a point of reference, the fifth column of this panel shows US actual annual inflation for each of the eight years in our sample.20 Corporate compensation growth assumptions hover around four percent, whereas public employee plan inflation assumptions generally are about three and a half to four percent and decline over time. Compensation growth rate assumptions are consistently and significantly higher for corporate pensions than for the public retirement systems, implying higher expected growth rates for their pension liabilities than for public retirement systems.

TABLE 5 Comparisons of Actuarial Assumptions between Corporate Pensions

and Public Retirement Systems: 2001- 2008

Panel A: Mean ERRs1

Year Corporate pensions

Public retirement systems

Difference (corporate -public)

2001 8.829 8.040 0.789*** 2002 8.505 8.053 0.452*** 2003 8.234 8.040 0.194*** 2004 8.118 8.004 0.114* 2005 7.994 7.995 -0.001 2006 7.898 7.997 -0.099* 2007 7.843 7.998 -0.155** 2008 7.809 7.962 -0.153**

Panel B: Mean discount rates for pension obligations2 2001 7.180 8.040 -0.860*** 2002 6.677 8.053 -1.376*** 2003 6.137 8.040 -1.903*** 2004 5.833 8.004 -2.171*** 2005 5.536 7.995 -2.459*** 2006 5.731 7.997 -2.266*** 2007 6.095 7.998 -1.903*** 2008 6.265 7.962 -1.697***


TABLE 5 (Continued)

Panel C: Mean assumed rate of compensation increase vs. mean assumed inflation rate3

Year

Corporate pensions:

Mean % assumed rate of

compensation increase

Public retirement systems: Mean % assumed rate of

inflation

Difference (corporate

public)

Average annual

inflation rate (%)

2001 4.448 3.965 0.483*** 2.83 2002 4.232 3.946 0.286** 1.59 2003 4.085 3.829 0.256** 2.27 2004 4.004 3.727 0.277** 2.68 2005 3.954 3.684 0.270** 3.39 2006 3.978 3.601 0.377*** 3.24 2007 4.016 3.573 0.443*** 2.85 2008 3.977 3.512 0.465*** 3.85

Notes: * significant at α < 0.05; ** significant at α < 0.01; *** significant at α < 0.0001.

1 ERR is expected rate of return on invested pension plan assets. T-tests of mean differences employ Satterthwaite’s approximation for samples with unequal variances.

2 PBO discount rate is the rate used by a corporate pension plan to determine the present value of the pension liability. As required by GASB, public employee pension plans determine their pension liabilities using ERR. T-tests of mean differences employ Satterthwaite’s approximation for samples with unequal variances.

3 T-tests of mean differences employ Satterthwaite’s approximation for samples with unequal variances. Average annual inflation rates are provided for comparison and come from US annual inflation comes from Historical inflation data from 1914 to the present, available at http://inflationdata.com/Inflation/Inflation_Rate/ HistoricalInflation.aspx

In summary, our analysis suggests that based on information disclosed in financial statements, public employee retirement systems appear to have generally more optimistic actuarial assumptions relative to those for corporate pensions and evidence of such optimism appears to have become even stronger in the years after 2005. Public employee pension assets are assumed to grow at higher rates; present values of pension obligations are computed using higher discount rates, and are implied to grow at lower rates.


Asset Allocations

Reported pension asset categorizations differ between the corporate and public sectors21 and we were able to partition the data reported by public retirement systems and companies into three common classes: debt, equity and all other investments not debt or equity. For both sectors, debt includes both foreign and domestic debt and our “all other” category includes, but is not limited to, cash, real estate (investments in real property as well as mortgage-backed securities), and investment vehicles such as derivatives.

Table 6 compares asset allocation means for pension assets. Allocations of pension assets to debt, generally considered to be low risk, are significantly higher for corporate pension assets than for public retirement system assets. Allocations to equities are weakly higher for corporations than for public retirement systems, although the situation reversed in 2008. Public retirement systems on average

TABLE 6 Comparisons of Annual Mean Percentages of Pension Assets Allocated to

Debt, Equity, and All Other

Mean % Allocated to Debt

Mean % Allocated to Equity

Mean % Allocated to All Other

Year

Cor

pora

te

Pens

ions

Publ

ic S

yste

ms

Diff

eren

ce:

Cor

pora

te-P

ublic

Cor

pora

te

Pens

ions

Publ

ic S

yste

ms

Diff

eren

ce:

Cor

pora

te-P

ublic

Cor

pora

te

Pens

ions

Publ

ic S

yste

ms

D

iffer

ence

: C

orpo

rate

-Pub

lic

2003 31.110 30.183 0.927 62.252 58.194 4.0583 6.638 11.623 4.9853 2004 31.267 27.982 3.2852 62.676 61.078 1.598† 6.057 10.910 4.8533 2005 31.263 27.971 3.2922 62.654 60.747 1.9071 6.084 11.278 5.1943 2006 31.241 27.252 3.9893 62.594 60.634 1.9601 6.164 12.113 5.9493 2007 32.369 25.595 6.7743 60.446 59.968 0.478 7.185 14.403 7.2183 2008 38.638 28.157 10.4813 51.981 54.164 -2.183† 9.381 17.696 8.3153

Notes: † significant at α < 0.10; 1 significant at α < 0.05; 2 significant at α < 0.01; 3 significant at α < 0.0001. Debt includes both foreign and domestic debt. All other consists of cash, real estate, derivatives, mortgage-backed securities and any other investments that are not debt or equity. T-tests of mean differences employ Satterthwaite’s approximation for samples with unequal variances.


invest much more heavily in the “all other” category than do corporate ones. Given the lack of common detail on investment classifications in our data sources and our mixed results, it is unclear if investment risk appetites and practices differ between the two sectors. We observe that both public employee and corporate pensions significantly changed their investment mixes in 2008, sharply reducing allocations to equity and increasing allocations to debt. Both public and corporate entities also report increases in allocations to the “all other” category in 2008, although limited allocation detail does not permit us to tease out if they are chasing higher returns or seeking additional safety. Both Figure 4 and Table 5, Panel A show that after 2005, ERRs for public retirement systems’ invested assets were slightly higher than for those in the corporate sector, possibly suggesting more aggressive investment strategies in the public sector linking to our results in Table 6. In summary, we have evidence that investment allocations differ between the two sectors but we cannot determine causal factors or comment on the relative riskiness of their investment strategies.

CONCLUSIONS

Both GASB and FASB strive to provide users of financial statements with timely, relevant information for decisionmaking. Consideration of accounting and disclosure requirements for pensions, and differences in these requirements between GASB and FASB, is important because they determine the types and formats of information available to stakeholders. Drawing on reported data available to financial statement users, we compare several important characteristics of DB pensions between the public and private sectors: funding status; actuarial assumptions; and pension asset investment allocations. We observe that reported liabilities of public employee DB pension systems were significantly larger than those reported by companies. Underfunding is widespread in both sectors, though public employee retirement systems appear to be better funded than most companies when making comparisons using data as reported under the appropriate respective GASB and FASB requirements. Importantly, we also show that inferences about funding status for public employee retirement systems depend at least in part upon whether pension assets are considered under GASB’s required actuarial methodology (smoothing investment gains and losses into asset valuation over time) or under fair value


(required by FASB for corporate entities, and voluntary disclosure of which is permitted by GASB). Assuming no changes under either regime to valuation of pension liabilities, if GASB required public employee retirement systems to report pension assets at fair value, we show that in our time period of study they in general appeared to be funded no better, nor worse, than corporate pensions.22

We offer evidence that reported actuarial assumptions for public employee pensions tend to be more optimistic than for companies’ pensions. Optimistic ERRs in the public sector are of critical importance given that not only are invested plan assets assumed to grow at generally higher rates than in the private sector, but higher ERRs also reduce the reported present value of public employee pension obligations. Finally, our evidence on asset allocations shows that corporate pension assets tend to be allocated more to equities than are public pension assets, but they also invest more in debt, generally considered to be a less-risky investment choice. Whether public employee pensions engage in more risky investment strategies cannot be determined from our data and is an empirical question we leave to future research.

In conjunction with other recent academic research on public sector pensions, our results suggest that differences between current GASB and FASB accounting and disclosure requirements may result in confusion or difficulties for stakeholders attempting to compare features common to DB pensions between the public and private sectors. Our analysis informs both public policy and accounting policy debates about proper management of and financial reporting for defined benefit pensions in both sectors. Both FASB and GASB have committed significant resources to improving financial reporting and disclosure for pensions, with each organization supporting multiple research projects and user outreach efforts. In particular, GASB’s recently released exposure drafts call for changes in the discount rates applied to pension obligations; providing additional note disclosures and supplementary information; faster recognition of some components of pension expense; and more uniform amortization and cost allocation methods. These changes, if implemented, could somewhat improve the comparability of financial information between public sector and corporate pensions in many of the areas highlighted in this research paper. In addition, a better understanding of optimal funding levels for pensions in both the


public and private sectors,23 and of true (compared to reported) magnitudes and timing of pension liabilities are two areas suggested for additional research.

Our study has limitations. The existing reporting and disclosure requirement differences between GASB and FASB – an important part of our study’s motivation –also data availability and formats vary between corporate and governmental entities. These issues limit our ability to analyze additional aspects of pension reporting that affect stakeholders’ understanding of their viability. We have selected some key aspects that, in our judgment, provide the most direct comparisons possible.

There is also the argument that, in contrast to firms in the private sector, bankruptcy and/or liquidation are not options for governmental entities and therefore the stricter funding requirements, accounting and reporting rules to which corporate plans are subjected are not required – or even desirable – for public sector pensions. Our response to this argument is that the needs of users singled out in GASB Concept Statement No. 1, par. 3, (1097), those with “limited authority, ability, or resources to obtain information and who therefore rely on the reports…” of government entities, should be carefully considered from multiple perspectives. Rising public concerns over transparency in business and governmental financial reporting, as well as over government spending and debt levels, suggest that further study and comparison of accounting and reporting for DB pensions is warranted for both the public and corporate sectors. We offer a first step.

ACKNOWLEDGEMENTS

We acknowledge many helpful comments received from participants at the 2010 AAA Ohio Regional meeting, the 2010 AAA Midwest Regional meeting, and several anonymous reviewers. We also gratefully acknowledge support from the Farmer School of Business, as well as the assistance of Keith Brainard, NASRA Research Director, who provided detailed survey data for use in this study. All remaining errors are ours.


NOTES

1. The two GASB exposure drafts are Accounting and Financial Reporting for Pensions—an amendment of GASB Statement No. 27 and Financial Reporting for Pension Plans—an amendment of GASB Statement No. 25.

2. Fiduciary Responsibilities is one of four active research projects being conducted by GASB. Additional information is available online at the following website www.gasb.org/jsp/GASB/ Page/GASBSectionPage&cid=1175804837137

3. Employee Retirement Income Security Act of 1974.

4. Rauh (2006) explained why Compustat data is insufficient for purposes of determining funding requirements and cash contributions for corporate pension plans. However, the purpose of our paper is to focus on similarities and differences in selected DB pension characteristics as reported by corporate vs. government entities. The issues raised by Rauh are beyond the scope of this paper; plan qualification status and categorization as domestic/foreign are not relevant to our investigation.

5. A detailed discussion of regulatory requirements applying to public retirement systems and corporate pensions can be found in Kozak (2008).

6. FASB Statement No. 158 (2006).

7. FASB ASC 715-30-35-43 and 44.

8. For additional information regarding this measure, refer to GASB’s Invitation to Comment on Pension Accounting and Financial Reporting, Governmental Accounting Standards Board Invitation No. 34, 2009.

9. The Pension Benefit Guaranty Corporation was created by Congress as part of ERISA to act as a safety net for employees if underfunding or bankruptcy causes a company’s DB pension plan to collapse. Additional information about the scope, purpose and funding mechanisms of the PBGC can be found on the federal corporation’s website, http://www.pbgc.gov/index.html.

10. An earlier study (Novy-Marx & Rauh, 2008) provides a detailed discussion of this point.


11. Specific evidence of this can be found in the 2004 Comprehensive Annual Financial Report for the Wisconsin Retirement System, which states that its projected salary increases of 4.5% per year are attributable to expected inflation (p. 47).

12. FASB ASC 715-30-35-1A.

13. Information reported by PFS is gleaned from a variety of sources: system annual financial reports, benefits guides, actuarial valuations and interviews with individual system employees. Additional information about PFS can be found at their website http://www.publicfundsurvey.org/publicfundsurvey/index.htm.

14. Most retirement systems in our sample consist of one or two DB pension plans.

15. The minimum number of people covered by a single public retirement system in our sample is 2,315 and the maximum is 1,244,940. Corporations are not required to disclose the number of active or retired employees in their DB plans and Compustat does not provide this data. Therefore we do not include this item in our analysis.

16. As Rauh (2006) pointed out, SEC filing data on which Compustat is based aggregates information by firm, not by pension plan. In addition, companies offering multiple DB plans are not required to disclose the number of DB plans, number of employees covered under such plans, or the plans’ qualification status. If a company offers foreign DB plan(s), the number of such plans is not a required disclosure. Accordingly, Compustat does not collect data for these items and we do not include them in our analyses.

17. State revenue data comes from The Fiscal Survey of States (2002-2009).

18. To allay concerns that the results of our empirical tests are driven by specific or unusual characteristics of extremely large (small) pension systems (companies) in the public (private) sector, we repeated the tests after removing the largest (smallest) pension systems (companies) from the sample, filtering by size of reported pension liabilities (PBO) for each year in our time period of study. Results (not included here for the sake of brevity) are


quantitatively similar and inferences do not change for any of the analyses in the paper. We thank an anonymous reviewer for raising this point.

19. We note that the studies that do estimate public pension liabilities using FASB standards invariably conclude that they would be much higher (Ennis, 2007; Novy-Marx & Rauh, 2009b, 2011). This would deflate public retirement system funding ratios and make them even lower than they are, using the two alternatives we analyze in this paper.

20. US annual inflation comes from Historical inflation data from 1914 to the present, available at the following website: http://inflationdata.com/Inflation/Inflation_Rate/HistoricalInflation.aspx

21. Compustat reports allocations to debt, equity, real estate and all other. Public employee plan asset allocation data is categorized as debt-domestic, debt-international, equity, real estate, alternatives, cash and other.

22. If adopted, GASB’s new exposure draft Accounting and Financial Reporting for Pensions—an amendment of GASB Statement No. 27, would impose additional changes to the reporting of pension liabilities that could potentially affect inferences about public employee pension funding. As these proposed rules are not in effect; we do not analyze them in this paper.

23. Also recommended in Kozak (2008).

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double (accounting) standards: a comparison of

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