Pension discount rate and investor sentiment

Abstract

Purpose The purpose of this paper is to examine how investor sentiment, proxied by Michigan consumer confidence index, affects the choice of defined benefit pension plan discount rates. Design/methodology/approach The authors use multivariate analysis to test our hypotheses. The dependent variable is defined pension plan discount rate and the testing variables are investor sentiment and a dummy variable representing underfunded status. Findings The authors find a negative and significant relation between investor sentiment and pension plan discount rate. During high (low) sentiment periods, pension discount rate tends to be adjusted downward (upward) discretionarily. Further analysis indicates the relationship between pension discount rate and investor sentiment is more pronounced for firms with underfunded pension plans. The results can be explained by limited attention effects, capital budgeting strategy and earning smoothing. Practical implications The empirical results of this study have important implications for corporate governance and regulation. Specifically, the results suggest the need for increased attention from boards of directors, auditors and regulators to reported pension liabilities, especially during periods of high investor sentiment when pension plan sponsors are more likely to adjust down pension discount rate and accordingly to increase pension liabilities. Originality/value The paper contributes to the extant literature by identifying investor sentiment as a new incentive of pension discount rate manipulation. The empirical results of this study also have important implications for corporate governance and regulation.

Pension discount rate, executive stock-based compensation and investor sentiment

“…We interpret that, in high sentiment periods, investors are more optimistic in firm performance and less anxious to reduced earnings (limited attention effects); borrowing costs tend to be lower (capital budgeting strategy) and lower pension discount rate helps smooth firms' earnings (earnings smoothing). The rational is consistent with Sun and Wei (2019).…”

“…The coefficient on investor sentiment is negative and statistically significant at 1% level, the same result as Sun and Wei (2019). It means that, during the higher (lower) sentiment period, pension plan sponsors could adjust down (up) discount rates, which leads to a higher (lower) liability and service costs with the assumption that all other variables are equal.…”

“…Especially, Schaller (2012) concludes that low (high) sentiment causes firms to use higher (lower) hurdle rates and triggers underinvestment (overinvestment) for other firms. Sun and Wei (2019) find that pension discount rate is lower in high sentiment periods as compared with low sentiment periods.…”

“…In the literature of the effects of investor sentiment on firms' rate of returns, Schaller (2012) directly estimates the impact of investor sentiment on hurdle rates and concludes that low (high) sentiment causes firms to use higher (lower) hurdle rates and triggers underinvestment (overinvestment) for other firms. Sun and Wei (2019) examine impacts of investor sentiment on pension discount rate and find that pension discount rate is lower in high sentiment periods as compared with low sentiment periods. In addition, the relationship between pension discount rate and investor sentiment is more pronounced for firms with underfunded pension plans.…”

Japanese firms' overpayments for cross‐border acquisitions

“…We conducted simple slope tests for a more detailed understanding of the interaction plots (Y. Kim & Ployhart, 2018; Koros et al, 2020; Liu & Hou, 2019; Sun & Wei, 2019). While the interaction term in the regression analysis represents the difference between the slopes, a simple slope analysis reveals the actual slope of the individual lines (Robinson et al, 2013).…”