Public-sector pension plans and the discount rate assumption: The role of political incentives

Abstract

We provide evidence that political pressure creates incentives for elected officials to choose higher discount rates to value defined benefit pension promises, thus artificially reducing the short-term reported cost of these benefits. We generate our inferences using a unique panel dataset for all local pension plans from the state of Pennsylvania for 2003-2013, and by comparing the differential response to the GASB requirement to lower the discount rate after the Great Recession for plans that are managed by elected officials versus those that are managed by non-elected officials (i.e., municipal authority plans). We find that appointed officials in charge of municipal authority plans decreased their discount rate by 29 basis points more than elected officials in charge of municipal plans. This difference is not attributable to plan factors or financial reporting requirements, and suggests that political pressure leads to optimistic discount rate assumptions.