Pension accounting conservatism in municipal governments

• In Event: Government and Nonprofit

Abstract

This paper examines whether municipal debt financing measures are affected by government pension accounting conservatism. Specifically, we investigate associations between pension plan funding ratios and two measures of municipal debt financing-municipal bond interest and municipal bond ratings. We also explore whether municipal debt financing measures are related to controllable versus uncontrollable measures of pension accounting conservatism by decomposing total pension plan funding ratios into state and local plan components. Primary results suggest that total pension funding ratios do not significantly impact municipal bond interest costs or bond ratings. However, we do find that municipal bond interest costs and bond ratings are associated with state-level pension plan funding conservatism – that is, state-level plans with greater (lower) funding ratios incur lower (higher) municipal bond financing costs. In contrast, local-level pension accounting funding ratios do not significantly impact municipal bond interest costs or bond ratings. Overall, our results suggest that the municipal bond market prices uncontrollable accounting conservatism in the form of state pension funding ratios, but does not reward or punish municipalities for controllable local-level pension funding ratios. We extend the literature on pensions by exploring relations between public sector pension accounting assumptions and municipal bond financing measures. Such research is important in part to help gauge the extent to which such accounting choices affect the cost of financing the municipal enterprise. Moreover, we consider several actuarial accounting assumptions, rather than using the more piecemeal approach taken in prior literature. Examining several assumptions simultaneously is important because it is unknown whether entities systematically select a portfolio of assumptions that combine to increase or decrease pension liabilities, or in contrast, select assumptions that offset each other to some extent. Finally, we explore whether funding levels of local and state plans differentially influence bond financing measures. Local government pension plans comprise a significant portion of public sector pension liabilities (Moody’s 2012), yet most prior research focuses on state-level pension plans. Further, examining the differential impacts of controllable versus uncontrollable conservatism has implications for accounting conservatism literature.

Author

• Yuan Ji, George Washington University