Regulatory Oversight and Earnings Management: Evidence from Pension Assumptions

I use two separate events that affect the regulatory oversight of pension assumptions to examine how the use of financial reporting discretion to manage earnings responds to regulatory oversight. My results show that firms reduce the use of discretion only in those assumptions where the SEC is devoting more time or where regulatory changes allow the SEC to more easily detect opportunistic reporting. In contrast, I find that firms increase the use of discretion in the other pension assumptions, consistent with a substitution effect. I also find that the variance of the distribution of discretion is reduced in those assumptions targeted by the SEC, but is increased in those that are not. The interconnectedness of the three main pension assumptions is important because it suggests that firms may be opportunistic in reporting pension costs collectively, rather than through a single assumption, and that the effectiveness of regulatory changes that target a single assumption may therefore be limited. This finding also has implications for prior research, which has generally focused on only one of the three main pension assumptions.