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Abstract
The market reaction to annual earnings news is used to study the effects of recent changes in accounting for pensions. Using the Choi and Salamon (1988) model of market reaction to earnings news, this study derives and tests hypotheses of the effects of the pension standard on changes in firm specific risk and noise in the financial reporting systems of firms implementing Statement of Financial Accounting Standards No. 87 - Employers' Accounting for Pensions.
The hypotheses suggest that the implementation of the pension standard was associated with a reduction in firm specific risk and an increase in the noise in the financial reporting system. Tests of the hypotheses were conducted on a sample of firms with significant defined benefit pension plans and a matched control sample of firms without such plans. Comparisons are done cross time--with analysis of differential market reaction to unexpected earnings news before and after implementation--and cross sectionally--with analysis of differential market reaction to unexpected earnings news between adopters and control firms.
Firm specific risk is measured as the variance of market model residuals in the period before earnings are announced. Measures of noise in the financial reporting system are imputed based on the Choi and Salamon theoretical relationship between noise, earnings response coefficients and firm specific risk.
The empirical results support the hypotheses. The evidence from a sample early adopters, timely adopters and control firms matched on size and industry is consistent with reductions in perceived risk and increases in financial reporting system noise. The combined effect of these factors is to reduce the linkage between unexpected earnings news and stock prices. Such a reduction may not be consistent with an increase in the information value of the earnings report.
