Amir E

TIe MavIel VaIualion oJ Accounling InJovnalion TIe Case oJ Foslvelivenenl BeneJils OlIev
TIan Fensions
AulIov|s) EIi Aniv
Souvce TIe Accounling Beviev, VoI. 68, No. 4 |Ocl., 1993), pp. 703-724
FuIIisIed I American Accounting Association
SlaIIe UBL http://www.jstor.org/stable/248500 .
Accessed 04/11/2013 0803
Your use of the JSTOR archive indicates your acceptance of the Terms & Conditions of Use, available at .
http://www.jstor.org/page/info/about/policies/terms.jsp
.
JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of
content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms
of scholarship. For more information about JSTOR, please contact support@jstor.org.
.
American Accounting Association is collaborating with JSTOR to digitize, preserve and extend access to The
Accounting Review.
http://www.jstor.org
This content downloaded from 202.43.95.117 on Mon, 4 Nov 2013 08:03:02 AM
All use subject to JSTOR Terms and Conditions
THE ACCOUNTING REVIEW
Vol. 68, No. 4
October 1993
pp. 703-724
The Market Valuation of
Accounting Information:
The Case of Postretirement Benefits
other than Pensions
Eli Amir
Columbia University
SYNOPSIS AND INTRODUCTION: The majority of empirical regulatory
accounting studies on financial reporting have focused on the ex post eval-
uation of accounting choices (see Lev [1979] and Barth [1991] among
others) after an accounting method is adopted. There has not been much
research involving the evaluation of accounting methods ex ante because,
it is argued, newly mandated accounting information is usually available
only some time after the Financial Accounting Standards Board (FASB)
has required its release.
In December 1990, after lengthy and controversial deliberations, the
FASB issued SFAS No. 106, Employers' Accounting for Postretirement
Benefits other than Pensions (PRB) replacing the current "pay as you go"
practice with a combination of present-value and accrual method. Few of
the information items mandated by SFAS No. 106 has yet been disclosed
earlier. Consequently, this research uses the data that were available during
the time of the FASB's deliberations as an example of ex ante empirical
research concerning the standard-setting process.
This study uses the PRB cash payments to retirees as disclosed by
firms in their footnotes to the financial statements under SFAS No. 81
(FASB 1984) to investigate whether investors underestimated the full effect
This paper draws on my Ph.D. dissertation completed at University of California-Berkeley. I would like to
thank Trevor Harris, Jonathan Leonard, Joshua Livnat, David Modest, Stephen Penman, Jacob Thomas,
Thomas Rothenberg, Paul Ruud, anonymous referees, and seminar participants at the University of Califor-
nia-Berkeley, Columbia University, University of California-Davis, Duke University, Harvard University,
New York University, University of British Columbia, and Washington University for helpful comments.
Baruch Lev and Brett Trueman deserve special thanks for their careful review and guidance. The financial sup-
port of the Deloitte Touche Foundation is gratefully acknowledged.
Submitted January 1992.
Accepted March 1993.
Editor's Note: This article was awarded the AAA Competitive Manuscript Contest Award for 1992.
703
704 The Accounting Review, October 1993
of the PRB liability on firms' values. Such underestimation would occur if
investors are not aware of the high rate of increase in health care costs or
when future benefits' payments to current employees are partially ignored.
Additionally, this study investigates whether an estimate of the present
value of the PRB liability is value-relevant to investors. Finally, an analysis
is made of the range and sensitivity of economic parameters (discount rate
and health care cost trend rate) used by investors to estimate the PRB
obligation.
The results indicate that, during the period 1984-1986, investors, on
average, valued each dollar of PRB cash payment in any year as a dollar;
i.e., they underestimated the full consequences of firms' promise to con-
tinue making such payments in the future. During the period 1987-1990, in
contrast, investors translated each dollar of PRB cash payment to an aver-
age of $13.75 PRB obligation. Further, estimating the present value of the
PRB obligation with publicly available data shows that the present-value
measure is value-relevant to investors in addition to the cash payments
disclosed by firms.
Key Words: Postretirement benefits other than pensions, FASB, Valua-
tion model, Present value.
Data Availability: Data used in this study were obtained from public
sources. A list of sample firms is available from the
author upon request.
Tp HE remainder of this study is organized as follows: Section I provides back-
ground information about the issue and its importance. The valuation model used
in this study and the tests conducted are discussed in section II. Section III
describes the sample selection and the data collection process. The results of the
evaluation of the value-relevance of the PRB cash payments disclosure mandated by
SFAS No. 81 are presented in section IV. Section V describes the estimation method
used to estimate the present value of the PRB obligation. Evidence on the value-
relevance of the estimated PRB obligation is reported in section VI. Section VII
contains concluding remarks.
I. Accounting for PRB-Background
Preliminaries
About 82 percent (41 percent) of U.S. companies with more (less) than 1,000
employees provide nonpension postretirement benefits, such as health care and life
insurance, to former employees and their dependents (Foster Higgins 1988). The U.S.
General Accounting Office estimated the aggregate unfunded PRB obligation of private
employers at approximately $402 billion in 1988 (GAO 1989). During the period
1985-1990, the average total spending of large and mid-sized firms on retiree health
care increased by 80 percent, an average annual increase of 12.4 percent. Possible
reasons for this increase are a growing pool of elderly retirees, more cost-shifting by the
federal government from the Medicare program to employer-provided retiree health
Amir-Market Valuation of Accounting Information 705
care plans, early retirement, longer life expectancy, and court rulings that have barred
employers from terminating postretirement health care plans (Geisel 1987).
In November 1984, the FASB issued SFAS No. 81, Disclosure of Postretirement
Health Care and Life Insurance Benefits, which mandates disclosure of firms' annual
cash payments to retirees for postretirement health care and life insurance benefits. In
February 1989, the FASB issued an Exposure Draft, Employers' Accounting for Postre-
tirement Benefits other than Pensions, which proposed to end the "pay as you go"
accounting practice used by firms with PRBs, and to require that they use accrual
accounting.
I
In December 1990, the FASB approved SFAS No. 106. The FASB concluded that
PRBs, like pensions, are part of employees' deferred compensation, and therefore
should be recognized on the basis of service rendered, in a manner similar to the provi-
sions of SFAS No. 87 (FASB 1985). For plans sponsored by U.S. public companies, the
standard became effective for fiscal years beginning after December 15, 1992. For non-
U.S. and small plans (fewer then 500 participants), the standard will become effective
in fiscal year 1995.
II. Research Design
The Valuation Model
To analyze the valuation issues discussed above, this study uses a valuation model
that relates the value of the firm to the information provided in the income statement
(earnings) and balance sheet (book value of equity).
The valuation model derived by Ohlson (1991) is adopted here. Unlike other valua-
tion models used in the literature, this model relates equity value to both accounting
earnings and book value of equity. Both are value-relevant because they assist in pre-
dicting future dividends, the theoretical basis for a firm's market price. The model can
be written as follows:
Pt=
TX
+'YI+ 2d,+OoVt
(1)
where Pt is the market value per share of the firm's common stock at time t; x, is the
firm's earnings per share over the period (t -1, t);
y,
is the firm's book value per share at
time t; d, is the firm's dividends per share at time t; V, is a vector of other value-relevant
information; ys
are parameters that relate earnings, book value, and dividends to value;
O3s
are parameters that relate other information to value; and
7q,
is a disturbance term.
Substituting the "clean surplus equation,"
yt
=
y,
+ x,
-
dt, into equation (1) yields
the following relation:2
Pt=acoyt-
+a1x,+a2y1+fOVt+7q.
(2)
By using the clean surplus equation, price is expressed solely as a function of account-
ing earnings, book values, and other value-relevant information.
' Espahbodi et al. (1991) document a significant negative market reaction around the announcement of the
Exposure Draft for firms with a PRB plan. Amir and Livnat (1992) document a significant positive market reac-
tion around firms' announcement of early adoption of SFAS No. 106.
2 The "clean surplus relation" is simply the accounting identity where the change in book value is equal to
earnings minus dividends.
A potential problem with the model, as reflected in both equations (1) and (2), is
heteroscedasticity. To correct for it, equation (2) is deflated by the book value of equity
at time t-1
(yr-l).
The following model is then used:
Pt__ Xt Yr VI
_ao~~~~ctl~~~~~~+a2 ~~(3)
yt-i yt-1 yt-i yt-i
Equation (3) represents the deflated version of Ohlson's model. Other information
is defined as value-relevant if it is not reflected in earnings (x) or book value
(y),
and
Analysis of the Valuation of PRB Cash Payments
This section addresses the valuation implications of the cash payments made to
retirees under the PRB plan. By analyzing the valuation effects of the PRB cash pay-
ments, one can infer whether investors properly estimate the magnitude of the firm's
promise to pay PRB cash payments and, to some extent, how they translate cash pay-
ments into a measure of PRB obligation. This analysis is conducted by using the follow-
ing model:
Pi. Ca
e it ei up,
-= et + a,, + Y>2r + Cit + p2t + U3t +1 (4)
yir-i yir-l yrt-i Yar-1 Yit-l yir-i
where Pit is firm i's per share market price at time t; xa is firm i's earnings per share
plus the per share tax-adjusted3 PRB cash payments expensed in year t, plus the per
share tax-adjusted pension expense for year t;
yi,
is firm i's book value per share at time
t; yir t- is firm i's book value per share at time t-1; cit
is firm i's tax-adjusted per share
amount of cash paid by firms to their retirees during the year (per SFAS No. 81);
pex,,
is
firm i's tax-adjusted pension expense per share; uplit is firm i's per share unfunded pen-
sion liability, calculated as the difference between the accumulated benefit obligation
(ABO) and the fair value of pension assets. The ABO measure of the pension liability is
used primarily because data is available for the whole test period. Lastly, Wtl is the
normally distributed error term with a zero mean. In this model, the PRB cash payments,
Cir, and the pension variables should be thought of as the "other information" variables.
Firms with higher PRB cash payments to retirees are expected to have larger obliga-
tions. Therefore, ,B is expected to be negative because it measures the extent to which
investors capitalize current cash payments in determining
firm value.
01
can be inter-
preted as a multiplier that investors use each period to translate after-tax cash pay-
ments to retirees into the tax-adjusted present value of the PRB obligation. A coefficient
below -1 will indicate that investors regard PRB cash payments as permanent. Note
that ,B may change over time because of changes in the economic parameters affecting
the size of the obligation (i.e., discount rate and health care cost inflation) or because of
changes in how investors perceive the PRB cash payments (i.e., transitory or perma-
nent).4 Therefore, changes in
i,3
over time will yield information on how investors
update their estimates of these obligations over time.
3
The tax adjustment is made by estimating the effective tax rate for each firm in each year. The effective tax
rate is defined as income tax expense divided by pre-tax income. This rate is bounded between zero and 40 per-
cent during 1984-1986 and between zero and 35 percent during 1987-1990.
4 In the present context, a transitory expense/payment is one that is not expected to repeat itself in the
future. A permanent expense/payment is expected to repeat itself in the future.
Analysis of the PRB Obligation
As in the case of the PRB cash method, it is important to understand how a measure
of the PRB obligation is related to the firm's market value. Is the obligation used in an
unbiased manner by investors in valuing firms? How sensitive is the PRB obligation to
the choice of different parameters used to estimate the obligation, and what set of
parameters is used by investors in valuing firms? The most relevant question, however,
is whether a measure of the present value of the PRB obligation, based on publicly avail-
able information, is value-relevant to investors in addition to the cash (pay as you go)
information. To understand how investors use the present value of the PRB obligation
in valuing the firm's equity, the following cross-sectional valuation model is estimated
with 1990 data:
Pi_ ___y0 pexi,g. upli
La9
ao+a,- +a2 Y 90 +132 +f83 +904 +#,
(5)
Yi.89 Y. 89 Yi.89 Yi.89 Y.89 Y..89
where the subscript 90 (89) refers to the 1990 (1989) fiscal year-end,
Li
go is the firm's
estimated PRB liability, and all other terms are as before.
If investors estimate the tax-adjusted present value of the PRB liability in an
unbiased manner, and if the estimate used here is an unbiased estimate, then /4 would
be about -1. However, since the estimated liability is sensitive to the choice of the dis-
count rate and the health care inflation rate, /3 will differ from -1 according to the set
of parameters used. Therefore, the size of 4 can indicate the range of parameters used
by investors in estimating the liability.
The analysis is conducted in two stages. First, -a measure of the PRB liability is
examined to see if it is value-relevant in addition to the cash payments information.
Second, the accounting numbers are adjusted such that earnings and book values
include the estimated present values of the PRB obligation. The cash information is
then examined to see if it is value-relevant to investors in addition to the liability infor-
mation.
The first stage of this analysis uses the following model (which is models
[41
plus
[5]):
Pi ~ x0 yi __ pexi190 P upl 90
Pi
O+a +a2 031 032 4+3
U
+034-
+. (6)
Yi. 8Q Yi.89 Yi.89
yi
.89
Yi ,89 Ya .8 9 Y
899
If the estimated liability is value-relevant in addition to cash, then 4 will be nega-
tive and significantly different from zero, which leads to the first hypothesis.
Hi: The liability estimate is value-relevant in addition to cash (/34<0).
In the second stage of the analysis, the accounting earnings, book value, and lagged
book value for each firm are adjusted to include the liability. These adjustments and
transformations are presented as follows:
Iy'.9o-yj,9o-Li
9f, [7a)
Y!.89_Yi,89_
isgo-A ci,
go
(7b)
1 +D
xi,90= Ao+pexi,9+cj,9-D*
'-1D(7c)
where D denotes the discount factor used to estimate the liability (discount rate and
health care growth rate), and all other terms are as defined before.
The following equation is then estimated:
Pi,
90 + 9 Yj 90 Ci 90 pexiso
9
0i 90
ol,90
__
+
(2 0r+2
+f33
+U?
(8)
Yi,89 Yi,89 Y3(89 Ya,89 Y1,89 Ya,89
In this formulation, Al is not expected to be significant, since earnings and book
value include sufficient PRB information. This yields the second hypothesis:
H2: Cash payments are not incrementally value-relevant to investors beyond the
estimate of the present value of the liability
(031
= 0).
III. Sample Selection and Data Collection
The 1990 COMPUSTAT data base was surveyed, and all firms that contributed to a
defined-benefit pension plan were identified as potential sample firms. Firms with pen-
sion plan assets less than $25 million were deleted from the sample in order to increase
the significance of postretirement benefits in the firm's operations. The initial sample
contained 556 firms. The footnotes to the 1984-1990 financial statements were read,
and the firms were classified into two groups according to their SFAS No. 81 disclo-
sure: (1) firms that disclosed some PRB information, and (2) firms that did not disclose
any PRB information. In 1990, 409 firms (74 percent of the initial sample) disclosed
some information regarding a PRB plan, and 147 firms (26 percent of the initial sample)
did not.5
Data Collection
Starting in December 1984, SFAS No. 81 required each firm to disclose information
regarding its PRB plan in footnotes to the financial statements. This information in-
cludes the total cash payments to retirees and some descriptive items about the plan. As
noted, 409 firms included some information regarding their PRB plan in 1990. How-
ever, some of these firms state that the PRB plan is insignificant with respect to the
firm's operations, and did not disclose the dollar amount paid in cash to retirees. These
firms were deleted from the analyses. The firms with the highest cash payments were
the automobile manufacturers GM and Ford. Total PRB cash payments for the sample
are $8.3 billion in 1989 and $9.2 billion in 1990, which represents about 80 percent of
total PRB payments made by the U.S. private sector (FERF 1989).
The 1990 COMPUSTAT industrial file was used to calculate the remaining account-
ing variables: earnings per share before extraordinary items, effective tax rate, book
value per share, pension expense per share, unfunded pension liability per share,
industry classification, and PRB payments per share. All variables were adjusted for
stock splits and stock dividends. The 1990 CRSP files were used to retrieve price data
for the fiscal year-end; demographic data and data used to estimate the PRB liability are
described in section V. The sample selection process for the years 1984-1990 is sum-
marized in table 1.
I
The test sample (409 firms) includes 30 (7.3 percent) public utilities, 16 (3.9 percent) financial firms, 22
(5.4 percent) retail and service firms, 34 (8.3 percent) oil and gas firms, 18 (4.4 percent) transportation firms,
and 289 (70.7 percent) manufacturing firms.
Table 1
Sample Selection
Year 1990 1989 1988 1987 1986 1985 1984
Potential sample size 556 556 556 556 556 556 556
Firms with no PRB data 147 178 175 168 187 194 232
Firms with insignificant
PRB cash payments 82 60 60 59 57 53 53
Firms for which other
COMPUTSTAT/CRSP data
is not available 9 9 15 26 19 37 24
Removed as outliers 5 5 5 5 4 6 4
Number of observations 313 304 301 298 289 266 243
Note: Firms with market-to-lagged-book ratios of above 15 and below 0.1 were removed as outliers.
IV. Valuation of PRB Cash Payments
Panel A of table 2 provides some statistics on the regression variables, and panel B
presents the sample correlation matrix. Table 3 provides the results of estimating equa-
tion (4) over the period 1984-1990. As can be seen, the a1 coefficient (earnings-to-
lagged-book ratio) varies between 3.37 (1985) and 7.069 (1989), which suggests that tran-
sitory components in earnings change significantly over time. The coefficient on PRB
cash payments over lagged book value,
O3,
is negative in five of the six years presented
(it is positive in 1986), and is significantly different from zero in each of 1987-1990.6 In
1987-1990,
fi' is below -12 and
significantly
different from -1. This
suggests
that
investors are discounting future cash payments because they believe them to be a per-
manent commitment-obligation.
The fl1 coefficient decreases (becomes more negative) almost consistently over
time. When the data are pooled, there appears to be a change in investors' assessment
of the PRB obligation from the period 1984-1986 to 1987-1990. An F-test to detect a
structural change (Chow test) between the two periods yields an F-statistic that is sig-
nificant at the 1 percent level. A two-tailed t-test to examine the change in Al from
1984-1986 to 1987-1990 indicates that the change is significant at a 1 percent level.
Dummy regressors were also used to test whether ,B in each of the years 1987-1990
is significantly smaller than Al in each of the years 1984-1986. In each regression, data
were pooled from one year in 1987-1990 with data from one year in 1984-1986
Intercept and slope dummies allow the regression coefficients to vary over time to test
the significance of the difference in
flis over time. The t-tests showed that each of the
coefficients in the 1987-1990 period is significantly smaller than each of the coefficient
6
When the data are pooled over the period 1987-1990, ,1
is negative and significant.
Table 2
Sample
Statistics
Panel A. Descriptive Statistics, 1984-1990 (s.e. in parentheses):
Pi, i,, yi, c,, pex,, upI,
Y;,-l Yitl Yit-l Yir-1 yert y,,,
1990:
Mean 1.79 0.13 1.06 0.009 0.010 -0.10
(1.60) (0.15) (0.21) (0.010) (0.020) (0.29)
1989:
Mean 2.25 0.17 1.09 0.009 0.009 -0.18
(1.55) (0.15) (0.29) (0.014) (0.017) (0.25)
1988:
Mean 1.92 0.17 1.08 0.007 0.010 - 0.12
(1.05) (0.13) (0.19) (0.011) (0.026) (0.41)
1987:
Mean 1.90 0.15 1.08 0.007 0.011 -0.13
(1.10) (0.14) (0.17) (0.014) (0.034) (0.48)
1986:
Mean 1.85 0.11 1.03 0.007 0.012 - 0.14
(1.07) (0.13) (0.21) (0.013) (0.027) (0.20)
1985:
Mean 1.59 0.11 1.04 0.005 0.016 -0.09
(0.75) (0.13) (0.15) (0.006) (0.019) (0.18)
1984:
Mean 1.40 0.15 1.04 0.004 0.017 - 0.09
(0.70) (0.11) (0.13) (0.009) (0.020) (0.17)
Panel B. Full-Sample Correlation Matrix (2,014 firm/year observations):
Pit /
yit,,
1.00 0.60 0.41 -0.03 0.00 -0.12
x<,X,# / Yitt
0.66 1.00 0.60 0.16 0.19 -0.05
yi, / yit-l
0.44 0.65 1.00 0.05 0.01 - 0.06
c, /y
Yi-
-0.09 0.08 0.03 1.00 0.50 0.35
pexit /y it-0.00
0.22 0.07 0.18 1.00 0.47
upli, i/ Y it -I -0.22 -0.16 -0.10 0.16 0.25 1.00
Note: In the matrix, numbers above the diagonal represent Pearson correlations, and numbers below the
diagonal represent Spearman correlations. Sizable differences between Spearman and Pearson
correlations may indicate that outliers play a significant role in the analysis. To avoid this problem,
the entire analysis was repeated with truncation to eliminate outliers, with no significant effect on the
results reported here. The variables are defined as follows:
P1,/yi, u=market value of common equity per share, divided by lagged book value of equity per
share,
x?, / yi, I
=
earnings per share adjusted for PRB and pension expenses divided by lagged book value
of equity per share,
yi, / y, =current book value of equity per share, divided by lagged book value of equity per share,
ci,/yi, =PRB cash payments to retirees per share, divided by lagged book value of equity per
share,
pexi, /y,_ =pension expense per share, divided by lagged book value of equity per share, and
upli, / yi,
=
unfunded pension liability per share, divided by lagged book value of equity per share.
Table 3
Regressions of PRB Model, 1984-1990
(p-values for a two-tail test in parentheses)
Pit
x?, Yi, C,, pexi, upli,
Model: =ao,+a,, +a2, +t3 u + +(3,, +pk.
yit-, yi1-% yoi,- yiW, . yet-l Yif-
Year(s) aot aI a2 (1 at 3 (2
1990 0.047 6.619 0.969 - 14.580 -4.761 -0.143 0.516
(n=313) (0.908) (0.000) (0.019) (0.000) (0.228) (0.596)
1989 1.013 7.069 0.150 -12.680 -9.982 -0.576 0.454
(n = 304) (0.001) (0.000) (0.610) (0.010) (0.047) (0.067)
1988 1.191 4.454 0.042 -12.690 8.877 - 0.296 0.331
(n
=
301) (0.000) (0.000) (0.899) (0.026) (0.000) (0.047)
1987 2.382 5.868 -1.180 -18.250 5.534 -0.221 0.371
(n
= 298) (0.000) (0.000) (0.003) (0.000) (0.047) (0.144)
1986 1.163 5.061 0.115 0.551 - 3.007 -0.405 0.431
(n=289) (0.000) (0.000) (0.695) (0.921) (0.239) (0.113)
1985 1.278 3.370 0.080 - 3.312 2.533 - 0.269 0.398
(n = 266) (0.000) (0.000) (0.812) (0.688) (0.270) (0.205)
1984 1.578 4.945 -0.780 -0.412 -6.312 0.102 0.397
(n
=
243) (0.000) (0.000) (0.033) (0.931) (0.007) (0.675)
1987-1990 0.771 5.823 0.328 - 13.752 2.293 -0.343 0.415
(n
=
1,216) (0.000) (0.000) (0.055) (0.000) (0.168) (0.001)
1984-1986 1.008 3.882 0.166 -0.772 -4.551 -0.323 0.341
(n = 798) (0.000) (0.000) (0.404) (0.982) (0.002) (0.026)
clients in the 1984-1986 period (at a 5 percent level).
This further supports the
conclusion of a material change in investors' perception of the PRB obligation.7
It appears that during 1984-1986, investors underestimated the present value of
current and future health care for retirees and other nonpension benefits relative to the
period 1987-1990. During 1987-1990, investors translate $1.00 of cash payment to an
average of $13.75 of obligation, with
f,1
ranging from -12.68 to -18.25. This signifi-
cant change in investors' perception could be explained by one or more of the follow-
ing: (1) investors changed their assessment of the future increase in health care costs; (2)
the discount rate (settlement rate) changed; (3) investors updated their assessment of
future PRB payments (scope of the plan); (4) court cases led investors to change their
beliefs about the legal status of the PRB obligation; (5) public debate about this issue
drew more attention to it.
Over the period 1985-1990, the PRB multiplier (il) has risen from 3.31 to 14.58 in
absolute values, indicating that changes in investors' assessments of the discount rate
7 The analyses were repeated by using the Heckman (1979) procedure, which attempts to detect and correct
sample selection bias. The inverse Mill's ratio was derived from a probit model that included size, industry
dummies, location dummies, labor intensity, and the ratio of retirees to active employees. The results were not
materially affected by the inclusion of the inverse Mill's ratio in the regression model.
or the health care cost trend rate are unlikely to be the only reason for the change in the
i3 coefficient.8
Changes in the coverage of PRB plans also are unlikely to have caused such signifi-
cant changes in investors' assessment of the PRB liability. Over the period 1984-1990,
overall coverage had not increased and most firms were trying to contain the PRB
costs. A telephone survey of more than 200 financial officers (see Bacon et al. 1990)
revealed that retirees will be paying more in the future for their own health benefits.
Furthermore, in 1984, U.S. district court used the common law to mandate vesting
of retiree health benefits. In 1989, the sixth U.S. Circuit Court of Appeals ruled that "if
plan documents clearly and consistently reserved a right to modify a plan, then modifi-
cations, based on those documents, are not illegal" (Geisel 1989). This suggests that
legal proceedings may not be responsible for investors' changing beliefs.
That investors were less aware of the consequences of paying medical expenses to
retirees during the period 1984-1986, is a plausible explanation. In contrast, during the
period 1989-1990, as a result of the FASB Exposure Draft, public hearings, SFAS No.
106, and numerous publications in the financial press, investors could have become
more cognizant of the size of the PRB liability.9
The coefficient on the pension expense (132) variable changed magnitude and sign
almost every year over the 1984-1990 period, which is consistent with the results found
in Grant (1991) and Barth et al. (1992). When the data were pooled, /2 is negative and
significant in the 1984-1986 period, and positive and insignificant for the 1987-1990
period. The coefficient on the unfunded pension obligation (f3) is more stable over
time. When the data were pooled, 3% is negative and significant over 1984-1986 and
1987-1990. This result is consistent with Landsman (1986). The analysis was repeated
without the pension variables and showed that i,3 values over 1984-1990 are not
affected by the inclusion of the pension expense and the unfunded pension liability as
regressors.
V. Estimating the Present Value of the PRB Liability
with Publicly Available Information
The method of estimating the firm-specific PRB liability (present value) with
publicly available data uses a general present-value model. Consider a firm that
sponsors a PRB plan that entitles eligible employees to full medical coverage when they
retire from the firm. The employee may retire on or after age y,; nj
denotes the number
of retirees of age j sponsored by the
firm; and
mi
the number of active employees of age i
working for the firm. Expected medical costs for a retiree of age y, for the current year
are denoted by
Cy,.
The cost is assumed to increase with age at a rate of g1 per year.
Also, because of inflation, medical costs are assumed to increase at a rate of g2 per year.
That means that a retiree of age
yr
today is expected to spend (and therefore be
8
To get a present-value multiplier of 3.31, assuming a 20-year horizon, the combined annual discount
factor should be 30 percent. That means that if the discount rate is 9 percent,
the annual health care cost trend
rate is around -21 percent. To get a present value of 14.58 under the same
assumptions,
the combined
discount factor is 3.2 percent, and the annual change in health care costs is around 5.8
percent.
9 There appears to be a market inefficiency because the footnote information on the size of cash
payments
for postretirement benefits was available in the financial statements
during
the time when
postretirement
benefits were relatively undervalued by investors.
reimbursed by the firm)
Cy,[(l+g,)(l+g2)Jt
for medical costs incurred t years from
today, if he or she is alive at that time. For simplicity, assume that all payments are
made at the end of the year. The nominal interest rate, r, is assumed constant over time.
For each individual, the probability of living through year a is denoted by PL(a). The
probability of staying with the firm between age a and b is denoted by PS
(a,
b). The
probability of retiring at age p (where p is greater than or equal to
y,)
is PR(p). Under
the above assumptions, the present value of the expected obligation of the firm is given
by:
10
PV=
E
njCy, E(
1+
g ) k-y,(J+ +g2) k-i(1
+r r)jkPL
(k)
_J=yr kJ
=
+ {
F
miPS(iy)Cy,
(1+g2)Y'-i(1 +r)iYyo
into
[
PR
(y, +q) (a(l +g, ) S-Or(l +g2) ti(
l
+r)j-i-PL(k) ) (9)
q=O I=j
Equation (9) has two components: The first component, which represents the
expected actuarial present value of paying health benefits to retirees, takes into account
the expected increase in health care costs because of aging, g1, and inflation, g2. The
second component represents the present value of future PRB payments to employees,
currently active, and takes into account the probability of their being employed by the
firm until retirement age,
PS(iy,)
as well as the distribution of all possible retirement
ages, y,+q(q>O). Since data on age groups and on other parameters in the model are
generally not publicly available, some assumptions are required to make the model esti-
mable.
Consider now the case of an employee who becomes eligible for PRB benefits upon
reaching age 55, which most firms use as the eligibility age in their PRB plan (see FERF
1989 and Foster Higgins 1988). Assume that the firm usually hires new employees when
they are 35 years old, and all employees retire at age 62 (ages 35 and 62 represent average
employment and retirement age according to Labor Department statistics). The choice
of three age groups is made mainly because of data limitations. In group 1, n1 retirees of
age 62 are eligible for PRB coverage; in group 2, n2 employees of age 55 are fully eligible
for PRB and will retire at age 62 if they live until that age; in group 3, n3 employees of
age 35 are not eligible for PRB.
Expected medical costs for a 62-year-old retiree for the current year are denoted by
C62. The cost is assumed to increase with age and over time in the manner described
above. For simplicity, assume that an employee does not leave the firm before retire-
ment except through death. Under the above assumptions, the present value of the
expected obligation for the whole firm, which is the sum of the obligations for the three
groups, is:
PV=S
n,+n2 (1 +2) PS(
55,62)
+ n (1 +92)
S27PS(3362 (10)
1+r
ler)
1? Derivation of actuarial models can be found in Ippolito (1986) and Mittelstaedt and Wharshawsky (1992).
where:
S=
aC62(1
+gl)j(l +g2)j(1 +r)-jPL(62 +j).
j=1
The date of estimation is December 31, 1990. The variables in equation (10) that
require estimation are the health care cost trend rate (g2), discount rate (r), average
health costs per retiree (C62), the three age groups (n1, n2, n3), and the probabilities of
staying employed [PS( * )] and alive [PL( *
Health Care Cost Trend Rate
To estimate the rate of increase in per capita health expenditures (PCHE), the fol-
lowing notation will be used: GNP = gross national product (annual), PCGNP = per
capita gross national product, CPI = consumer price index, MCCPI = medical compo-
nent of the consumer price index, HE = national health expenditure (annual), PCHE
= per capita health expenditure, Q
=
quantity of goods produced in the economy,
QH = quantity of health services produced in the economy, n =
general population size.
A solid dot ( * ) above a variable represents its percentage change over one year.
Taking derivatives with respect to time:"1
G4P=CPI+Q. (11)
Equation (11) means that the percentage change in the GNP is equal to the percentage
change in prices plus the percentage change in the quantity of goods produced (real
growth). Similarly, for health services only,
HE
=
MCCPI + QH. (12)
The per capita versions of equations (11) and (12) are:
PCGNP=CPI+Q- h, (13)
PCHE
=
MCCPI + QH-h. (14)
Four scenarios are considered here. The first scenario (Si) is that of no real growth
in per capita medical services (QH=A), that medical costs will grow at the same rate
as general inflation (CPI= MCCPI).
PCHE =
CPI. (15)
Some believe that the minimum estimate of future change in health care costs could be
based on the general inflation rate. Proponents of this approach believe that the CPI is
more reliable than other measures (see FERF [1989, 103] for further discussion of the
issue).
With the second scenario (S2), real growth in per capita medical services (QH >A)
is allowed, but medical costs still grow at the same rate as general inflation (CPI
-
MCCPI).
PCHE=CPI+QH- A. (16)
"Equation (11) is derived as follows:
aGNP/at a(CPI*Q)/dt a8CPI)/at aQiat
- - ~~ ~~~+ =CPI +Q.
GNP CPI*Q CPI Q
Equations (12) through (14) are derived similarly.
The third scenario (S3) places no restriction on real growth or prices of medical
services.
PCHE = MCCPI + QH-A. (17)
Scenarios Si and S2 are special cases of scenario S3. Scenarios S2 and S3 are less
conservative and allow for higher forecasts of the health care cost trend rate. Because
economists argue that the share of HE from the GNP cannot be higher than a certain
percentage (see GAO 1989; U.S. Department of Commerce 1989),12 a fourth scenario
(S4) is added to restrict the share of HE not to exceed 15 percent of GNP in 30 years.13
For PCHE to rise from 11.1 to 15 percent in 30 years, the annual increase must be
(15/11.1)1/30
or 1 percent. This yields the following equation:
PCHE =PCGNP+ 1 = CPI+ Q-i + 1. (18)
The next step is to forecast PCHE according to these four scenarios. First, the
annual change in the general inflation rate (CPI) must be forecast. The pattern of infla-
tion has changed considerably during the last 50 years (see U.S. Department of Com-
merce 1975, 1986, 1989). An estimate of 4.5 percent as FERF (1989) will be used.14
Second, a forecast of the MCCPI is needed. The average MCCPI over the period
1950-1987 was 6 percent, and the average for 1984-1987 was 6.6 percent, which is
about 2 percent over the CPI. A forecast of 6.5 percent will be used here. To forecast
QH, the techniques of Box and Jenkins (1976) are used to identify and estimate the fol-
lowing model over the period 1960-1987 (t-values are in parentheses):
QHt
= 0.496QHt l + 0.493 QHt-5. (19)
(3.9) (3.8)
With this model, QH is forecast to be, on average, 4 percent over the next 30 years. The
U.S. general population (i) has been growing at an average annual rate of 1.5 percent
(see U.S. Department of Health and Human Services 1988), and this is the forecast used
here. As for Q, I adopt the U.S. Department of Commerce (1986) forecast, which is 2
percent on average for the next 30 years.
Using the above forecasts, one can now calculate PCHE under the four scenarios.
Si: PCHE = CPI=4.5 percent.
S2: PCHE =
CPI + QH-A
=
7.0 percent.
S3: PCHE = MCCPI + QH - n = 9.0 percent.
S4: PCHE = CPI + Q -i + 1% -=6.0 percent.
The forecasts result in very different estimates of the PRB obligation. Scenarios Si and
S4 would be more acceptable to the GAO and the U.S. Department of Labor, but sce-
narios S2 and S3 yield higher estimates.
Discount Rate
Four possible discount rates may be appropriate for calculating the PRB obligation.
The first nossibilitv is the settlement rate [D li. which is the rate required to "sell" the
"
For example, if PCGNP=2 percent and MCCPI-CPI=4 percent, then the share of HE from the GNP
will rise from 11.1 percent (the share of HE from the GNP in 1988) to 20.1 percent in 30 years. This is
considered by economists to be extremely unlikely.
13
GAO (1989) uses 14.9 percent and the U.S. Department of Labor (1986) uses 12.8 percent.
1 Using time-series models may give unreliable forecasts. The average CPI over the period 1950-1987
was 4.25 percent, and the average over 1982-1987 was 3.8 percent. GAO (1989) uses an annual forecast of 5
percent.
obligation to an outside party. This may be the appropriate discount rate because it
measures the marginal interest rate that the firm pays to an independent agent to meet
the PRB obligation. The problem is that firms are currently unable to "sell" the PRB
obligations. Therefore, the settlement rate may not be identifiable by the firm. Indeed,
firms disclose their own calculations of the pension rates in their footnotes to the
annual financial statements, and this rate is used here.
The second possibility is the marginal borrowing rate of the firm (D2). Assuming
the firm has to borrow funds to pay the PRB liability, the marginal borrowing rate may
be the appropriate discount rate. This rate is set equal to the average yield on a bond
with the same S&P rating as that of the firm. The S&P bond rating for each firm is taken
from COMPUSTAT, and the average yield on each class of bonds for the year 1989 is
taken from the S&P Bond Guide. These rates are: AAA=8.70 percent, AA=8.99
percent, A=9.51 percent, BBB=10.01 percent, BB=12.07 percent, and B=13.85
percent. iS
The third possibility is the return on equity (D3). Employers may self-finance the
PRB obligation by issuing stock. In that case, the return on equity may be the appropri-
ate rate to use. To estimate the return on equity, the market model is estimated by using
monthly returns over the period 1984-1989.
The last possibility for the discount rate is the average cost of capital of the firm
(D4). The funds to pay future PRB claims may come from both borrowing and issuing
new captial. Therefore, the appropriate rate would be the average cost of capital calcu-
lated as the weighted average of D2 and D3 as follows:
(D4)=
(D2)+
ME
(D3), (20)
BD+ME BD+ME
where BD is the book value of the firm's debt, and ME is the market value of the firm's
equity. Book value of debt is used because the market value of debt is usually not
available, and the book value serves as a good proxy for it. The sample averages for Di
through D4 are 8.9, 10.3, 18.5, and 13.3 percent, respectively. The corresponding
medians are 9, 9.5, 18.2, and 13.2 percent.16
Average Per Capita Health Care Costs and Demography
The average cost per retiree is calculated as:
cash payments for PRB
# retirees
15
If the firm's bonds were unrated, the yield is estimated by using the following ratio:
Interest on Long-Term Debt
Long-Term Debt+Current Portion of Long-Term Debt
This ratio is restricted to the interval 8.7 through 13.85 percent to be consistent with the interval AAA through
BB used for rated bonds.
16
More than 470 comment letters were received by the FASB in response to its 1989 Exposure Draft. Also,
five days of public hearings on this topic were held in October and November 1989. In a comment letter, Unocal
Corp. argued that the discount rate should be the firm's cost of capital. Others, including the Financial
Executives Institute (FEI), claimed that a normalized bond rate should be used instead. FEI, Chrysler, and
others argued that the CPI index should be used as the appropriate measure of the health care cost trend rate.
The Academy of Actuaries, GAO, and IBM, among others, supported the FASB's opinion that a "best estimate"
should be used. S&P Corp. argued that no estimate can be reliable enough and that the present value of the
liability is too sensitive to the choice of this parameter.
Although annual cash payments to retirees are disclosed by firms in their annual finan-
cial statements, firm-specific data by age group are not generally available. This study
uses the ERISA Blue Book of Pension Funds (1983, 1984-1985, 1985-1986), which is
based on form 5500 filed by each firm with the U.S. government, as a source of informa-
tion for number of firm employees and retirees for some specific years. These data may
be used to estimate the number of retirees and the number of active employees age 55
and older. The following notation is used throughout this section:
R,=the number of retirees at the end of year t;
At=
the number of active employees at the end of year t;
R, (a, b) = the number of retirees between ages a and b at the end of year t;
A,(a,
b) =the number of employees between ages a and b at the end of year t;
PL (a, b)
=
the probability of staying alive between age a and b.
As before, assume all employees retire at age 62. Assume further that the ratio of
retirees to active employees and the number of employees age 55 and over to total
employees remain fixed over time. Then:
R89 R84 R83 R82
(21)
A89 A84 A83 A82
A89(55,62)
A84(55,62) A83(55,62) A82(55,62) (22)
A89 A84 A83 A82
Given these assumptions, the number of retirees in 1989 can be presented as follows:
61
R89= R82o PL(62,69)+
E
A82(k) oPL(k,k+ 7). (23)
k=55
Because of data availability problems, equation (23) is approximated as follows:
R89= R82oPL(62,69)+A82(55,62)oPL(55,62). (23)
Equation (23) approximates the number of retirees in 1989 as the sum of two com-
ponents: (1) the number of retirees in 1982 that are expected to live until 1989 and (2) the
number of active employees between age 55 and 62 who are expected to live until age
62 and retire at that age. Using equations (22) and (23) and rearranging terms:
A82(55,62)= A89R84
_R82 FPL(62,69)1 (24)
A84PL(55,62)
LPL(55,62)i
Using equations (22) and (24):
A89(55,62)= {
A89
A9R84
_
R82
PL(62,69)
(25)
A82 A84PL(55,62) PL(55,62)
Equation (25) is an estimate of the number of employees between ages 55 and 62. The
number of active employees age 55 and under will be the difference between A89 (55,62)
and A89. The number of retirees in 1989 is given by the left-hand side of equation (23).
Probabilities of Staying Employed and Other Parameters
This study assumes that the probability of staying with the firm depends only on the
event of death. This is a reasonable assumption for employees age 55 and over, because
Table 4
Estimated PRB Liability as a Percentage of Book Value
Panel A. Sample Medians:
Health Inflation Rates"
Discount
Rate, Si S2 S3 S4
Dl 0.25 0.48 0.90 0.38
D2 0.21 0.36 0.62 0.29
D3 0.06 0.08 0.10 0.08
D4 0.10 0.14 0.21 0.12
Panel B. Correlations Between Liability Over Lagged Book Value (Li.90/yj,,9) and Other Variables:
Variables Correlation
Pi. /Y,.-1
-0.27
x ,, / yi- , -0.13
Yi/ yir-1 -0.20
cill/yf, , 0.65
pexi, / y.- l 0.17
upli,/y,,, -0.14
a
The discount rates are: D 1 =
pension; D2 =
bond; D3 =
equity; and D4 = cost of capital.
b
The health inflation rates are: SI=4.5 percent; S2
=
7.0 percent; S3
=
9.0 percent; and S4
=
6.0 percent.
c
The variables are defined in table 2.
employees nearing retirement age are more likely to stay with the firm. For younger
employees, this may not be a good assumption, but data on employee turnover are not
available. Each probability of staying employed (alive) is thus calculated with actuarial
life tables published by the U.S. Department of Health and Human Services (1988).
It is also assumed that the level of health care expenditure does not change with the
retiree age (g1 =0 percent in equation [10]). This assumption is made because data on
health care costs for different age groups were not available.
By using all the data described above, the PRB liability was estimated for each firm
according to equation (10). The estimates are calculated with each of the four discount
and health inflation rate combinations. Descriptive statistics for the 231 firms in the
sample without missing data are
reported
in table 4. The
sample
medians of the estimated
PRB liability for each pair of health care cost trend rate and discount rate (panel
A) show that the liability measures are very sensitive to the choice of parameters. The
average correlation between the liability estimates and the other variables used in the
analysis are shown in panel B.
VI. Valuation of the Estimated PRB Liability
As expected, the PRB liability and annual cash payments are highly correlated.
Given this high correlation, does the estimate of the PRB liability add value-relevant
information to investors in addition to the cash payments information? The results of
Table 5
Regressions of Cross-Sectional Valuation Model with 1990 Data
(231 observations)
Pi.9 go 9a0 y i.90 pex, i g up, i go L i 90
Model: (=ao+a, +a2 + 32 +03 +(34
+?7-.
YJ.89 Yi.89 YE.89 Y. 89 Yi. 89 Yi.89
S D a 0 a1 a2 02 03 14 P(-1) I2
1 1 - 0.520 7.640 1.350 - 9.439 0.031 -0.369 0.60
(0.1613 (0.00) (0.000) (0.049) (0.908) (0.094) (0.01)
1 2 - 0.497 7.620 1.338 - 9.409 0.052 - 0.526 0.61
(0.183) (0.000) (0.000) (0.050) (0.847) (0.085) (0.11)
1 3 -0.414 7.781 1.267 -8.900 0.131 -1.775 0.62
(0.266) (0.000) (0.000) (0.056) (0.627) (0.011) (0.84)
1 4 -0.386 7.733 1.272 -7.610 0.141 -1.531 0.62
(0.300) (0.000) (0.000) (0.110) (0.601) (0.022) (0.76)
2 1 - 0.557 7.577 1.366 -10.102 0.012 -0.134 0.59
(0.131) (0.000) (0.000) (0.034) (0.964) (0.221) (0.00)
2 2 - 0.545 7.549 1.356 -10.212 0.025 -0.179 0.59
(0.142) (0.000) (0.000) (0.033) (0.923) (0.216) (0.00)
2 3 - 0.468 7.720 1.309 - 9.411 0.096 -1.121 0.62
(0.205) (0.000) (0.000) (0.042) (0.721) (0.033) (0.57)
2 4 - 0.427 7.683 1.322 - 7.623 0.106 -1.073 0.62
(0.248) t0.000) (0.000) (0.109) (0.693) (0.021) (0.55)
3 1 - 0.569 7.540 1.364 - 10.543 0.009 -0.050 0.59
(0.123) (0.000) (0.000) (0.026) (0.972) (0.629) (0.00)
3 2 - 0.562 7.510 1.348 - 10.825 0.020 - 0.040 0.50
(0.128) (0.000) (0.000) (0.023) (0.934) (0.803) (0.00)
3 3 -0.513 7.661 1.340 - 9.908 0.065 - 0.559 0.61
(0.163) (0.000) (0.000) (0.031) (0.806) (0.047) (0.07)
3 4 - 0.474 7.626 1.366 -7.895 0.068 - 0.597 0.62
(0.197) (0.000) (0.000) (0.096) (0.798) (0.017) (0.06)
4 1 - 0.545 7.601 1.363 - 9.841 0.017 -0.210 0.59
(0.140) (0.000) (0.000) (0.039) (0.948) (0.182) (0.00)
4 2 - 0.528 7.576 1.353 - 9.874 0.034 - 0.296 0.59
(0.155) (0.000) (0.000) (0.040) (0.899) (0.201) (0.02)
4 3 - 0.445 7.747 1.291 - 9.181 0.111 -1.382 0.62
(0.230) (0.000) (0.000) (0.047) (0.680) (0.026) (0.70)
4 4 - 0.407 7.706 1.300 - 7.580 0.122 -1.264 0.63
(0.271) (0.000) (0.000) (0.111) (0.649) (0.015) (0.67)
Note: The p-values for a two-tail test are presented below the coefficients; p(- 1) is the p-value of a two-tail
test that I34 is different from - 1.
The health trend (S) and discount rates (D) are as defined under table 4.
estimating equation (5) are shown in table 5. The results are reported for four separate
measures of the discount and health care cost trend rate.
Under all measures, the regression coefficient of the estimated PRB liability divided
by lagged book value
(04)
is, as expected, negative and is significantly different from
zero at p
< 0.10 in ten of the 16 cases reported. In nine of the 16 cases the coefficient is
significantly different from -1 at a 10 percent level. The liability appears to be sensi-
tive to the choice of parameters. When the discount rate is the firm's equity rate and the
health care cost trend rate is assumed to be 4.5 percent, the 34 coefficient is
-
1.775.
When the health care cost trend rate increase to 9 percent, the
O.,
coefficient increases
to -0.559.
The results suggest that the market forecasts of the health care cost trend rate does
not exceed 7 percent because when the health care cost trend rate exceeds 7 percent,
the
034
coefficients are close to zero. The results also indicate that a discount rate based
only on bond yields (pension rate and marginal borrowing rate), as suggested by the
FASB (1985, par. 44; 1990, par. 31), is considered by the market as too low. Instead, the
results appear consistent with market's assessment of a higher discount rate based on
the return on equity or the cost of capital.
The results of estimating equation (6) are reported in table 6. The coefficient on
PRB cash payments,
i3,,
is not significant (at a 5 percent level) in any of the 16 cases
reported. The coefficient on the liability estimate,
0,d,
is again negative in all cases, and
is statistically significant in eight of the 16 cases reported.
O.4
is not statistically signifi-
cant when the discount rate used is either the pension rate or the estimated marginal
borrowing rate, which is consistent with the suggestion that the market uses a firm-
specific discount rate (cost of equity or cost of capital). In addition, F-tests for the
increase in R2 values resulting from including the PRB liability were significant at the 5
percent level in ten of 16 cases and at the 10 percent level in 12 of the 16 cases. This
indicates that the liability measure appears to be value-relevant to investors in addition
to the cash information.
The results of estimating equation (7) for the second hypothesis are shown in table
7. The (3, coefficients were not, as expected, significant at a 10 percent level for a two-
tailed t-test in 14 of the cases reported."7 The size of the coefficient, in general, lies be-
tween -4.182 and 3.203, which is significantly higher than the case when the liability
measure is not included in the regression model ((3190 = -14.58 in table 3).
The results reported in table 7 are somewhat puzzling because a2, which was signif-
icant in tables 5 and 6, is no longer significant. Because this may be due to the high cor-
relation between
Y1',901/Y89
and the regression intercept, a collinearity analysis was con-
ducted with the procedure of Belsley et al. (1980). The highest condition index was 17,
which indicates medium collinearity at most.
18
Further analysis confirmed that most of
the collinearity is from the correlation between the intercept term and
y!' 9o/yg,89.
The
analysis was then repeated after excluding the book-over-lagged-book variable,
(y,! 90/Yi 89), without any significant effect on the results and with the
highest condition
index reduced to 3.7.
VII. Summary
This study analyzes the valuation implications of firms' obligations to provide cur-
rent and future retirees with postretirement benefits other than pensions. In particular,
this study examined investors' assessment of disclosed PRB cash payments prior to
SFAS No. 106, and whether a measure of the PRB obligation is regarded by investors as
value-relevant in addition to the disclosed cash payments.
The main findings are that investors have changed their assessment of the PRB obli-
gation over the period 1984-1990 from a position of underestimation during 1984-1986
17
In the remaining two cases, t,3 is positive.
18
According to Belsley et al. (1980), a condition index of below 10 indicates mild collinearity, and one of
more than 30 indicates severe collinearity.
Table 6
Regressions to Ascertain the Value-Relevance of PRB Obligations
(1990 data, 231 observations)
pi.90 i. 90 ye. ,0 Ci.90 pex i. g up, i go L i 90
Model: +f3+o, +CU2 + t + 2 + 3 +34 +n3.
Y.89 Yi.89 yi.89 y.89 Yi.89 Yi.89 3i.89
S D cOf oai a}2 i3 2 03 R2
1 1 -0.391 7.695 1.211 - 12.753 -9.253 0.179 -0.206 0.61
(0.307) (0.000) (0.002) (0.198) (0.053) (0.537)
(0.223)
1 2 -0.402 7.705 1.211 -13.414 -9.340 0.173 -0.359 0.61
(0.300) (0.000) (0.002) (0.186) (0.052) (0.542) (0.210)
1 3 -0.405 7.787 1.259 1.683 - 8.767 0.141 -1.582 0.62
(0.283) (0.000) (0.001) (0.853) (0.063) (0.609) (0.050)
1 4 -0.413 7.688 1.305 9.919 - 7.565 0.107 - 2.224 0.62
(0.272) (0.000) (0.001) (0.550) (0.112) (0.550) (0.005)
2 1 - 0.377 7.695 1.192 -12.487 -9.322 0.191 -0.123 0.61
(0.327) (0.000) (0.002) (0.114) (0.051) (0.511) (0.308)
2 2 - 0.386 7.711 1.181 - 13.350 -9.523 0.187 - 0.256 0.61
(0-310) (0.000) (0.002) (0.191) (0.047) (0.509) (0.252)
2 3 -0.422 7.761 1.274 -4.702 -8.841 0.135 -0.807 0.62
(0.264) (0.000) (0.001) (0.198) (0.061) (0.625) (0.090)
2 4 -0.439 7.665 1.334 1.545 - 7.652 0.093 -1.170 0.62
(0.244) (0.000) (0.000) (0.867) (0.109) (0.736) (0.040)
3 1 - 0.370 7.696 1.183 - 12.070 - 9.338 0.194 -0.068 0.61
(0.337) (0.000) (0.002) (0.089) (0.051) (0.501) (0.288)
3 2 - 0.376 7.716 1.166 -12.711 -9.594 0.193 -0.153 0.61
(0.323) (0.000) (0.003) (0.067) (0.045) (0.496) (0.212)
3 3 - 0.430 7.745 1.280 -6.471 - 8.889 0.132 -0.428 0.62
(0.256) (0.000) (0.001) (0.343) (0.060) (0.632) (0.081)
3 4 -0.451 7.657 1.345 -2.057 -7.781 0.089 - 0.622 0.62
(0.232) (0.000) (0.001) (0.792) (0.103) (0.749) (0.050)
4 1 - 0.382 7.695 1.199 - 12.683 -9.303 0.187 -0.158 0.61
(0.321) (0.000) (0.002) (0.138) (0.051) (0.519) (0.310)
4 2 -0.392 7.708 1.192 -13.547 -9.465 0.183 -0.311 0.61
(0.302) (0.000) (0.002) (0.119) (0.048) (0.520) (0.275)
4 3 -0.416 7.770 1.269 -3.579 -8.812 0.137 -1.077 0.62
(0.271) (0.000) (0.001) (0.659) (0.062) (0.620) (0.045)
4 4 -0.430 7.673 1.325 3.682 -7.600 0.097 -1.549 0.62
(0.254) (0.000) (0.001) (0.718) (0.111) (0.724) (0.026)
Note: The p-values for a two-tail test are presented below the coefficients.
to realization of the large size of the present value of the expected PRB liability during
1987-1990. When the firm-specific present value of the PRB obligation is estimated and
the relation between market values and this estimate is analyzed, it is shown that the
estimated PRB obligation is value-relevant to investors in addition to the cash
payments, and that cash payments are not value-relevant when the accounting
numbers are adjusted to reflect the estimated PRB obligation. This result is important
because it shows that even a measure of the PRB obligation based on publicly available
information is more informative than the cash information. Most firms are expected to
release their private PRB information during fiscal year 1993. This is expected to be
more informative than the PRB liability measure used here, and therefore more infor-
Table 7
Regressions to Ascertain the Superiority of Liability Information
(1990 data, 231 observations)
Pi. 90
X ', 90
y
.90 C i.90 pexi,9o upli,90
4
Model: Y.8
=
YC89-+1I y:89 CY2 + +13 l +133 X 7.8 .
S D a0 al a,2 i} 1 2 33 fl3
1 1 0.724 7.765 - 0.023 1.945 - 5.200 - 0.414 0.68
(0.011) (0.000) (0.937) (0.342) (0.051) (0.066)
1 2 0.879 7.503 - 0.092 -0.852 -4.784 - 0.245 0.58
(0.002) (0.000) (0.746) (0.746) (0.067) (0.313)
1 3 0.893 7.427 -0.045 -3.548 -4.625 -0.079 0.55
(0.002) (0.000) (0.879) (0.266) (0.073) (0.756)
1 4 0.868 7.398 -0.040 - 2.272 -4.627 - 0.131 0.56
(0.003) (0.000) (0.892) (0.431) (0.073) (0.604)
2 1 0.233 7.482 - 0.050 3.203 - 7.869 -0.080 0.70
(0.327) (0.000) (0.788) (0.070) (0.007) (0.578)
2 2 0.902 7.691 - 0.163 0.624 - 5.150 - 0.381 0.64
(0.002) (0.000) (0.576) (0.792) (0.051) (0.096)
2 3 0.894 7.445 - 0.050 - 3.586 -4.603 - 0.090 0.56
(0.002) (0.000) (0.867) (0.252) (0.075) (0.725)
2 4 0.847 7.420 -0.033 - 1.663 -4.671 -0.167 0.57
(0.003) (0.000) (0.909) (0.543) (0.071) (0.500)
3 1 0.974 7.536 - 0.322 2.712 -4.912 - 0.755 0.74
(0.001) (0.000) (0.246) (0.229) (0.076) (0.001)
3 2 1.005 8.098 - 0.343 2.556 - 6.191 - 0.581 0.76
(0.000) (0.000) (0.219) (0.213) (0.021) (0.004)
3 3 0.925 7.458 -0.076 -4.182 -4.388 -0.093 0.57
(0.001) (0.000) (0.796) (0.167) (0.089) (0.716)
3 4 0.814 7.482 -0.019 - 0.990 -4.761 -0.210 0.59
(0.005) (0.000) (0.949) (0.700) (0.067) (0.386)
4 1 0.445 8.450 0.156 3.147 - 6.259 -0.436 0.73
(0.106) (0.000) (0.587) (0.080) (0.023) (0.030)
4 2 0.887 7.591 -0.124 -0.056 -4.947 -0.315 0.61
(0.002) (0.000) (0.671) (0.982) (0.060) (0.182)
4 3 0.893 7.436 - 0.047 - 3.545 -4.619 - 0.856 0.56
(0.002) (0.000) (0.874) (0.261) (0.073) (0.738)
4 4 0.857 7.407 - 0.037 - 1.933 -4.648 -0.151 0.56
(0-003) (0.000) (0.900) (0.490) (0.072) (0.546)
Note: The letter 1 above a variable in the model indicates adjustment for the PRB liability. The p-values for a
two-tail test are given below the coefficients.
mative than the cash measure. These findings support the motivation behind the
FASB's decision to adopt SFAS No. 106.
It appears that the PRB liability is highly sensitive to the choice of param-
eters-health care cost trend rate and discount rate-used to calculate it. The FASB
tried to mitigate this problem by requiring some disclosure about the sensitivity of the
PRB obligation and annual cost to the choice of the health care cost trend rate (SFAS
No. 106, par. 74). A similar requirement for the discount rate used to calculate the
obligation may be helpful to financial statement users. In addition, the results suggest
that the market uses a measure of the health care cost trend rate close to the general
inflation rate to estimate the obligation. It is also suggested that, unlike the discount
rate suggested by the FASB in its Exposure Draft, a firm-specific measure of the return
on equity or the cost of capital is used by investors to estimate the present value of the
PRB obligation.
This research is limited by the fact that the estimate of the PRB liability cannot be
fully validated. To date, no firm-specific demographic data are available to researchers,
and only a small number of firms have adopted SFAS No. 106. When audited estimates
are reported by firms in their financial statements, it will be possible to examine
whether the actual reported liability is incrementally informative over the estimated lia-
bility used in this reserch. It would also be interesting to examine managers' choice of
parameters to calculate the PRB obligation.
References
Amir, E., and
J.
Livnat. 1992. Recognition vs. disclosure: Does it make a difference? A study of other
postretirement benefits. Working paper, Columbia University, New York.
Bacon, P., J. Kasper, G. De Lissovoy, S. Dicarlo, and J. Gabel. 1990. The employer response to the
FASB proposal of accruing postretirement health benefits. Benefits Quarterly 6: 48-50.
Barth, M. E. 1991. Relative measurement errors among alternative pension asset and liability mea-
sures. The Accounting Review 66 (July): 433-63.
, W. H. Beaver, and W. R. Landsman. 1992. The market valuation implication of net periodic
pension cost components. Journal of Accounting & Economics 15 (March): 27-62.
Belsley, D. A., E. Kuh, and R. E. Welsch. 1980. Regression Diagnostics. New York: McGraw-Hill.
Blue Book of Pension Funds. 1983, 1984-1985, 1985-1986, ERISA Benefits Funds, Inc., Washing-
ton, D.C.
Box, G. E. P., and G. M. Jenkins. 1976. Time Series Analysis: Forecasting and Control. San Francisco:
Holden-Day.
Espahbodi, H., E. Strock, and H. Tehranian. 1991. Impact on equity prices of pronouncements related
to
nonpension postretirement benefits. Journal of Accounting
& Economics 14
(December):
323-46.
Financial Accounting Standards Board. 1984. Statement of Financial Accounting Standard No. 81:
Disclosure of Post Retirement Health Care and Life Insurance Benefits. Stamford, CT: FASB.
. 1985. Statement of Financial Accounting Standard No. 87: Employers' Accounting for Pen-
sions. Stamford, CT: FASB.
. 1990. Statement of Financial Accounting Standard No. 106: Employers' Accounting for Post-
Retirement Benefits other than Pensions. Norwalk, CT: FASB.
Financial Executives Research Foundation. 1989. Retiree Health Benefits: Field Test of the FASB
Proposal. Morristown, NJ: FERF.
Foster Higgins. 1988. Third Annual Health Care Benefits Survey. New York: A. Foster Higgins & Co.
Inc.
Geisel, J. 1987. Court says firm can alter retiree health plan benefits. Business Insurance 21 (April): 6.
. 1989. Burden of retiree health benefits growing. Business Insurance 23 (January): 2, 7.
General Accounting Office. 1989. Report to Congressional Requesters. Employee Benefits. Wash-
ington, D.C.: GAO.
Grant, J. 1991. Liabilities for non-pension retirement benefits-Valuation impact of expenditure dis-
closures. Working paper, Case Western Reserve University, Cleveland, OH.
Heckman, J. 1979. Sample selection bias as a specification error. Econometrica 47 (January): 153-61.
Ippolito, R. A. 1986. Pensions, Economics and Public Policy. Homewood, IL: Dow Jones-Irwin.
Landsman, W. 1986. An empirical investigation of pension fund property rights. The Accounting
Review 61 (October): 662-91.
Lev, B. 1979. The impact of accounting regulation on the stock market: The case of oil and gas com-
panies. The Accounting Review 54 (July): 485-503.
Mittelstaedt, F., and M. Wharshawsky. 1992. The impact of liabilities for retiree health benefits on
share prices. Working paper, University of Notre Dame, Notre Dame, IN.
Ohlson, J. 1991. Earnings, book values, and dividends in security valuation. Working paper, Colum-
bia University, New York.
U.S. Department of Commerce, Bureau of the Census. 1975. Historical Statistics of the United States
-Colonial Time to 1970. Washington, D.C.: Government Printing Office.
--. 1986. Money and Income of Households, Families and Persons in the United States, Series P-G0.
Washington, D.C.: Government Printing Office.
. 1989. Statistical Abstract of the United States, 109th ed. Washington, D.C.: Government Print-
ing Office.
U.S. Department of Health and Human Services. 1988. Vital Statistics of the United States 1986.
Hyattsville, MD: Government Printing Office.
U.S. Department of Labor. Pension and Welfare Benefits Administration. 1986. Employer-Sponsored
Retiree Health Insurance. Washington, D.C.: Government Printing Office.

Amir E

Uploaded by

Document Information

Original Description:

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Amir E

Uploaded by

Copyright:

Available Formats

TIe MavIel VaIualion oJ Accounling InJovnalion TIe Case oJ Foslvelivenenl BeneJils OlIev

You might also like