Some money managers and analysts are now factoring in pension liabilities in their valuation models, according to a report in Pensions & Investments. It's about time. After all, wasn't that what FAS 87 was for?
The pension accounting and disclosure rule, adopted by the Financial Accounting Standards Board in 1985, has been pretty much ignored by most investors, until recently, when the collapse of pension plan funding and the new scrutiny of all corporate accounting practices highlighted corporate retirement liabilities.
Part of the blame lies with the FASB, but fault mostly falls on analysts.
The FASB invented "pension income," through which companies could recognize positive investment or actuarial experience. Unfortunately, "pension income" was not of the same quality as earnings from operations.
A recent study by two economists at the Federal Reserve Board, Washington, found stock prices of many companies in the Standard & Poor's 500 were substantially overvalued long after the stock market plunge in 2000 because investors failed to distinguish between the quality of operating earnings and lesser quality pension income.
Some companies, to their credit, tried to warn investors about interpreting pension income. Donald E. Graham, Washington Post Co. chairman and chief executive officer, said in a company annual report that pension income "is of lesser quality than the rest of our earnings ... and it is important that shareholders take note of its extent," according to a Pensions & Investments' story in 2000.
It was the responsibility of analysts to recognize the fragility of pension income and to warn investors of it. They failed miserably, possibly because they never took the time to understand pension accounting and disclosure, though it might also have been because they needed good earnings growth to justify their stock recommendations.
Analysts' failure to recognize the problems with pension income, and, indeed the larger implications of the assumptions surrounding corporate pension funds, prompts doubt as to whether they ever carefully analyze any corporate financial report footnotes.
Some money management firms now are taking steps to ensure their analysts grasp the implications of pension financials. At Putnam Investments, "the younger analysts had to be reminded that pensions are important because they don't show up on the balance sheet ..." P&I reported.
Also, three major debt-rating agencies - Standard & Poor's, Moody's Investors Service and FitchRatings Inc. - have beefed up their pension research capabilities.
The FASB is beginning to acknowledge problems associated with its pension accounting rule. It will make recommendations by the end of the year to improve corporate pension disclosure. But it has yet to tackle overhauling pension accounting itself, as some experts have called for.
The only long-term solution is for the FASB to revise pension accounting and reporting to reduce opportunities for corporations to mislead investors about their fiscal health through pension accounting rules.