Does mandatory recognition of off–balance sheet liabilities affect capital structure choice? Evidence from SFAS 158

Abstract

The Statement of Financial Accounting Standards (SFAS) No. 158 mandates the recognition of previously disclosed off–balance sheet liabilities (OBLs) for sponsors of defined benefit (DB) retirement plans. This recognition significantly increases reported liabilities, with notable variation across DB plan sponsors. We find that unrated DB plan sponsors reduce financial leverage following OBLs recognition, driven by net debt retirements and net equity issuances. These adjustments appear optimal because they bring firms closer to their estimated leverage targets. In contrast, DB plan sponsors with tight, floating-GAAP covenants also reduce financial leverage, primarily through net debt retirements. The evidence suggests that on–balance sheet reporting requirements impact capital structure decisions through a rating or a covenant channel.