Recognition Versus Disclosure and Managerial Discretion: Evidence From Japanese Pension Accounting

I examine the impact of disclosing versus recognizing pension liabilities on managerial discretion regarding pension assumptions, exploiting the unique Japanese accounting standard. In Japan, the current pension accounting standard requires firms to recognize pension items—actuarial gains/losses and prior service costs—in consolidated financial statements; however, firms still disclose these items in the notes when preparing unconsolidated financial statements. I find that recognition firms, those that recognize the previously disclosed pension items on the balance sheet, choose higher discount rates than disclosure firms, those that still disclose them in the notes. Further, I find that my results are driven mainly by firms with more debt-contracting incentives. Overall, my findings suggest that mandating the recognition of pension liabilities induces managerial manipulation of pension assumptions.