Standards or incentives: What determines financial reporting transparency for defined benefit pension assets?

We examine whether regulation intended to improve disclosure can itself lead to higher disclosure quality in the absence of a change in preparer incentives. We exploit a setting involving a sequence of two similar regulatory changes, which have one key difference – while both regulatory changes mandate improvements to disclosure (specifically, on pension asset allocation), only one removes preparer incentives to disclose opaquely (by eliminating a key reporting assumption – the expected rate of return on pension assets or ERR, which can be more effectively manipulated if asset allocation remains opaque). We construct two difference-in-difference (DD) research designs to examine the disclosure consequences of each of these changes mandating more transparent disclosures on pension assets((i) a 2008 rule change under US GAAP and (ii) a 2011 rule change under IFRS), and examine the difference in disclosure outcomes between these two changes. We find that the IFRS disclosure standard, which also removes preparer incentives to obfuscate asset allocation, is effective at improving pension asset transparency as intended by the standard, whereas the US standard, which solely mandates better disclosure while leaving unchanged preparer incentives to disclose or obfuscate, is not as effective at improving pension asset transparency. Using a setting in which firms have a welldocumented incentive for lower financial reporting quality (i.e., incentives to manipulate the ERR so as to lower pension expense and boost reported income), our findings reinforce the view in the “standards versus incentives” literature that accounting quality cannot be improved effectively with higher-quality standards alone; preparers’ incentives must work in concert with higher-quality standards to pull firms towards more transparent reporting.