Economic Consequences of Public Pension Accounting Rules

A growing stream of accounting research suggests that managers use the data reported in a company’s financial reports to make real investment decisions. We extend this idea to the public sector, investigating whether the employment decisions made by governmental entities are influenced by the reporting rules for public pensions and the discretion pension managers use in implementing these rules. In this paper, we begin by investigating the extent to which states understate their pension deficits. We find that the total reported pension deficit for state governments averages $350 billion per year over our sample period, and that this deficit grows to $2 trillion when we use the FASB’s approach and estimate the pension liabilities using Treasury yields. Approximately $500 billion of this increase is due to the use of discretion. The remainder is due to the methodology inherent in the GASB pension rule which, unlike the FASB rule, does not provide an accurate reflection of the resources needed to extinguish the pension deficit. We then provide evidence that the larger the pension deficit understatement the more likely the state government is to incur larger payrolls, hire more workers, and grant more generous retirement packages in future periods. Importantly, these results are driven both by the use of discretion and by the implementation of the GASB’s rules. Thus, even in the absence of discretion, our results highlight how the GASB’s rules can lead to an over-investment in employees, potentially exacerbating future fiscal problems. These findings should be of interest to both accounting academics and policymakers.