2. Literature Review Throughout last decades numerous researchers have studied the important role of discount rate for pension valuations. At 1995 Gopalakrishnan et al argued that the status of the pension plan funding could influence the choice of the actuarial assumptions, particularly the discount rate. They concluded that firms with large unfunded pension liabilities and leverage are likely to choose higher discount rates to understate the magnitude of the reported liability. Peterson at this year stated that the correct discount rate should depend upon the type of risk inherent in the pension promise. In the United States, evidence from the 1980s showed that more profitable firms used lower rates of discount in assessing their future pension liabilities than less profitable ones (Bodie et al 1987). By inflating their future pension liabilities, firms were able to make larger deductible contributions, and thus lower their taxes, without reaching prescribed limits on overfunding. On the other hand, firms facing financial difficulties used high discount rates in order to understate their pension liabilities and lower their required contributions. A similar pattern was also reported for the 1990s (Asthana 1999). Godwin (1999) showed that firms with underfunded plans choose higher pension discount rates, although the difference declined over time. At 2000 Obinata investigated what factors affect the choice of pension discount rates. He showed that, the significant factor affecting the choice is not leverage, but firms’ profitability (return on equity). His results indicated that the firms, which chose lower pension discount rates, are valued higher. At 2009 Brown et al stated that using the expected return on the assets held in the pension trust as discount rate would contrast sharply with finance theory. Their paper noted that the strong constitutional and other legal benefit protections make many defined benefit pension obligations virtually risk free. If governments discount liabilities in this way, it would reveal that state and local pensions are more underfunded than is generally reported. On the other hand, Stadler (2010) analyzed pension accounting choice in Germany. He showed that firms choose the pension discount rate and the treatment of actuarial gains and losses in order to smooth the effect of inherently volatile pension numbers. Vittas (2010) recommended the use of
2. Literature Review Throughout last decades numerous researchers have studied the important role of discount rate for pension valuations. At 1995 Gopalakrishnan et al argued that the status of the pension plan funding could influence the choice of the actuarial assumptions, particularly the discount rate. They concluded that firms with large unfunded pension liabilities and leverage are likely to choose higher discount rates to understate the magnitude of the reported liability. Peterson at this year stated that the correct discount rate should depend upon the type of risk inherent in the pension promise. In the United States, evidence from the 1980s showed that more profitable firms used lower rates of discount in assessing their future pension liabilities than less profitable ones (Bodie et al 1987). By inflating their future pension liabilities, firms were able to make larger deductible contributions, and thus lower their taxes, without reaching prescribed limits on overfunding. On the other hand, firms facing financial difficulties used high discount rates in order to understate their pension liabilities and lower their required contributions. A similar pattern was also reported for the 1990s (Asthana 1999). Godwin (1999) showed that firms with underfunded plans choose higher pension discount rates, although the difference declined over time. At 2000 Obinata investigated what factors affect the choice of pension discount rates. He showed that, the significant factor affecting the firms’ choice is not leverage, but profitability (return on equity). His results indicated that the firms, which chose lower pension discount rates, are valued higher. At 2009 Brown et al stated that using the expected return on the assets held in the pension trust as discount rate would contrast sharply with finance theory. Their paper noted that the strong constitutional and other legal benefit protections make many defined benefit pension obligations virtually risk free. If governments discount liabilities in this way, it would reveal that state and local pensions are more underfunded than is generally reported. On the other hand, Stadler (2010) analyzed pension accounting choice in Germany. He showed that firms choose the pension discount rate and the treatment of actuarial gains and losses in order to smooth the effect of inherently volatile pension numbers. Vittas (2010) recommended the use of