Executive pension, default risk, and earnings management

Abstract

The value of executive pension plans depends significantly on the incidence of bankruptcy because executive pension plans have characteristics similar to unsecured debt. These unique characteristics lead us to investigate whether managers change their firms’ accounting policy to protect their pension plans when their firms face imminent default risk. Identifying a firm’s default risk with various proxies, we find that managers with executive pension plans are more likely to engage in income-increasing earnings management during a year of high default risk as compared to managers without such pension plans. The result remains robust with the use of propensity score matching and two-stage least squares regression analysis to alleviate the endogeneity issues in our hypothesized relationships. In addition, we find that the results are more pronounced for ex-post bankrupt firms.