Fed: Pension Errors Puffed up Some S&P Stocks

June 20, 2003 (PLANSPONSOR.com) - Late 1990s stock prices for the average Standard & Poor's 500 firm with a defined benefit pension plan, were puffed up by 2% to 3% because of pension valuation errors, a US Federal Reserve study found.

The effect, according to the study, Did Pension Plan Accounting Contribute to a Stock Market Bubble?, was to distort US stock prices during the stock market bubble that lured many investors into the market only to face the run of the bears the last few years, according to an IPE news report

Fed economists Julia Lynn Coronado and Steven Sharpe also found that the market paid little attention to pension information in the footnotes of company reports, though that is now changing.

The Fed study said pension-induced distortions rose “considerably” in 2001 – “when the plunge in pension net values had not yet shown through to pension cost accruals.”

“The market appears to pay more attention to the flow of pension-induced accruals reported in the income statement that to the marked-to-market value of pension assets and liabilities reported in the footnotes. The results suggest that investors do not distinguish between these two sources or earnings, at least not in the way that one would expect in an efficient market.   If anything, the earnings associated with pension accruals appear to receive a higher valuation multiple than do core earnings,” Coronado and Sharpe wrote.  

But that appears to be changing, the economists say. “The greater scrutiny now being given to pension accounting may already have begun to induce investment professionals to differentiate between core and pension earnings and devote greater attention to pension balance sheets”

They estimate that as of early 2002, one in ten of the firms in their sample that sponsored a DB pension plan were at least 20% overvalued. They add that pension earnings accounted for almost 25% of some firms’ total expected earnings by 2001.