Revised pension rules and the cost of debt

ABSTRACTStatement of Financial Accounting Standards No. 158 significantly changes how firms report the financial position of their defined-benefit pension plans. Under this new standard, firms must report the funded status, equal to the net of the projected benefit obligation and the fair value of their pension plan assets, on the balance sheet. As a result, prior service costs and gains or losses, previously unrecognized but disclosed in footnotes to the financial statements, are included on the balance sheet. Using a sample of firms with defined-benefit pension plans over 1999–2005, this study examines the relation between yield spreads on new debt issues and recognized or disclosed pension information. The results show that both recognized and disclosed pension information are related to yield spreads. Further, there is no significant difference in the relation between pension information and yield spreads depending on the location of pension information in the financial statements. Overall, the results suggest that bond investors utilize both recognized and disclosed pension information in their pricing decisions, suggesting little potential impact of Statement of Financial Accounting Standards No. 158 on the cost of debt.