The Market Valuation of Accounting Information: The Case of Postretirement Benefits Other Than Pensions

The majority of empirical regulatory accounting studies on financial reporting have focused on the ex post evaluation of accounting choices (see Lev [1979] and Barth [1991] among others) after an accounting method is adopted. There has not been much research involving the evaluation of accounting methods ex ante because, it is argued, newly mandated accounting information is usually available only some time after the Financial Accounting Standards Board (FASB) has required its release. In December 1990, after lengthy and controversial deliberations, the FASB issued SFAS No. 106, Employers' Accounting for Postretirement Benefits other than Pensions (PRB) replacing the current "pay as you go" practice with a combination of present-value and accrual method. Few of the information items mandated by SFAS No. 106 has yet been disclosed earlier. Consequently, this research uses the data that were available during the time of the FASB's deliberations as an example of ex ante empirical research concerning the standard-setting process. This study uses the PRB cash payments to retirees as disclosed by firms in their footnotes to the financial statements under SFAS No. 81 (FASB 1984) to investigate whether investors underestimated the full effect of the PRB liability on firms' values. Such underestimation would occur if investors are not aware of the high rate of increase in health care costs or when future benefits' payments to current employees are partially ignored. Additionally, this study investigates whether an estimate of the present value of the PRB liability is value-relevant to investors. Finally, an analysis is made of the range and sensitivity of economic parameters (discount rate and health care cost trend rate) used by investors to estimate the PRB obligation. The results indicate that, during the period 1984-1986, investors, on average, valued each dollar of PRB cash payment in any year as a dollar; i.e., they underestimated the full consequences of firms' promise to continue making such payments in the future. During the period 1987-1990, in contrast, investors translated each dollar of PRB cash payment to an average of $13.75 PRB obligation. Further, estimating the present value of the PRB obligation with publicly available data shows that the present-value measure is value-relevant to investors in addition to the cash payments disclosed by firms.