Cost of Equity, Pension Intensity Risk and Audit Quality: An Empirical Examination of Their Relations

Abstract

Prior research documents that markets efficiently impound pension plan risk into a defined benefit plan’s market value. This study adds to these prior works by investigating how audit quality affects the pension risk – cost of equity relation. Using proxies to measure pension intensity, and audit quality, we document that audit quality attenuates the positive relation between a sponsoring firm’s cost of equity and the scaled magnitude of the firm’s pension intensity risk. We rationalize these findings by asserting that the positive relation between a defined benefit plan firm’s cost of equity and pension intensity reflects increased financial risk associated with higher pension obligations but the quality of the auditor reduces this risk.