Do Japanese firms systematically inflate expected rate of returns from defined benefit pension plans?

Abstract

Japanese firms systematically inflate expected rate of returns (ERRs) on pension assets relative to several benchmark rates including actual rate of returns (ARRs), historical ARRs, and future expected ARRs. The Accounting Standard Board of Japan began requiring firms to disclose asset allocation in 2013. With asset allocation data, we are able to infer the implied equity returns assumed by managers to be 6.61% per annum. The implied cost of equity from the Gebhardt, Lee, and Swaminathan (2001) model is 5.47% per annum. The difference is highly significant. Japanese managers are more optimistic about equity returns in their pension assets than what typical market investors anticipate from the stock market. We finally construct accrual-based earnings opacity measures and find that Japanese firms with more opaque earnings are more inclined to manage pension parameters to boost reported earnings.