Does Mandatory Recognition of Off-Balance-Sheet Items Affect Capital Structure Choice?

Abstract

We investigate whether mandatory recognition of previously disclosed off-balance sheet liabilities affects corporate capital structure decisions. Specifically, we use the introduction of the Statement of Financial Accounting Standards No. 158 as a quasi-exogenous shock to financial reporting decisions as it requires sponsors of defined benefit (DB) pension plans to recognize the level of pension and healthcare plan funding explicitly on the balance sheet. Our findings show that underfunded DB plan sponsors decrease financial leverage following the new accounting standard. Importantly, this result obtains for subsamples of underfunded plan sponsors with tight financial covenants, those with unrated debt or with low analyst coverage. The results suggest that the mandatory financial statement recognition was sufficiently costly to warrant a change in corporate funding decisions.