Abstract
We develop an analytical framework that divides the contribution of pension risk to the total systematic risk of the firm into two parts: (1) the risk due to the investment strategy of the pension plan (“Mismatch Risk”); and (2) the risk due to the funded status of the pension plan (“Deficit Risk”). We then use this framework to show that the financial statement treatment of pension plan obligations has implications for how pension risk is impounded into equity returns. Our empirical strategy uses variation in the financial statement effect of two new accounting standards as natural experiments to generate inferences. In contrast with the empirical finding in Jin, Merton and Bodie (2006), we find that pension risk is only reflected in equity returns when the underlying drivers of risk are disclosed and recognized on the firm’s financial statements.
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