Readability of Pension Narrative Disclosures, Pension Regulatory Changes, and Corporate Credit Risk

Abstract

We examine, using corporate bond yield spreads, whether and how the readability of pension narrative disclosures is associated with corporate credit risk. The empirical results show that lower readability of pension narrative disclosures is associated with higher bond yield spreads. This association is driven by theoretical mechanisms, including incomplete information, asset value volatility, and financial leverage. The implementation of SFAS No. 132R-1 and the Pension Protection Act (regulatory mechanisms) has strengthened this association. We also consider two potential mechanisms that weaken the association between the readability of pension narrative disclosures and bond yield spreads: bond seniority and collateralization and shorter duration of debt to pension liability. Furthermore, our results show that pension plan size strengthens this association, whereas the funded status, actual return on pension assets, and equity allocation of pension assets weaken this association. Lastly, the results still hold when considering endogeneity issues, controlling for the tones and the length of pension narrative disclosure, employing difference-in-differences analysis, and examining firms with defined-benefit pension plans only or those with newly issued bond observations.