Public Pension Governance and Opportunistic Accounting Choice: A Politico-Economic Approach

• Author: Pierre Donatella,Odd J. Stalebrink
• Published date: 01 April 2021
• Date: 01 April 2021
• DOI: 10.1177/0275074020954397
• Subject Matter: Articles

https://doi.org/10.1177/0275074020954397

American Review of Public Administration

2021, Vol. 51(3) 227 –245

© The Author(s) 2020

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DOI: 10.1177/0275074020954397

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Article

Introduction

Unfunded pension liabilities have become a pressing fiscal

challenge for many state and local governments in the U.S.

Recent analyses suggest that only modest improvements have

been made over the last decade in terms of placing pension

plans on a sustainable funding path (Munnell & Aubry, 2016;

Prosek & Rodriguez, 2019). Moreover, those improvements

are contingent on the extent to which pension plans are able

to realize assumed long-term expected investment returns,

which is a highly contested issue. A failure to realize these

returns is problematic not only because it adversely affects

investment revenue, but also because it reduces annual

required contribution (ARC) amounts.1 The latter follows

from prevailing state and local government accounting stan-

dards, which require pension plans to use their assumed long-

term expected returns when calculating the actuarial value of

their pension liabilities. The selected rate, commonly referred

to as the discount rate, has a significant impact not only on

this value, but also on ARC amounts. The selection of the

discount rate has, as a result, become one of the most fre-

quently mentioned causes of the current public pension fund-

ing problem (Wang & Peng, 2018).

However, despite its influence on the value of pension

liabilities and ARC amounts, systematic research aimed at

determining the causes of discount rate changes has been

scant. It has been confined to a limited number of studies

that examines how various institutional, economic, and

organizational factors affect the selection of the discount

rate and other related actuarial assumptions (Brooks, 2019;

Eaton & Nofsinger, 2004; Stalebrink, 2014; Vermeer et al.,

2010; Wang & Peng, 2018). The evidence generated by

these studies indicates that the selection of actuarial assump-

tions often is driven by the pursuit of political and economic

goals, rather than accurate measurement. The literature

refers to such selection choices as either “optimistic” (Eaton

& Nofsinger, 2004; Vermeer et al., 2010) or “opportunistic”

(Stalebrink, 2014).

The purpose of this research is to further the understand-

ing of opportunistic pension accounting choices (OPAC), by

developing and testing a politico-economic model that con-

siders the role of professional gatekeepers in OPAC. The

study is conducted in the context of U.S. state-administered

defined-benefit (DB) pension plans. Explicitly stated, there-

fore, the following research question is examined: How do

954397ARPXXX10.1177/0275074020954397The American Review of Public AdministrationStalebrink and Donatella

research-article2020

1Pennsylvania State University-Harrisburg, USA

2University of Gothenburg, Sweden

Corresponding Author:

Odd J. Stalebrink, Pennsylvania State University–Harrisburg, 777 W.

Harrisburg Pike, Middletown, PA 17057, USA.

Email: ojs10@psu.edu

Public Pension Governance and

Opportunistic Accounting Choice:

A Politico-Economic Approach

Odd J. Stalebrink1 and Pierre Donatella2

Abstract

The selection of actuarial assumptions used to value state and local government pension liabilities is an important culprit of

the looming state and local pension crisis in the U.S. Due to the impact these selection choices have on the value of pension

liabilities and annual required contributions (ARC), pension plans are often said to make these choices opportunistically

for purposes of freeing up budget resources and making pension funding look better. Using empirical data on 114 state-

administered pension plans, this research shows that the likelihood of such opportunistic pension accounting choices (OPAC)

increases when the plan is underfunded, organized as a cost-sharing plan, governed by a politically embedded fiduciary body,

and when the sponsoring government is surrounded by a high degree of unionization, and is divided in terms of partisan

control. The results also show that the likelihood of OPAC decreases when a pension plan is subjected to an audit by a

Certified Public Accountant (CPA), suggesting that professional gatekeepers can play an important role in limiting the adverse

effects of OPAC behavior, including insufficient ARC payments and reduced transparency of governmental financial reports.

Keywords

public pension governance, opportunistic accounting, pension funding, discount rates

228 American Review of Public Administration 51(3)

professional gatekeepers and politico-economic factors

influence OPAC in the context of U.S. state-administered

DB-plans?

The application of a politico-economic model is helpful

when examining this question, because it captures not only

the incentives of elected officials, but also the influence that

other key political stakeholders might have on accounting

choices. Moreover, by considering the role of professional

gatekeepers, the research contributes toward focusing exist-

ing theory on a topic that has received scant attention in the

public pension context. In the literature review conducted as

part of this research, only one study was found that consid-

ered the role of auditors in combatting OPAC. Moreover, this

study, by Vermeer et al. (2010) produced findings that,

although weak, contradict the accepted theoretical idea that

audits conducted by industry specialist auditors induce mon-

itoring effects that deter organizations from engaging in

opportunistic accounting choice (Deis & Giroux, 1992; Elder

et al., 2015; Garven et al., 2018; Giroux & Jones, 2011;

Lowensohn et al., 2007). Vermeer et al. (2010, p. 535) sug-

gest that this may indicate that “. . . specialized auditors

know how to follow the rules but may ‘help’ their clients

[with OPAC] at the same time.” Our research adds clarity to

this finding by examining a broader set of gatekeeper charac-

teristics that are theorized to affect a gatekeeper’s ability to

detect and prevent OPAC, including proxies for their level of

competence and their ability to make decisions indepen-

dently. Our research also controls for the potential effect that

actuaries might have on OPAC. As noted by Chen (2018),

state pension systems are assisted by actuaries who set

assumptions in accordance with professional actuarial stan-

dards. Similar to auditors, they fulfill a gatekeeper function

and are often required to adhere to high professional stan-

dards of expertise and independence to enter their profession

(Gunz et al., 2009).

This research also makes improvements to the empirical

testing of OPAC. To minimize endogeneity, we exploit the

implementation of the Governmental Accounting Standards

Board’s (GASB) Statements No. 67 and 68 (GASB 67 and

GASB 68) as an exogenous shock that temporarily increased

the prevalence of OPAC among state and local pension plans.

Most important, GASB 67 required a large number of under-

funded pension plans to make downward adjustments to their

discount rates, unless they made sufficient improvements to

their funding policies. Such downward adjustments are politi-

cally challenging because they increase the actuarially

reported value of pension liabilities, and the size of ARC pay-

ments. ARC payments are typically funded via general funds

and as such compete directly with government programs that

serve more general and immediate needs than pension fund-

ing do (Coggburn & Kearney, 2010; Peng, 2004). The adop-

tion of GASB 68 augmented the significance of GASB 67

from an OPAC perspective, by requiring sponsoring govern-

ments to place pension liabilities on their balance sheet. Prior

to the implementation of GASB 68, these were left off the

sponsoring government’s balance sheet and reported as part

of the general long-term debt and asset account group section

of the financial report. It should be noted that GASB 68 was

implemented in fiscal year (FY) 2014/2015 and that GASB

67 was implemented in FY 2013/2014. In this research we

assume that OPAC decisions made in 2013/2014 include con-

sideration, at least partly, of the impact they will have on the

2014/2015 accounting period.

The article is organized into five major sections. The

first section explains how the adoption of GASB 67 and

GASB 68 produced new opportunities and incentives for

pension plans and sponsoring governments to engage in

OPAC, and relates these changes to prior literature. The

second section introduces the politico-economic theory of

accounting policy, and the hypotheses that are tested. The

third section describes the empirical research approach,

including data, variables and methods. The fourth section

presents the results and the analysis. The concluding sec-

tion offers a brief summary of the results and a discussion

of their policy relevance and what practitioners can learn

from the study.

Actuarial Assumptions and

Opportunistic Accounting Choice

Consistent with prior research, we define opportunistic

accounting choice as the deliberate use of accounting discre-

tion for purposes of artificially distorting measures of finan-

cial performance, including financial position (i.e., financial

health) and results (see Healy & Wahlen, 1999). While the

large majority of empirical research on this topic has cen-

tered on private firms (Dechow et al., 2010; Healy & Wahlen,

1999), several empirical studies have also been produced in

public sector contexts (e.g., Arcas & Marti, 2016; Cohen

et al., 2019; Donatella, 2020; Ferreira et al., 2013; Greenwood

et al., 2017; Stalebrink, 2007). Similar to studies conducted

on private firms, these studies have typically relied on an

agency or public choice framework, where it is argued that

public officials have incentives to use discretion in account-

ing policy, because it aids them in the pursuit of economic

and political goals.

In the public pension context, empirical work has been

built around the argument that elected officials have incen-

tives to engage in OPAC because it allows them to free up

current budget resources, and artificially improve a govern-

ment’s reported financial health. The main focus has been on

determining whether public pension plans adopt actuarial

assumptions for purposes of reducing the actuarial value of

pension liabilities. For underfunded plans, such actions

reduce the size of the unfunded actuarial liability (UAL),

thereby making the plan appear better funded. Moreover, an

improvement in a plan’s UAL increases available budget

resources, by reducing the size of ARC amounts. In brief, the

ARC is an estimate of the cost of pension benefits earned

during a fiscal year (referred to as the “normal cost” of