US – A study by two economists at the US Federal Reserve has found that “pension-induced valuation errors” distorted US stock prices in the late 1990s stock market bubble.

It also found that the market paid little attention to pension information in the footnotes of company reports, though that is changing.

“The simulations suggest, for the average firm in the Standard & Poor’s 500 with a DB defined_benefit plan, pension-induced valuation errors added two to three percentage points to the stock price during the late 1990s,” says the 37-page report by the Fed’s Julia Lynn Coronado and Steven Sharpe.

But it said pension-induced distortions rose “considerably” in 2001 – “when the plunge in pension net values had not yet shown through to pension cost accruals.”

“The market appears to pay more attention to the flow of pension-induced accruals reported in the income statement that to the marked-to-market value of pension assets and liabilities reported in the footnotes.

“The results suggest that investors do not distinguish between these two sources or earnings, at least not in the way that one would expect in an efficient market.

“If anything, the earnings associated with pension accruals appear to receive a higher valuation multiple than do core earnings.”

But that appears to be changing, the economists say. “The greater scrutiny now being given to pension accounting may already have begun to induce investment professionals to differentiate between core and pension earnings and devote greater attention to pension balance sheets”

They estimate that as of early 2002, one-tenth of the firms in their sample that sponsored a DB pension plan were at least 20% overvalued. They add that pension earnings accounted for almost 25% of some firms’ total expected earnings by 2001.

Coronado and Sharpe are economists in the Fed’s Division of Research and Statistics. Their report is titled “Did Pension Plan Accounting Contribute to a Stock Market Bubble?”

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