Implications of Pension and Other Post-Retirement Benefits (OPRB) Recognition Biases on Leverage Ratio Components

The leverage ratio is a frequently used measure of firm risk, utilized by firms, analysts, and investors. However, pension and other post-retirement benefits (OPRB) are largely ignored in determining a firm’s total liabilities. Similarly, pension and OPRB assets are not accurately incorporated into a firm’s total assets listed on the balance sheets. This is largely due to intricacies in pension fund accounting under Statement of Financial Accounting Standards (SFAS) No. 87 that can cause the true pension and OPRB liabilities and assets to be masked from the financial statements. SFAS No. 158 attempted to solve this problem, but while it has certainly mitigated it, it has not succeeded in mandating that the true asset and liability numbers are incorporated into balance sheet numbers. Furthermore, the rise in life expectancy has also increased the costs and presents a burden on firms’ activities (Taussig, RD (2024). Pension expenses, risk, and implications for stock returns. Finance Research Letters, 61, 105016). In this paper, we find that the measurement error in calculating leverage ratios may be significant if the leverage ratio does not accurately reflect the off-balance sheet items. We propose two new, innovative methods to correct this bias by adjusting “Total Assets” and “Total Liabilities” to properly incorporate pension and OPRB data. Our methods are more accurate since they encompass previously ignored footnote data. The implications are far-reaching, necessitating a closer look at previous research that uses leverage ratios as a factor.