Several times, we have written about the Financial Accounting Standards Board's proposed renovation of its standards for pensions and other post-retirement benefits, mostly in support of its initial modest proposal to move the off-balance-sheet assets and liabilities onto that statement. To avoid controversy, FASB is leaving the expense untouched for now, but will thoroughly reconsider it in Phase Two of this project.Despite this caution, the comment letters show that this go-slow approach certainly has not sheltered FASB from the same self-serving, inane arguments that were offered up two decades ago.
As we see it, like psychologists who force troubled patients to confront their worst fears, FASB has once again made management come to grips with their pensionaphobia, which, simply put, is the fear of telling the truth about one's own pension plans. For years, managers pretended that the fabricated numbers in the statements were authentic, and ignored the relevant (and revealing) numbers hidden away in arcane footnotes where they don't have to be explained in earnings calls and releases.
It comes as no great surprise that these managers continue denying their neurosis. The consequence is that FASB once again is receiving comment letters that offer up irrational, even foolish, resistance to its proposal. As we see it, pensionaphobia is a complex syndrome that comprises several other phobias described below.
One component of pensionaphobia is the intense fear of reported liabilities. Strangely enough, managers who suffer from liabilitaphobia actually love going into debt, but are deathly afraid of reporting the obligations on their balance sheets. The phobia manifests itself in pensions and OPEB plans, of course, but we also see it in their willingness to enter into sophisticated leases that avoid capitalization. Another long-time favorite manifestation is derivative liabilities, particularly stock options.
The best cure for liabilitaphobia is a large dose of common sense mixed with responsibility. If they're going to enjoy the benefits of liabilities, then they have to face reality and report their existence, their size and their impact on earnings. Who knows, once they come to grips with their risks, they might not want to have so many of them ... .
What happens if this condition isn't treated? These delusional managers vainly hope that the capital markets will reward their seemingly sound fiscal management, as evidenced by their misleadingly low reported debt to equity ratio. As it turns out, though, the markets know that real liabilities are missing from balance sheets, and management's lack of forthright reporting depresses stock prices - just the opposite of what they want.
FASB's March 2006 exposure draft has provoked the formerly rare PBObaphobia, which is the abject fear of the projected benefit obligation measure of pension liabilities. The need to use the PBO, which incorporates expected future salaries, arises because management promised to pay defined benefits based on future salaries, even though employees worked with lower salaries in the past.
This provision of defined-benefit plans makes them different from defined-contribution plans. Under DC plans, employers incur an expense equal to a percentage of today's salaries. Under DB plans, employers incur expense equal to a percentage of future salaries. The resulting costs and obligations are obviously different, and financial statements would not be reliable if they didn't reflect that difference.
In producing SFAS 87 on DB plans, FASB opted to use the PBO for most purposes, using the accumulated benefit obligation (ABO), which is based on current salaries, for only the minimum liability provision. For 20 years, the difference has been a non-issue. But now that FASB intends to reflect underfunded liabilities on the balance sheet, a great many managers have suddenly grasped that the ABO is the liability's only true measure. (There is a strange similarity in their comment letters, which looks to us like someone inspired these folks. They use similar language, for example, and they refer to the liability definition in the conceptual framework.)
They also claim they can instantly wipe out the liability and settle it at today's balance. To them, the arguments must seem convincing. But to those of us who didn't just discover the framework, they are naive.
As we said, there is significant difference between paying a percentage of a future salary instead of a present salary. Because of management's absurdly risky open-ended promise to pay an unknown amount, the only way to produce faithful measures is to predict likely future salaries.
The pension obligation is simply understated by the ABO, because it is produced under the assumption that the future payments will be based on today's salaries. (Incidentally, Paul Miller went through this issue more than 20 years ago with a national firm partner who was in his cups on the occasion of an after-dinner speech in New Jersey. Paul mistakenly attributed the person's fervor to his alcohol haze, without recognizing it as an early case of PBObaphobia.)
With regard to managers' newfound affinity for reporting liabilities at their settlement amount, we wonder whether they're now willing to report their bond liabilities and accounts payable at their settlement values, too. Further, if they like settlement values for liabilities, logic demands that they should also report their assets at liquidation values. In their shortsighted haste to make a point on pensions, they have thrown their support behind market-value accounting. Now isn't that ironic?
A large proportion of comment letters plead with FASB to delay liability recognition to avoid putting the writers' firms in jeopardy of violating loan covenants. They suffer from covenantaphobia, which is the fear of being discovered to have violated binding contracts.
We are resolute in condemning this argument as unethical. Debt covenants are imposed on borrowers by creditors to ensure that the former don't endanger the latter's ability to collect. There is no trustworthiness in borrowers who plead with FASB to keep the truth under wraps a little longer so that they can continue to mislead their creditors. Covenants can be effective only when both parties know the full truth. It cannot be FASB's business to harm creditors by hiding liabilities.
If covenants have been violated, it's because borrowers went too far into debt, period. Let the truth be revealed and let the chips fall. Neutrality demands that the board turn a deaf ear to covenantaphobes' anguished cries.
Another pension-related syndrome is volatilaphobia, the abject fear of volatility. This is the most destructive of them all, and is the main source of the really bad practices in SFAS 87 and 106.
FASB's pity on volatilaphobes is a prime reason why it created the original convoluted reporting model in the first place. The present board is temporarily caving in to the same pity in its decision to leave the expense smoothing practices intact, at least for now. Although the idea behind the two-phase project was to avoid controversy, the opponents of change are still objecting.
Unfortunately, their volatilaphobia is so intense that they can't see that FASB's forbearance won't last. The current board members are united on these issues, and we expect the Phase Two standard to shake things up pretty thoroughly. Of course, it will be tempting for the board to slip in a temporary compromise or two to assuage the complainers, but they know that would not be a good idea.
It turns out that pensionaphobia and all its sub-phobias are manifestations of a broader and totally destructive neurosis that we call veritasaphobia. (Latin scholars and Harvard grads will recognize that "veritas" means "truth.") Indeed, we find that virtually all complaints against the board's proposal grow out of managers' fear of letting the truth be known. Bad accounting has allowed them to pretend they weren't in debt and that the annual expense isn't volatile. That condition must come to an end, now.
The best antidote to veritasaphobia would be a widespread infusion of fibbaphobia, which used to be prevalent when accounting was a noble profession instead of a pandering service industry. This phobia is simply the fear of fibbing, which is not telling the truth to avoid negative consequences for your poor decisions.
A lot of us developed fibbaphobia as youngsters, through repeated applications of belt and switch, but apparently that teaching wasn't universally applied, because fibs are part of not only pension accounting but virtually every other area of financial reporting. This is all the more reason to pity the sad state of ethics for preparers and auditors, and that's no fib.
Paul B. W. Miller is a professor at the University of Colorado at Colorado Springs and Paul R. Bahnson is a professor at Boise State University. The authors' views are not necessarily those of their institutions. Reach them at email@example.com.
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