Chapter 17 competition among pressure groups over the determination of UK pension fund accounting rules

CHAPTER 17 Competition among Pressure Groups over the Determination of U.K Pension Fund Accounting Rules Paul John Marcel Klumpes and Stuart Manson CONTENTS 17.1 I ntroduction 17.2 Theoretical and Institutional Background 17.2.1 Pr ior Research 17.2.2 Overview of Institutional Setting 17.2.3 The oretical Antecedents 17.3 Competition among Pressure Groups for Political Influence 17.3.1 A uditors 17.3.2 P ension Management 17.3.3 Accounting Standard Setting Body 17.4 Data Selection and Variable Descriptions 17.4.1 S ample Selection 17.4.2 V ariable Descriptions 390 393 393 395 398 401 401 402 403 405 405 406 389 © 2010 by Taylor and Francis Group, LLC 390 ◾ Pension Fund Risk Management: Financial and Actuarial Modeling 17.5 E mpirical Tests 17.5.1 Results—Adoption Period 1996–1997 17.5.2 Results—Retention Period 2002–2003 17.6 C onclusion References 410 411 411 413 15 T his ch a pter a na l yz es co mpet iti on a mong p ressure g roups f or political i nfluence o ver t he de velopment o f acco unting r ules a nd examines i ts i mplications f or u nderstanding t he f orm a nd co ntent o f legally en forceable r egulations t hat g overn financial r eporting b y U K pension fund managers Pension management, auditors, and accounting standard setting bodies are predicted to apply political pressure in order to affect the final form of government regulation of the accountability of pension f unds These p ressure f unctions, i n t urn, a re a pplied t o sec ure political influence over the form and content of financial reporting that is incorporated into government legislation in two separate reporting periods We discriminate between private interest and public interest explanations for the determination of financial reporting rules Consistent with a private interest perspective, the audit profession and pension management exert most pressure in the adoption period Consistent with a public interest perspec tive, t he accounting st andard se tter applies most pressure i n the retention period Keywords: Pressures, pressure groups, accounting rules JEL Classifications: G2, L3, M4 17.1 INTRODUCTION The t raditional “ public i nterest” v iew o f t he g overnment r egulation o f business organizations is based on the assumption that the government’s objective is to maximize social welfare Such activities are justified in order to overcome the apparent failure of free markets to deal with problems of consumer detriment arising externally, economies of scale, imperfect i nformation, a nd i nadequate ma rkets f or r isky o utcomes, a nd a lso because of the problem of the maldistribution of wealth However, an alternative “public choice” view of the government regulation of business organizations questions the assumption that business organizations regulation is inherently different from other markets It suggests instead that politicians and regulators seek to maximize and secure their own welfare through imposing taxes and conferring subsidies Under this view, the © 2010 by Taylor and Francis Group, LLC Determination of U.K Pension Fund Accounting Rules ◾ 391 government regulation is only justified to the extent that it reduces or eliminates costs associated with observed market failure and the delivery of these services This view leads to claims that the financial regulation incurs costs that are primarily borne by consumers and taxpayers, which probably exceed the benefits they receive and that regulation favors the politically powerful In common with other types of not-for-profit organizations, pension funds hold monies in trust that are relevant to various constituencies, whose values and interests may conflict with one another (Hofstede, 1981) An important issue in this political process is the role of pressure groups in exerting control over t he flow o f financial i nformation about t he c urrent pension f und management’s performance in order to secure the accountability of a pension fund t o it s c onstituents These pre ssure g roups c omprise pr ivate i nterests, such as the U.K audit profession, as well as pension management, comprising pension industry associations a nd pension professionals (i.e., actuaries a nd administrators) We posit that the United Kingdom’s nominated pension fund accounting standard setting body (the Pension Research Accounting Group or PRAG) developed competing v iews as to how a pens ion f und’s position and per formance is to be r eported a nd measured The pressure g roups a re assumed to face both political and economic incentives to influence government regulatory agencies that can determine the form of pension fund financial reports that is formally enacted by the government pension legislation.* Economy-oriented li terature e xamining t he im pact o f a ccounting regulation s pa id m uch a ttention t o ex amining t he eco nomic co nsequences of n ew accounting r ules (e.g., B enston, 1969) or i ncentives facing corporate ma nagers to engage i n lobbying ac tivities (e.g., Watts a nd Zimmerman, 1978) Other social science–oriented research focuses more broadly on analyzing how the internal dynamics of standard setting bodies have antecedents in a broader social and economic environment (Burchell et al., 1980) Yet elements of both these research traditions must be combined t o u nderstand t he b roader po litical p rocesses su rrounding t he development of pension accounting rules Analyzing co mpetition a mong m ultiple p ressure gr oups o ver t he determination of U.K pension accounting rules provides two new major * Rue a nd Tosh (1987) a rgue t hat t he p ension a ccounting s uffers f rom t he u nit pro blem, whereby t he selection of t he scope or p erspective f rom which to appl y measurement a nd recognition c onventions i s pro blematic The u nit pro blem i s f undamentally re levant to discriminating a mong a lternative p erspectives a bout t he n ature a nd s cope of p ension commitments b ecause t hey t end to a dopt e ither a n i ndividual or a ggregate p erspective (Klumpes, 2001) © 2010 by Taylor and Francis Group, LLC 392 ◾ Pension Fund Risk Management: Financial and Actuarial Modeling insights into t he existin g literature t hat s eeks t o exa mine p olitical ac tivity a nd acco unting r egulation Fir st, in t he co ntext o f U K p ension accounting, industry-specific government legislation (Pensions Act 1995 and Dis closure Regula tions), ther t han co rporate s ecurities la w, s ets out a nnual r eporting r equirements f or p ension f unds F urthermore, t he United K ingdom’s Accounting S tandard B oard (AS B) al though f ormally setting generally accepted accounting principles (GAAP) for U.K pension funds delegates t he p ower to s et a st atement of t he recommended practice (SORP) to the PRAG, an industry-based association Thus, PRAG, as industry standard setter, is also a pressure group that competes with other narrow industry groups in o rder to attain ultimate government endorsement o f t heir acco unting r ule-making p rocess S econd, ma nagerial discretion o ver acco unting p olicy c hoices a nd dis closure decisio ns ca n b e effective sources of pressure, which empowers those subject to accounting rules to exert political influence over their legal enforceability This chapter analyzes how powerful special-interest groups that lobby accounting rule-making bodies can translate their expenditures into political influence over government-sanctioned, and thus legally enforceable, accounting regulation It applies a m odel of competition a mong multiple pressure groups originally developed by Becker (1983) to analyze the sources of political pressures A primary source of these pressures is the economic and political accountability processes by which these groups attempt to develop competing accounting standards in an attempt to secure their political credibility These standards in turn codified different interpretations over the nature and ownership of the pension fund surplus among the various pressure groups.* We predict that auditors, pension management, and accounting rule-making bodies all had incentives to influence both the adoption and the retention of the U.K pension fund disclosure regulations Consistent with a private interest perspective, t he audit profession a nd t he pension ma nagement a re posited to apply the most pressure over accounting regulation in the adoption period Consistent with the public interest perspective, we predict that PRAG is most influential in the retention period The sample comprises 54 matchpaired U.K pension schemes voluntarily producing accounting reports in the periods 1996–1997 and 2002–2003 Our findings are consistent with our predictions in the adoption period only; the accounting standard setting body (PRAG) appeared to exert most influence in the retention period * Empirical studies of accounting policy choice and lobbying behavior typically not address the bro ader p olicy qu estion of w hether s uch b ehavior a ctually i nfluences t he subs equent course of accounting rule development © 2010 by Taylor and Francis Group, LLC Determination of U.K Pension Fund Accounting Rules ◾ 393 The rest of t his chapter i s organized a s follows S ection 17.2 provides the theoretical background to the study Section 17.3 briefly outlines the main p ressure g roups Section 17.4 d iscusses va rious fac tors t hat a ffect the p ropensity t o a pply p ressure f or po litical i nfluence o ver acco unting rules Section 17.5 de scribes t he s ample a nd de velops em pirical p roxies for attempts by groups to exert political pressure and their success in garnering political influence over pension plan financial reporting rule-making activity Section 17.6 presents t he statistical procedures and primary results Section 17.7 concludes this chapter 17.2 THEORETICAL AND INSTITUTIONAL BACKGROUND This section briefly gives an overview of the theoretical and institutional background underlying the subsequent analysis of the development of pension fund reporting rules in the United Kingdom Section 17.2.1 reviews prior research, Section 17.2.2 outlines and justifies the institutional setting used to a nalyze competition a mong pressure g roups, a nd Section 17.2.3 introduces the theoretical antecedents 17.2.1 Prior Research Two apparently contradictory research paradigms have sought to explain the political processes underlying the development of accounting regulation These i n t urn m otivated em pirical r esearchers t o de velop a nd te st competing explanations for the determination of accounting rules Each of these paradigms assumes that the process of accounting standard setting is subject to a single, dominating pressure group For ex ample, Watts a nd Z immerman (1978) (WZ h ereafter) assume that corporate managers are self-interested and that their own lobbying behavior i s primarily motivated by sel f-interest Their st udy st imulated a large body o f literature t hat examined t he factors a ffecting t he choice of accounting methods in corporations (e.g., Hagerman and Zmijewski, 1979; Bowen et al., 1981), municipalities (Zimmerman, 1977), and public sector pension funds (Stone et al., 1987) Accounting is viewed by WZ as a product of r ational dec ision ma kers a nd a s a m echanism for controlling potential conflicts of interest between principals (e.g., pension plan participants) a nd t heir agents (i.e., pension scheme ma nagers) WZ r ely on an underlying economic theory of regulation, which assumes that politicians a nd r egulators a ttempt t o ma ximize t heir o wn sel f-interest This assumption provides both a theoretical basis for analyzing corporate managers’ discretion over accounting policy choices and enables positive © 2010 by Taylor and Francis Group, LLC 394 ◾ Pension Fund Risk Management: Financial and Actuarial Modeling accounting theory (PAT) researchers to adopt an agency theory of the firm to develop theories of accounting practice (WZ, 1986) The economic theory of regulation upon which WZ based their analysis had been developed by an earlier generation of economists (Stigler, 1971; Pelzman, 19 76) This theory depicted corporate managers as essentially driving r egulatory p rocesses; t he po tential i nfluence o f o ther p ressure groups in shaping accounting rule development tended to be ignored Politicians a re a ssumed m erely t o r espond o nly t o t he p ressures o f t he corporate management interest group who are seeking to secure political influence over attempts to regulate their accounting practices However, WZ (1986, p 112) acknowledge that this assumption is limited and that there is a need for further theory to model explicitly competition among interest groups for political influence An a lternative soc ial sc ience a pproach t o u nderstanding t he po litics surrounding acco unting r ule-making p rocesses su ggests t hat po liticians u ltimately ch oose acco unting a nd a uditing st andards a nd d isclosure requirements that favor the politically powerful (e.g., Benston, 1969; Walker, 1987) This literature employs case studies to explore the regulatory space occupied by pressure groups in influencing the standard setting process (Hancher and Moran, 1980; Young, 1994) It emphasizes the role of public policy in “correcting” market failures This public interest perspective recognizes the complexity of the formation of agendas and of standard setting, particularly by examining the situation of the standard setting body and its social and historical contexts (Burchell et al., 1980; Hopwood, 1983) Viewing accounting standard setting as a political process, with its sensitivity to environmental pressures and the pursuit of legitimacy affords important insights into the behavior of such pressure groups (Fogarty, 1998) This characterization of accounting regulation a lso places st andard se tting ac tivities w ithin t he broader political arena (Hope and Gray, 1982; Cooper and Sherer, 1984; Hussein and Ketz, 1991; Fogarty et al., 1994) The setting of agendas for standard setting c ommittees i s e videnced in t he l obbying a ctivities o f in terested parties (Sutton, 1984; Gorton, 1991) These disparate economic and social science views about the nature of the accounting standard setting process can be reconciled by recognizing that each perspective assumes that a single powerful pressure group effectively determines the political processes that underlie the development of accounting r ules A n a lternative, more sophisticated perspective instead views legally enforceable accounting rules as being ultimately determined © 2010 by Taylor and Francis Group, LLC Determination of U.K Pension Fund Accounting Rules ◾ 395 as o utcomes o f co mpetition f or po litical i nfluence a mong a n umber o f influential pressure g roups B ecause a ll of t hese g roups a re ex perienced in political lobbying, t he de termination of accounting r ules i s t herefore ultimately determined by their relative success or otherwise in their ability to both garner economic pressure and effectively convey their views to gatekeepers, in order to ultimately secure political influence over the pension reporting rule-making process.* 17.2.2 Overview of Institutional Setting Prior to t he 1990s, pension f unds were not required by either st atutory law or professional accounting standards to prepare formal accounts In 1997, t he P RAG p repared a r evised SO RP, wh ich l egally r equired U.K pension f unds to report t heir net assets at market va lue—in contrast to the situation facing U.K shareholders Efforts made to develop standardized rules for pension financial reporting of the ownership rights (i.e., to resolve disputes over their entitlement to the pension plan’s net surplus or deficits) therefore potentially impact the economic and political interests of a wide and diff use range of pressure groups analyzed by Becker (1983); for example, pensioners, corporate sponsors, corporate accounting rulemaking bodies, and employees.† Analyzing competition among pressure groups c an t herefore p rovide u seful i nsights i nto t his i ssue bec ause (1) alternative, v alue-relevant d isclosure a nd/or me asurement c hoices a re available; (2) these choices can in turn affect a pressure group’s propensity to apply political i nfluence; (3) t he st ructure of t he pension accounting standard setting process and incentives for producing pressure in order to obtain political influence are interdependent; and (4) political influence over the determination of accounting standards can be empirically proxied by political influence and pressure functions as modeled by Becker.‡ Industry pressure groups and accounting rule-making bodies have developed s ubstantially d iffering i nterpretations abo ut h ow pens ion assets a nd/or l iabilities should be m easured, a nd t he ex tent of financial * Klumpes (1994a) reports that these liabilities were excluded from the balance sheet recognition requirements of competing industry-developed standards, which were sanctioned by government regulations for the annual preparation of membership financial reports † Becker (1983, p 371) claims that this model unifies the view that regulation (e.g., accounting standard setting) activities correct market failures with the alternative view that they favor the politically powerful: both are produced by the competition for political influence ‡ Becker’s (1983) model has been applied to model political game plays between various pressure groups that seek to exert political influence over the outcome of congressional reviews of U.S business organizations regulation (Krosner and Stratmann, 1996) © 2010 by Taylor and Francis Group, LLC 396 ◾ Pension Fund Risk Management: Financial and Actuarial Modeling TABLE 17.1 Alternative Financial Reporting Standards Available to U.K Pension Funds Issuing authority Form of standard Issue date Effective date Assumed concept of pension fund net surplus Relevant pressure group Financial reports to be produced Financial Reporting by Pension Plans (Revised SORP 1) IndustryRecommended Guidelines (IRG) Pensions Research Accounting Group Revised statement of recommended practice 1996, revised 2002 Reporting periods ending on or after April 6, 1997 Spin-off or termination value of assets (market value of assets) but going concern valuation of liabilities (discounted using an actuarial determined rate of interest) Pension fund trustees Accounting Standards Committee Statement of recommended practice (1986) 1986 Reporting periods ending after April 1997 Going concern valuation (actuarial value of assets less the actuarial value of liabilities, determined in accordance with actuarial estimates of the long run return on assets) Employer sponsors Fund account Net assets statement Statement of net assets Statement of changes in net assets available to pay benefits Revenue account disclosures p rovided t o m embers ( Klumpes, 1994a) Table 17.1 su mmarizes the positions of the two pressure groups on U.K pension plan financial reporting, which are briefly explained in more detail in the rest of this section The ownership of pension f unds i n t he United K ingdom is governed by the unique agency relationships between trustees and delegated professional ma nagement t hat a re r esponsible f or e ssential ad ministration and investment functions Consistent with prior research, it is assumed that sponsoring firm shareholders own both pension assets and liabilities (e.g., Landsman, 1986), and hence their interests are also assumed to be compatible with those of pension management.* * The role of t he employer sponsor i n U.K pension f und accounting standards is somewhat ambiguous, since firm cash flows are not directly affected by pension fund financial reporting For DBPPs, employer sponsors face incentives that are both compatible (i.e., provide retirement income insurance) and incompatible (i.e., confl ict over the ownership of surplus/ deficit) with that of their employees © 2010 by Taylor and Francis Group, LLC Determination of U.K Pension Fund Accounting Rules ◾ 397 These relationships are economically significant since pension funds in aggregate hold more equities than individual investors in many international financial markets (Davis, 1995) and involve a number of participants For example, pension fund trustees pay managerial expenses and fees for the delegated administration and investment services provided to pension funds by pension professionals, such a s ac tuaries a nd auditors (Klumpes and McCrae, 1999) Another important interested party is pension management whose main concern is managing the vast assets under their control and wh om a re a ssumed t o be sel f-interested a gents wh ose a im i s va luemaximizing their fee income derived from operating the pension fund This institutional setting bears on the analysis of the determination of pension f und financial reporting rules because auditors, pension management, and PRAG may significantly influence a del egated pension f und manager’s attitude toward the political visibility in adopting or retaining certain pension fund financial d isclosures P ension ma nagement first d eveloped i ndustryrecommended guidelines (IRG) for annual reporting to participants in 1986 (Klumpes, 1994b) Unlike the SORP subsequently developed by PRAG, IRG constituted “best practice” reporting standards and were not enforceable However, a fter t he Ma xwell pens ion sch eme f raud wa s d iscovered in 991, t he adeq uacy o f t he ex isting, sel f-regulated r eporting a rrangements affecting U.K pension funds was criticized in public enquiries into the financial accountability of pension fund managers to participants (Klumpes, 1994a) These i nquiries p roposed t hat f ully a udited financial statements be included in annual participant reports (Klumpes, 1993) In the United Kingdom, the original SORP (pension scheme accounts), issued in 1986, asserted that pension fund assets and liabilities are subjective actuarial estimates that were beyond the scope of the scheme’s accounts Subsequently, PRAG sought to update the SORP to improve the usefulness and intelligibility of the annual report by incorporating robust, externally credible market valuations of pension fund assets (but not their liabilities) An exposure draft (ED) of the revised SORP was published by PRAG in September 1995 Following an invitation for further comment on a range of issues, the final version of the revised SORP was published in September 1996 The revised SORP was subsequently mandated by U.K government legislation u nder t he Pension Di sclosure Reg ulations of 1997 W hile t he SORP was further amended to include reference to ongoing developments in the U.K GAAP during 2002, long-term pension liabilities were still not incorporated into t he financial st atements o f pens ion p lans; de spite t he U.K GAAP requiring this for employer sponsors’ financial statements © 2010 by Taylor and Francis Group, LLC 398 ◾ Pension Fund Risk Management: Financial and Actuarial Modeling U.K pensions legislation now requires that the board of trustees responsible for managing pension funds comprises equal representation by both their employee (to whom auditors, who must comply with accounting standards, are ultimately accountable) and employer pressure groups (to whom pension management, who may seek to voluntarily comply with IRG, are accountable) These institutional features are important for a number of reasons First, the form a nd t he content of financial statements can have a ma terial a nd noncosmetic effect on how these interests are represented, that is, how the pension fund net surplus or deficit is measured Second, differing views can also critically affect the employer sponsors’ funding and asset allocation policy Thir d, there was a o ne-time, nonreversible voluntary switch available to adopt t he competing accounting standards during an extended transitional period.* 17.2.3 Theoretical Antecedents The a nalytical f ramework em ployed i n t his cha pter r elies o n B ecker’s (1983) t heory o f co mpetition a mong pressure g roups f or po litical i nfluence This theory seeks to reconcile the opposing views that the government corrects market failure with the view that they favor the politically powerful Instead, it is assumed that both are produced by the competition f or po litical fa vors C onsequently, a nalyzing t he cost s a nd ben efits of financial s ervices re gulation d iffers subst antially f rom t hat o f p rior researchers Furthermore, this view ignores the extrinsic or intrinsic benefits of regulation a nd t he endogeneity of a r ange of soc ially i nfluenced costs and benefits that can significantly vary among groups Consistent with the U.K government’s notion of a stakeholder society, this chapter assumes instead that relevant costs and benefits are not objectively determined but are subject to influence by multiple pressure groups that compete for taxes and subsidies that arise from any politically determined regulatory system Thus, understanding the nature and dynamics of this political equilibrium is necessary in order to approximate the magnitude and the incidence of a wider range of socially influenced costs and benefits associated with any regulatory change This insight is based on the economic theory of regulation (Becker, 1983), which recognizes that any regulatory change is subject to a po litical process in which some groups (e.g., intermediaries) receive benefits that are effectively paid for by costs imposed on other groups (e.g., investors) Politicians and rule-makers are * Standards for pension fund financial reporting were subsequently mandated by government regulation (Pension Act, 1995) pension laws © 2010 by Taylor and Francis Group, LLC 404 ◾ Pension Fund Risk Management: Financial and Actuarial Modeling politicians (Hirschleifer, 1976) However, in most democratic societies, regulatory a gencies o perate sepa rately f rom, a nd n ot a lways i n t he be st interests of, politicians (Mitnick, 1980) We model overall political influence as those economic and political factors a ffecting a pens ion f und ma nager’s policy to provide pension fund d isclosures i n a nnual f inancial r eports ( POLICYi) C onsistent with prior accounting literature, it is assumed that PRAG has incentives to i ssue o r r evise i ts SO RP o r i nfluence pens ion r eporting i n o ther ways Direct pressure is a lso applied by the audit profession v ia audit fees and pension management via expenses and related delegated monitoring costs PRAG c an p rimarily ex ert po litical i nfluence v ia t heir d iscretion over t he eq uivalent v oluntary d isclosure o f pens ion o bligations t o their employees i n t heir own fi nancial statements (PASi) Auditors a nd pension management also seek to obtain political influence directly through revealing the performance-related information about the level of ex penses pa id f or t he p rovision o f fi nancial i ntermediated se rvices from the pension fund’s own financial resources (FEEi and COSTi) and indirectly t hrough t he l evel o f acco untability p roxied b y t he ex tent o f voluntary a ctuarial i nvestigation re port i nformation re vealed by t he pension funds (DISCLi) Finally, political visibility proxied by fund size must be controlled for in disclosure policies (SIZEi) Combining t hese factors into equation form, the following generalized political influence function is hypothesized: POLICYi = f ii (SIZEi , FEEi , COSTi , PASi , DISCLi ) (17.7) In summary, Equation 17.7 predicts that direct sources of pressure in the form of pressure by PRAG over accounting standards for reporting (via DISCL and PAS), together with fees paid directly to auditors (Equation 17.5), as well as costs incurred by delegated pension management in securing this accountability relationship (Equation 17.6), are credible sources of political pressure functions produced by special interest pressure groups These pressure functions in turn then combine with both pension funds’ accounting policy choices and the disclosure of financial information to members to determine a regulatory agency’s discretion over the form and the co ntent o f g overnment-mandated a nd l egally en forced acco unting regulation (see Figure 17.1) © 2010 by Taylor and Francis Group, LLC Determination of U.K Pension Fund Accounting Rules ◾ 405 Sources of pressure Pressure functions Political influence PAS INVRISK FEE (Equation 17.5) POLICY (Equation 17.7) MATRISK COST (Equation 17.6) DISCL LNSIZE FIGURE 17.1 Graphical representation of Equations 17.5 through 17.7 This diagram represents t he assumed relationship between various sources of pressure exerted b y t he p ension i ndustry t hat t ranslate i nto p ressure f unctions r elated to t heir fees (Equation 17.5) a nd t he accounting standard setter t hat t ranslates into a pressure function related to information production costs (Equation 17.6) These p ressure f unctions i n t urn a re a ssumed to r esult i n t he a bility to e xert political i nfluence o ver t he de termination o f p ension ac counting s tandards (Equation 17.7) 17.4 DATA SELECTION AND VARIABLE DESCRIPTIONS This section explains the sample selection and describes the data used to test t hese h ypothesized r elationships i n a cha nging U K pens ion f und reporting environment 17.4.1 Sample Selection The sample was selected on the basis of a t hree-step procedure First, the sample was chosen to be representative of the population of U.K pension funds The s ample per iod w ere t he y ears wh en t he co mpeting acco unting r ules w ere i ssued, b ut n ot y et f ully i mplemented, t hus a llowing f or managerial discretion over accounting policy and disclosure policy The sample wa s a lso st ratified b y i ndustry cla ssification ( private a nd pu blic sector), since voluntary disclosure incentives may differ for these sectors This controls for the possible confounding industry-based effects on comparative analysis of the data © 2010 by Taylor and Francis Group, LLC 406 ◾ Pension Fund Risk Management: Financial and Actuarial Modeling Second, a sample of pension funds whose address details were published in the industry digest were asked to supply copies of their annual financial reports and annual reports sent to members The final sample comprises 54 defined benefit pension plans (DBPPs) 17.4.2 Variable Descriptions Table 17.2 reports descriptive statistics for the sample U.K DBPPs The sample of U.K DBPPs, on average adopted more st ringent forms of PAS a nd pension f und ma nagers voluntarily d isclosed more items of financial information in annual employee participant reports during the study period.* Two economic va riables were developed to proxy for sources of pressure for both pension management (i.e., the administration and actuarial expenses, COST) and by the audit profession (i.e., the audit and nonaudit fees paid by pension funds, FEE) COST is calculated as the total marginal periodic professional administration expenses paid to delegated pension management (trustees, i nvestment ma nagers, ad ministrators, ac tuaries), while FEE is calculated as auditing and nonaudit fees of the sample of pension funds Both were calculated for the adoption year April 5, 1997 and retention year April 5, 2003 (or the nearest reporting date) as a percentage of the total invested assets of the plan Other two political variables entered into the political influence functions t o r epresent t he acco untability o f pens ion ma nagers t o st akeholders in terms of their disclosure practices (DISCL), and pension accounting standards (PAS), respectively PAS is a categorical variable that proxies for the pension financial reporting disclosure used by the pension fund in its audited financial statements Pension funds either did not voluntarily disclose its assets at market values (=0), provided complete disclosure of the market value of pension assets but did not report information about the funding ratio or the accrued benefit obligation (=1), or presented complete financial statement disclosures of pension assets and liabilities and/or revealed the pension funding ratio as required by pension accounting standards (=2) In add ition t o ex amining t he ex tent o f i nformativeness o f a udited financial statements as formally required by professional accounting standards, another variable is needed to measure the extent to which industry * This is consistent with the results of prior survey research (i.e., Anderson and Sharpe, 1992; Klumpes, 1994b; Herbohn and Buchan, 1995) © 2010 by Taylor and Francis Group, LLC Determination of U.K Pension Fund Accounting Rules ◾ 407 TABLE 17.2 Factors Influencing Pressure Groups and Competition for Political Influence Descriptive Statistics for Sample and Population of Pension Funds Population Mean Sample Mean Min Max Std dev Panel A: Adoption period sample (population size 1370; sample size N = 54) FEE 0.52 0.63 0.00 12.57 COST 0.96 0.51 0.00 1.01 PAS n.a 1.07 0.00 2.00 DISCL n.a 1.60 0.00 2.00 INVRISK n.a 0.63 0.00 0.92 MATRISK n.a 0.02 0.18 −0.46 LNSIZE 3.23 5.40 1.79 9.90 2.08 2.05 0.50 0.63 0.26 0.08 1.52 Panel B: Late period sample (population size 1370; sample size N = 54) FEE 1.93 0.02 0.00 1.01 COST 0.14 0.09 0.00 3.83 PAS n.a 1.15 0.00 2.00 DISCL n.a 1.71 0.00 2.00 INVRISK n.a 0.56 0.00 1.00 MATRISK n.a 0.05 1.48 −0.13 LNSIZE n.a 5.40 2.40 10.27 2.08 0.55 0.56 0.63 0.27 0.26 1.61 Notes: Variable descriptions: PAS, A dummy variable indicating the extent of dis closure o f p ension financial p osition in financial reports, from no dis closure of p ension ass ets at market value (=0) or t he disclosure o f p ension ass ets a t ma rket val ue in acco rdance wi th industry-recommended guidelines ( =1) to the full recognition of pension ass ets at market value and t he dis closure of t he f unding ratio a nd/or p ension lia bilities in acco rdance wi th p rofessional accounting standards (=2); DISCL, a categorical variable extent of voluntary disclosure in the pension member report, scaled from to 100; FEE, log of periodic audit and nonaudit fees charged to pension f unds as a % o f p ension f und t otal in vestment p ortfolio in A$m (£m); COST, log of periodic information production expenses incurred by pension plans, other than audit and nonaudit fees, as a percentage o f p ension f und t otal in vestment p ortfolio in £m; INVRISK, percentage of total invested assets of pension plan comprising equity investments; MATRISK, net contributions; LNSIZE, log of total pension fund investment portfolio; POLICY, a categorical variable representing the extent of voluntary disclosure in t he annual financial report, scaled from to 144 © 2010 by Taylor and Francis Group, LLC 408 ◾ Pension Fund Risk Management: Financial and Actuarial Modeling pressure g roups c an i nfluence t he ac tual d isclosure o f so lvency-related information b y pens ion p lans i n r eports sen t t o t heir m embers DISCL is a c ategorical variable that proxies for the extent of voluntary financial disclosures i n t he ac tuarial i nvestigation r eport i nformation co ntained pension a nnual reports sent to employee pa rticipants It i s a c ategorical variable ba sed o n a d isclosure i ndex o f u p t o 100, wh ich m easures t he extent o f v oluntary d isclosure o f so lvency i nformation i tems i n a nnual member reports The member report comprises a n audit report, a st atement of financial position, a statement of changes in financial position, an investment per formance report, a nd a su mmary of t he actuarial report In addition to disclosure and accounting practices, another predicted economic source of pressure for costs incurred by pension plans is MATRISK, which is a proxy for the pension plan’s financial condition The older the age profile of pension plan members, the greater is the cash flow needed to fund benefits, which must be generated from investments It is measured as the flow funding relationship of total contributions received, plus gross investment returns, less total benefit pa yments U nlike t he t raditional stock funding ratio, the flow funding ratio is not subject to actuarial discretion over assumption rates used to discount pension liabilities During the study period, there was considerable political pressure placed on U.K pension f unds to maintain a n et surplus by using conservative actuarial assumptions for the estimation of pension liabilities Besides MATRISK, it is also posited that the extent and the level of fees paid b y pens ion p lans t o i ntermediaries i s co rrelated w ith t he pens ion fund risk INVRISK is a p roxy for t he r isk t hat t he pension plan’s portfolio is invested in nonliquid financial products, which cannot be used to fund current benefit payments It measures the percentage of pension plan total assets that comprised classes of risky assets (e.g., fi xed interest bonds, stocks, property) Amir and Benarttzi (1998) show that the proportion of risky a ssets i nvested i s potentially correlated w ith a pens ion f und ma nager’s ability to generate future investment returns Besides the disclosure practices and economic factors posited to influence financial reporting rule-making, a variable is needed to proxy for the political visibility of pension scheme managers that are subject to the various regulations Lim and McKinnon (1993, p 200) cite prior authorities (e.g., Zmijewski and Hagerman, 1981, p 147; Holthausen and Leftwich, 1983, p 108) who caution against the unquestioning acceptance of firm size as a proxy for political visibility, a nd t hat Watts a nd Zimmerman (1990, p 152) have st ressed t he importance of developing more precise proxies for political costs © 2010 by Taylor and Francis Group, LLC Determination of U.K Pension Fund Accounting Rules ◾ 409 While accepting the limitation mentioned earlier because of the lack of recognized alternatives in this study, LNSIZE is a proxy for political visibility It is measured by the net market value of assets of a pension fund For statistical testing purposes (see discussion in the following text), these were converted to natural log scale Finally, a proxy is needed to measure political influence However, prior research has not successfully identified a measurable proxy for this variable I n t his chapter, a d isclosure i ndex POLICY is u sed to measure t he extent of political influence This variable is comprised of 144 items that are subject to audit review Table 17.3 presents, for adoption and retention samples, bivariate correlations among the factors affecting political pressure and influence functions The high correlation between FEE and COST is expected since these variables a re a ssumed t o be en dogenous On t he o ther nd, t he h igh correlations bet ween PAS an d FEE (in t he ad option per iod 996–1997) are u nexpected a nd may a ffect t he ability to meaningfully i nterpret t he coefficients related to the political pressure influence functions However TABLE 17.3 Factors Influencing Pressure Groups and Competition for Political Influence Bivariate Correlations between Variables INVRISK LNSIZE MATRISK PAS DISCL Panel A: Adoption period sample FEE 1.000 COST −0.973** 1.000 INVRISK 0.315* −0.260 LNSIZE 0.122 −0.075 MATRISK 0.104 0.071 PAS 0.289* −0.300* DISCL 0.097 −0.112 1.000 0.083 −0.023 0.171 0.260 1.000 −0.205 0.014 0.202 1.000 −0.343* 0.086 1.000 0.094 1.000 Panel B: Late period sample FEE 1.000 COST 1.000 −0.234 INVRISK 0.088 −0.359* LNSIZE −0.060 −0.017 MATRISK −0.034 −0.030 PAS 0.201 0.138 DISCL 0.199 −0.104 1.000 0.026 0.021 0.164 0.216 1.000 0.088 0.162 0.147 1.000 0.110 −0.037 1.000 0.083 1.000 FEE COST **Significant at 0.01 level *Significant at 0.05 level © 2010 by Taylor and Francis Group, LLC 410 ◾ Pension Fund Risk Management: Financial and Actuarial Modeling these high correlations are removed when log-based fee and cost functions are substituted for marginal functions in the empirical tests, the results of which are reported in the following text 17.5 EMPIRICAL TESTS In analyzing the causes and effects of competition among pressure groups for political influence, a basic linear model of the three-equation simultaneous system developed earlier is estimated Specifically, it is assumed that all disturbances are normally distributed Exploratory data a nalysis a nd specification t ests in dicated t hat t his as sumption a ppears t o b e r easonable Ordinary least squares regression is applied to estimate the following model as specified in Equations 17.5 through 17.7: FEEi = a0 + a1COSTi + a2 PASi + a3 INVRISK i + ε (17.8) COSTi = b0 + b1FEEi + b2 DISCLi + b3 MATRISK i + εi (17.9) POLICYi = c0 + c1FEEi + c2COST + c3 PASi + c4 DISCL + εii (17.10) In e valuating t he r esults o f t his m odel, t he f ollowing ex pectations a re made regarding the signs of the coefficients: (17.8): a1 0; a2 0 (retention) (17.9): b1