Saturday, January 28, 2017

Accounting standards and pension liabilities

I had blogged earlier explaining the rise of Trump and similar movements elsewhere on the lack of elite leadership to address egregious excesses.

The FT reports that an analysis by pension consultancy JLT Employee Benefits of 2015-16 showed that UK blue-chip companies could have cleared their pension deficits with payment of one year's dividends,
An examination of the latest annual accounts for FTSE 100 companies found the UK’s leading listed businesses paid £68.5bn to shareholders, more than five times the £13.2bn they made in pension contributions... According to the research, based on accounts published up to June 30 last year, only six FTSE 100 companies paid more in contributions to their defined benefit pension schemes than in dividends to their shareholders... However, of the 60 companies that disclosed pension deficits, 46 could have cleared their shortfalls by withholding a year’s dividends, according to the analysis.
This highlights attention on the need for regulatory oversight on the issue of balancing pension accounts. For more than a generation, coinciding with the Great Moderation, equity markets were trending upward and asset returns were stable and high enough. In such times, pension plans made their returns even with the high management fees and relatively risk-free investing.

That is now history. The average annual returns on equities and fixed income assets have been on a long declining trend and likely to remain at the low levels. Pension funds everywhere are facing the heat from the declining returns and have been accumulating liabilities. It is surprising that the rise in liabilities has been accompanied by a rise in shareholder payouts. 

It is Accounting 101 that profits are calculated after excluding all costs from revenues, and that employee costs includes wages and other commitments. And pension payouts are the largest part of non-wage payments. One of the principles of corporate finance is that equity has a charge on profits only after all the liabilities are paid off. It is therefore baffling that accounting standards do not mark-to-market the pension liabilities and provision for all those liabilities before profits are calculated. Pension liabilities are no less a liability that they are superseded by the claims of equity holders.

In the aftermath of the Enron debacle, regulations were amended to introduce mark-to-market accounting in many areas. Funny that they were not extended to liabilities like pensions. Such egregious excesses are simply a blot on capitalism and underlines the point about saving "capitalism from capitalists".

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