Friday, March 31, 2006

A Test of the Efficient Markets Hypothesis?

I recognize that I don't have much street credibility in proposing profitable asset trading strategies. But, this New York Times article suggests that there is money to be made by selling short companies such as General Motors with an older workforce. This article claims that with the new pension accounting rules that such companies will have a negative net worth. You don't have to be Eric Mindich to predict that this might lead to a lower stock price. My question for you is whether stock prices already reflect this information or whether stock prices have not adjusted yet to this "new news" concerning how the new pension rules will affect corporate accounting claims.

One leading berkeley researcher (see http://www.econ.berkeley.edu/~sdellavi/) has documented how the stock market does not capitalize clear demographic trends. For example, if there are a lot of little infants in a new birth cohort then demand for bicycles will rise when they reach age 5+.

If you do make money trading on my demographics based strategy, I would appreciate it if you buy a few copies of my Brookings "Green Cities" book when it is published this summer. If Hollywood makes a movie about my book, I hope you go see it!


March 31, 2006
Shocks Seen in New Math for Pensions
By MARY WILLIAMS WALSH

The board that writes accounting rules for American business is proposing a new method of reporting pension obligations that is likely to show that many companies have a lot more debt than was obvious before.

In some cases, particularly at old industrial companies like automakers, the newly disclosed obligations are likely to be so large that they will wipe out the net worth of the company.

The panel, the Financial Accounting Standards Board, said the new method, which it plans to issue today for public comment, would address a widespread complaint about the current pension accounting method: that it exposes shareholders and employees to billions of dollars in risks that they cannot easily see or evaluate. The new accounting rule would also apply to retirees' health plans and other benefits.

A member of the accounting board, George Batavick, said, "We took on this project because the current accounting standards just don't provide complete information about these obligations."

The board is moving ahead with the proposed pension changes even as Congress remains bogged down on much broader revisions of the law that governs company pension plans. In fact, Representative John A. Boehner, Republican of Ohio and the new House majority leader, who has been a driving force behind pension changes in Congress, said yesterday that he saw little chance of a finished bill before a deadline for corporate pension contributions in mid-April.

Congress is trying to tighten the rules that govern how much money companies are to set aside in advance to pay for benefits. The accounting board is working with a different set of rules that govern what companies tell investors about their retirement plans.

The new method proposed by the accounting board would require companies to take certain pension values they now report deep in the footnotes of their financial statements and move the information onto their balance sheets — where all their assets and liabilities are reflected. The pension values that now appear on corporate balance sheets are almost universally derided as of little use in understanding the status of a company's retirement plan.

Mr. Batavick of the accounting board said the new rule would also require companies to measure their pension funds' values on the same date they measure all their other corporate obligations. Companies now have delays as long as three months between the time they calculate their pension values and when they measure everything else. That can yield misleading results as market fluctuations change the values.

"Old industrial, old economy companies with heavily unionized work forces" would be affected most sharply by the new rule, said Janet Pegg, an accounting analyst with Bear, Stearns. A recent report by Ms. Pegg and other Bear, Stearns analysts found that the companies with the biggest balance-sheet changes were likely to include General Motors, Ford, Verizon, BellSouth and General Electric.

Using information in the footnotes of Ford's 2005 financial statements, Ms. Pegg said that if the new rule were already in effect, Ford's balance sheet would reflect about $20 billion more in obligations than it now does. The full recognition of health care promised to Ford's retirees accounts for most of the difference. Ford now reports a net worth of $14 billion. That would be wiped out under the new rule. Ford officials said they had not evaluated the effect of the new accounting rule and therefore could not comment.

Applying the same method to General Motors' balance sheet suggests that if the accounting rule had been in effect at the end of 2005, there would be a swing of about $37 billion. At the end of 2005, the company reported a net worth of $14.6 billion. A G.M. spokesman declined to comment, noting that the new accounting rule had not yet been issued.

Many complaints about the way obligations are now reported revolve around the practice of spreading pension figures over many years. Calculating pensions involves making many assumptions about the future, and at the end of every year there are differences between the assumptions and what actually happened. Actuaries keep track of these differences in a running balance, and incorporate them into pension calculations slowly.

That practice means that many companies' pension disclosures do not yet show the full impact of the bear market of 2000-3, because they are easing the losses onto their books a little at a time. The new accounting rule will force them to bring the pension values up to date immediately, and use the adjusted numbers on their balance sheets.

Not all companies would be adversely affected by the new rule. A small number might even see improvement in their balance sheets. One appears to be Berkshire Hathaway. Even though its pension fund has a shortfall of $501 million, adjusting the numbers on its balance sheet means reducing an even larger shortfall of $528 million that the company recognized at the end of 2005.

Berkshire Hathaway's pension plan differs from that of many other companies because it is invested in assets that tend to be less volatile. Its assumptions about investment returns are also lower, and it will not have to make a big adjustment for earlier-year losses when the accounting rule takes effect. Berkshire also looks less indebted than other companies because it does not have retiree medical plans.

Mr. Batavick said he did not know what kind of public comments to expect, but hoped to have a final standard completed by the third quarter of the year. Companies would then be expected to use it for their 2006 annual reports. The rule will also apply to nonprofit institutions like universities and museums, as well as privately held companies.

The rule would not have any effect on corporate profits, only on the balance sheets. The accounting board plans to make additional pension accounting changes after this one takes effect. Those are expected to affect the bottom line and could easily be more contentious.

1 comment :

Anonymous said...

^^ nice blog!! ^@^

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