The impact of internal control weaknesses on pension assumptions manipulation

This study examines the effect of internal control weaknesses (ICWs) on managers' choices of pension assumptions, using data disclosed under Sarbanes-Oxley Act Section 404 from 2004 to 2012. We hypothesise that firms with ICWs are better able to opportunistically set pension assumptions, such as the expected rate of return (ERR) and the discount rate (DR), which in turn helps to report higher earnings or healthier balance sheets. First, we find that firms with ICWs tend to report higher ERR and DR than non-ICWs firms. Particularly, the use of higher DR by ICW firms is heightened under FAS 158 which requires the funding status of plans to be reported on the balance sheets. Next, we find that the effect of ICWs on pension assumptions is much stronger when managers have greater incentives to report high profits. Finally, we find that remediation of ICWs reduces the bias in assumed ERR for smaller plans.