Pension accounting is starting to raise eyebrows all over Wall Street, according to the current issue of Barron’s.
Analysts — including Morgan Stanley, which last week released a controversial report alleging that a good chunk of Qwest Communications International Inc.’s earnings came from pension-accounting changes — say the earnings of as many as 157 companies in the Standard & Poor’s 500 got a boost from pension income last year and wonder whether those earnings boosts can be sustained year after year.
A June report from Credit Suisse First Boston entitled “A Pension Accounting Primer” noted that pension income contributed about 12% to the pretax profits of the 30% of companies in the S&P 500 that report pension income. And because the outlook for corporate earnings looks to be grimmer this year than last, pension income may become a more significant, though not necessarily more visible, component of the bottom line, says Barron’s.
Jack Ciesielski, publisher of the Analyst’s Accounting Observer, told the weekly journal that “the easiest and most direct way for a company to boost the current year’s reported earnings is to raise the expected rate of return on pension assets.” If you do that, during the year, “it will go right to the operating line,” he told Barron’s. The changes often boost reported earnings, but never does any real cash flow into the companies’ coffers.
Interestingly, Ciesielski notes that as recently as 1997, defined- benefit pension plans were a liability for the 81 companies in the S&P 100 that have plans, not an asset to be drawn upon to increase reported earnings. “From a nearly $5 billion in cost in 1997, pension plans now chip in nearly $7 billion of cost reduction in 2000,” he told the weekly journal.
While overfunded pension plans can make a company’s earnings look good, it is very difficult for a company to actually tap into the funds and use them for operations without paying big tax penalties. “When you see pension income, it doesn’t hold the promise of having the cash go back to the company and the shareholders,” Ciesielski told Barron’s. “But if companies can’t tap pension funds for general corporate purposes, executives whose compensation is tied to earnings performance can benefit from overfunded plans’ contribution to the bottom line.”
Qwest may be a case in point. This year, a US West retiree group proposed exempting any surplus from Qwest’s pension fund from income reports, which are used to calculate executives’ bonuses. Qwest Chief Executive Joseph Nacchio last year received $2.8 million in salary and bonuses, realized $93.4 million from options exercised last year and was paid $1.1 million in shares promised to him before Qwest went public in 1997. Robin Szeliga, Qwest’s CFO, said in an interview with Barron’s that the proposal, which the company opposed, was voted down. She explained that the company uses generally accepted accounting principles in providing information to the compensation committee, which then determines compensation. The retiree group’s “suggestion was to deviate from GAAP, and we think that wasn’t appropriate.”