The Use of Accounting Flexibility to Reduce Labor Renegotiation Costs and Manage Earnings

We investigate whether managers' discretionary choices when adopting SFAS 106 are consistent with incentives to influence future labor negotiations and improve future reported income. We hypothesize that firms are more likely to opt for the immediate recognition method if i) they have large transition obligations and intend to reduce plan benefits subsequent to SFAS 106 adoption; and ii) they are more unionized. The magnitude of the transition obligation sets a ceiling on the opportunity to improve future earnings through a reduction in the already-recognized liability. Consequently, firms with relatively large transition obligations have greater incentives to be immediate recognizers if they intend to implement negative plan amendments after adopting SFAS 106. Also, if accounting numbers do play a role in labor negotiations, more unionized firms have greater incentives to use the immediate recognition method as a means of strengthening their bargaining power in subsequent negotiations to reduce plan benefits.Our results are consistent with hypothesized incentives. Overall, our findings suggest that firms made discretionary SFAS 106 choices likely to reduce labor renegotiation costs and improve future reported income unless they were constrained by the prospect of potential debt covenant violations