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This study explores whether UK managers behaved opportunistically when determining the expected rate of return on pension assets (ERRs) during an extended period of major changes in pension accounting rules (1998�2002), and whether this behaviour changed with the transitional adoption of FRS 17. The empirical results support the contracting hypothesis that UK firms with tightening debt covenants inflated their reported ERRs over this period. The contracting cost incentive underlying reported ERRs appears to be stronger during the FRS 17 transitional adoption period, and ERRs were used jointly with salary growth rate to manage balance sheet leverage. One important implication of our findings is that the IASB's 2011 revision to IAS 19, Employee Benefits, which removed the flexibility that firms could exercise in selection of ERR assumptions, potentially improves the reliability of reported pension cost components.
