Strategic Reporting of Fair Value Estimate Levels

Abstract

We investigate whether firms strategically report Levels that indicate reliance on lower quality inputs to allow flexibility to bias fair value estimates, or higher quality inputs to convey better asset liquidity. Specifically, we examine the dispersion of year-end fair value estimates and Levels for identical fixed-income securities held by multiple insurers. We find that insurers inflate estimates more when they report these estimates at Levels indicative of lower quality inputs than the consensus. Relatedly, insurers deviate from consensus Levels to indicate reliance on lower quality inputs, when they switch to carrying an asset at fair value and when they have less regulatory capital. When insurers face a decrease in liquid assets, they deviate from the consensus to a Level indicative of higher quality inputs likely to convey better asset liquidity. Collectively, our findings suggest that insurers exploit the ambiguity in the fair value estimate Level hierarchy consistent with financial reporting incentives.