Fair Value Measurement Discretion and Opportunistic Loss Avoidance

This study examines whether fair value measurement discretion and discretion not related to fair value measurement are sources of opportunistic reporting. Prior literature observes earnings management in settings in which fair value measurement occurs simultaneously. However, as Barth and Taylor (2010) note, the existence of earnings management is not a sufficient condition for determining fair value measurement discretion is its source. Using the rich setting of insurers’ investment holdings, we identify potential measurement discretion across holders of the same security, observe instances when discretion is used to avoid impairment loss recognition, and provide evidence on the extent to which the use of discretion is opportunistic. In contrast to Ramanna and Watts (2012), our evidence suggests that potential discretion in fair value measurement is associated with greater impairment loss recognition. We also find that insurers with earnings management incentives are more likely to use non-fair value measurement discretion to avoid loss recognition.