Third-Party Source Switches: Objective Valuation or Fair Value Opinion Shopping?

Abstract

Fair value estimates from external third-party sources are generally considered more reliable than internal estimates based on managerial inputs. However, even externally sourced estimates are subject to managerial opportunism, because firms can switch from one external source to another. In the context of life insurance companies that mostly rely on external sources, we posit that such source switches could be driven by managerial incentive either to faithfully report fair values (objective valuation) or to inflate estimates to avoid other-than-temporary impairment (OTTI) (opinion shopping). Our results support both motives. In instances in which the two incentives yield conflicting predictions for source-switching, we find the opinion-shopping motive dominates. We also find that switches that increase fair value estimates are associated with a reduced OTTI likelihood and magnitude, especially for high-impairment-risk securities. On balance, our evidence suggests that opportunism with respect to source-switching can compromise the reliability of externally sourced fair value estimates.

Keywords: Fair value opinion shopping, objective valuation, fair value estimate, fair value inflation, external pricing sources, fixed income security, insurance companies

JEL Classification: G20, G22, G30, M41