Accounting Standards and Gains Trading

Abstract

We examine gains trading behavior under a unique accounting rule in the U.S. life insurance industry. When a bond is sold, the proceeds must be amortized over its remaining maturity. This limits opportunities to manage earnings using realized capital gains and losses (RGL). We find evidence of gains trading to offset operating losses by those firms in highest quartile of RGL; such behavior becomes more extreme in higher quantiles of the RGL distribution. In addition, gains trading is concentrated among non-public firms; publicly-traded life insurers, who report to investors under standards with no amortization rule, do not appear to gains trade. Our study contributes to the literature on earnings management among financial institutions, highlighting the nuances of gains trading when reporting rules dilute the effectiveness of such behaviors.

Keywords: Insurance Accounting, Financial Institutions, Earnings Management, Accounting Standards, Capital Gains

JEL Classification: G11, G22, G28, M41, M48