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

Abstract

The literature suggests that fair value (FV) estimates from external third-party sources are more reliable than those from managerial inputs. However, using a sample of private insurance companies, we provide evidence that even verifiable FV estimates derived from external third-party sources are not immune to managerial opportunism due to the discretion insurers have in switching sources. We posit that such source switches could either be driven by managerial incentive to faithfully report FV (objective valuation) or to inflate FV estimates to avoid other-than-temporary impairment (OTTI) (FV opinion shopping). Our results indicate FV opinion shopping is the more dominant motive and that source-switches yield less accurate and more upwardly biased FV estimates. Upward switches also reduce both the likelihood and magnitude of OTTI especially for high-impairment-risk securities. Overall, our evidence suggests that opportunism with respect to source-switching potentially compromises the disciplining role of independent third parties in the valuation of fair-valued assets.

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