Fair Value versus Non-fair Value Discretion and Auditing

Managers have alternative discretionary choices. I exploit security-level disclosures in the insurance industry to examine auditors’ role in insurers’ choice between using two specific types of discretion to avoid other-than-temporary-impairment (OTTI) losses. Managers can avoid recognizing an OTTI loss on investment either by (1) using the discretion over fair value measurements to inflate fair values above amortized cost or (2) exercising the discretion over non-fair value related aspects of an OTTI assessment to argue that such decline of fair values is temporary. Employing within-security analyses, I find that insurers engaging Big 4 and leading auditors in the insurance industry are more (less) likely to use non-fair value (fair value) discretion to avoid OTTI losses. This effect is stronger when insurers have a greater OTTI avoidance incentive. I also document that, in the presence of these two types of auditors, insurers using non-fair value discretion to avoid OTTI are more likely to dispose of the security at a loss in the subsequent year. The results are consistent with these auditors having a comparative advantage in auditing fair value measurements versus non-fair value discretion due to their increased access to fair-value-related resources at the national level