Real Effects of Recognizing Fair Value Changes in Net Income on Firms’ Investment Choices

We study the impact of recognizing fair value changes in net income rather than other comprehensive income on firms’ investment portfolio holdings. Using the adoption of Accounting Standards Update 2016-01 for a sample of property and casualty insurance companies as our setting, we find that firms required to adopt the new standard and recognize changes in the fair value of equity securities in earnings decreased the riskiness of their equity holdings relative to firms that did not adopt the new standard. This resulted in a decrease in the volatility of affected firms’ unrealized gains and losses on equity securities. This is consistent with concerns expressed by preparers that recognizing fair value changes would prompt them to change their investment holdings to mitigate an increase in volatility of reported net income