Cost Anchoring in Fair Value Estimation

Fair value estimation is a ubiquitous and growing disclosure requirement, relied upon by both insiders and outsiders in decision-making. Accurate fair value estimates require expertise and professional judgment, but due to their inherent subjectivity may be influenced by biases or reporting incentives. We examine a previously unstudied bias in fair value estimation: cost anchoring. While anchoring is widely documented in experimental settings, little evidence exists as to whether anchoring persists, or is consequential, in the real world. Using a uniquely granular dataset of insurance company investment holdings, we find that variation in acquisition cost explains variation in fair value estimation, within the same security on identical reporting dates. The results are more pronounced when the anchor is more salient, or the valuation is more uncertain. Estimates that exhibit anchoring are less accurate and in a downward bias, inconsistent with expectations of opportunistic reporting. Additionally, the bias appears to result in sub-optimal, subsequent trading behavior for the firm. Our research suggests procedures should be implemented to reduce anchoring bias in fair value estimation.