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ASU 2016-01 requires that public companies' net incomes recognize changes in unrealized gains and losses from investments in equity securities. This paper studies the rule’s effects on stock prices and firms’ capital allocation decisions. We build a model with risk-averse investors who can be attentive or inattentive and managers who maximize firms' stock prices. The model makes two main predictions. First, with inattentive investors, the rule change will cause stock prices to react more to changes in net income that stem from fluctuations in financial asset prices. Second, under certain conditions, inattentive investors will assign larger price discounts to firm values because of higher perceived residual uncertainty, and managers respond by cutting financial asset holdings. We use insurance company data to test these predictions. Prices of stocks with low analyst coverage react more to changes in unrealized gains and losses, highlighting the role of investor inattention. Using a difference-in-differences approach, we find that by 2020, publicly traded insurance companies cut investments in public stocks by $23 billion. |
