Accounting Under Pressure: How Accounting Rules Shape Bond Prices and Firm Investment Post Crises

We examine how accounting standards, specifically the choice between held-to-maturity (HTM) and mark-to-market (MTM) accounting, shape bond market stability and firm investment behavior during financial crises. We develop a theoretical framework showing that HTM accounting allows insurers to strategically internalize their price impacts, stabilizing bond prices by avoiding forced liquidations during market downturns. In contrast, MTM accounting rules amplify market instability by forcing immediate recognition of losses, triggering forced asset sales. Empirically, using comprehensive data on corporate bond holdings by insurers and mutual funds, we demonstrate that bonds predominantly held by insurers experience significantly smaller price declines during crises compared to bonds held primarily by mutual funds, who are constrained by MTM accounting requirements. Employing a shift-share instrumental variable approach, we further establish the causal stabilizing effect of insurer ownership on bond prices. Additionally, we show substantial real economic consequences: firms whose bonds are largely held by insurers benefit from lower debt costs, enabling greater investment in capital expenditures and acquisitions post-crisis. Our results underscore the critical role of accounting discretion in influencing market stability, investor behavior, and firm-level economic resilience during periods of financial distress.