Slide AKT 405 Teori AKuntansi 11 Godfrey

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GODFREY HODGSON HOLMES TARCA

CHAPTER 11 POSITIVE THEORY OF

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Early demand for theory

• _{Capital markets research tried to explain}

the effects of accounting

– _{was ultimately inconclusive and inconsistent}

• _{mechanistic and no-effects hypotheses}

• _{This research relied upon the EMH}

– _{ultimately there were too many departures}

• _{Led to the development of a positive}

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Early demand for theory

• _{Positive theory incorporated a number}

of observations

– _{many firms voluntarily provided}

accounting reports

– _{firms lobbied in relation to accounting}

standards

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Contracting theory

• _{The firm is seen as a ‘nexus’ of}

contractual relationships

• _{The firm is seen as an efficient way}

of organising economic activity to

reduce contracting costs

– _{equity (management) contracts (an}

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Agency theory

• _{An agency contract is one where one party}

(the principal) engages another (the agent) to act on their behalf

– _{e.g. where there is a separation of management}

and ownership

• _{Both parties are utility maximisers}

– _{agent may therefore act from self-interest}

• _{divergence of interests is the agency problem} – _{contracts incorporating accounting numbers can}

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Agency theory

• _{The agency problem in turn gives}

rise to agency costs spent to

overcome it

– _{monitoring costs} – _{bonding costs}

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Agency theory

• _{Monitoring Costs}_{– the cost of monitoring}

the agent’s behaviour; initially borne by the principal but passed on to the agent through an adjustment to their remuneration (price protection)

• _{auditing costs, operating rules…}

• _{Bonding Costs}_{– the cost borne by the agent}

as a result of them taking action to align their interests with those of the principal

• _{providing more regular financial reports (a cost}

to the manager in terms of time and effort)

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Agency theory

• _{The agents incur bonding costs in}

order to reduce the monitoring costs

they eventually bear

• _{Agents stop spending on bonding}

costs when the marginal cost equals

the marginal reduction in the

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Agency theory

• _{Residual Loss}_– _the _{loss associated with}

not being able to fully align the interests of the agent with those of the principal

• _{Ex post}_{settling up –}₍_{ex post}_{= at the}

end of each period)

– _{agent’s future remuneration based on}

observed agent performance

– _{the principal changes the remuneration to be}

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Agency theory

• _{In the real world, price protection and}

settling up are not perfect or complete

• _{Agents perceive that they will therefore not}

be fully penalised for their divergent behaviour

• _{They have incentives to act opportunistically} • _{This increases the residual loss}

• _{This loss is borne by the principal as well as,}

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Agency theory

• _{Agency theory attributes a role for}

accounting

• _{Accounting is part of the monitoring}

and bonding mechanisms

• _{Accounting numbers are used in}

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Price protection and

shareholder/manager agency

problems

• _{The separation of ownership and}

management leads to divergent

behaviour by agents

• _{Divergence comes about because of}

– _{the risk-aversion problem}

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Price protection and

shareholder/manager agency

problems

• _{Risk aversion}

– _{managers prefer less risk than do}

shareholders

• _{different degrees of diversification affecting}

risk

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Price protection and

shareholder/manager agency

problems

• _{Dividend-retention}

– _{managers prefer to pay out less of the}

profits as dividends than shareholders prefer

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Price protection and

shareholder/manager agency

problems

• _Horizon

– _{managers have a shorter time horizon}

with respect to their association with the firm than do shareholders

• _{shareholders are interested in future cash}

flows

• _{managers have a time horizon only as long}

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Price protection and

shareholder/manager agency

problems

• _{Contracting can be used to reduce}

the severity of these problems

– _{manager remuneration is usually tied to firm}

performance in some way to motivate

managers to act in the shareholders’ interest

• _{performance can be related to accounting numbers}

such as sales, profits, return on assets, net asset growth, cash flow, etc

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Shareholder-debtholder

agency problems

• _{In this context, the manager is}

assumed to be either the sole owner

of the firm, or has interests that are

totally aligned with the interests of

the shareholders

– _{the principal is the debtholder}

– _{the agent is the manager acting on}

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Shareholder-debtholder

agency problems

• _{Firm value is the value of debt plus}

the value of equity

• _{The value of equity can be increased}

by

– _{either increasing the value of the firm}

(efficient contracting); or

– _{transferring wealth away from}

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Shareholder-debtholder

agency problems

• _{Varieties of opportunistic behaviour}

– _{excessive dividend payments} – _{asset substitution}

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Shareholder-debtholder

agency problems

• _{Excessive dividend payments}

– _{reduces the asset base securing the debt}

– _{shareholders have received cash but limited}

liability protects them from being personally liable for the debts of the firm in the event of bankruptcy

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Shareholder-debtholder

agency problems

• _{Asset substitution}

– _{firm invests in higher risk projects to}

benefit shareholders

• _{no benefit to debtholders}

• _{but do share in possible losses}

– _{shareholders are able to diversify and}

have limited liability

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Shareholder-debtholder

agency problems

• _{Underinvestment}

– _{in some circumstances, shareholders}

have incentives not to undertake

positive NPV projects because to do so would increase the funds available to the debtholders but not to the

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Shareholder-debtholder

agency problems

• _{Claim dilution}

– _{occurs when the firm issues debt of a}

higher priority than the debt already on issue

– _{decreases the relative security and}

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Shareholder-debtholder

agency problems

• _{Lenders will price protect}

– _{through interest rates, the withholding}

of funds and the length of the loan

• _{The interests of shareholders can be}

bonded to those of debtholders via

restrictions in lending agreements

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Ex post

opportunism

versus

ex

ante

efficient

contracting

Ex post

opportunism

– _{occurs when, once a contact is in place,}

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Ex post

opportunism

versus

ex

ante

efficient

contracting

Ex ante

efficient contracting

– _{occurs when agents take actions that}

maximise the amount of wealth available to distribute between principals and agents

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Signalling theory

• _{Managers voluntarily provide}

information to investors - signals - to

assist in their decision making

• _{Similar to efficient contracting}

• _{Aligned with the information hypothesis}

• _{Managers signal expectations and}

intentions regarding the future

• _{Incentives to signal good, neutral and}

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Political processes

• _{Often firms try to avoid public}

attention that is costly to them

– _financially

– _{in terms of public perception and}

reputation

• _{They reduce their reported profit or}

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Conservatism,

accounting standards and

agency costs

• _{Conservatism shows a bias by}

accountants accelerating recognition

of expenses and decelerating

recognition of revenue

• _{IASB argues this does not reveal the}

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Additional empirical tests

of the theory

• _{Testing the opportunistic and political}

cost hypothesis

• _{Tests using contract details}

• _{Refining the specification of political}

costs

• _{Testing the efficient contracting}

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Additional empirical tests

of the theory

• _{Evidence that managers use}

accounting numbers to

– _{counter political pressure}

– _{gain political advantages}

– _{set management targets related to}

remuneration

– _{minimise breaching debt covenants}

– _{provide dividend constraints}

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Evaluating the theory

• _{Mixed support for positive accounting}

theory

• _{Two categories of major criticism}

– _{methodological and statistical criticism}

• empirical evidence is weak and inconclusive

– _{philosophical criticism}

• _{contrary to its claims, it is laden with value}

judgments

• _{focuses on human behaviour and not the behaviour}

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Issues for auditors

• _{The demand for auditing can be}

explained by agency theory as part

of the monitoring and bonding

activity and costs

– _{higher quality auditors}

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Summary

• _{Positive accounting theory has been a major} force in academic accounting research

• _{Incorporates a theoretical model of}

contractual exchange between persons who use accounting numbers to effect their payoffs • _{Provides an explanation as to why accountants}

account as they do

– _{minimises the cost of agency relationships}

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Key terms and concepts

• _{Positive theory}

• _{Contracting theory} • _{Agency theory}

• _Agents • _Principals

• _{Monitoring costs} • _{Bonding costs} • _{Residual loss}

• _{Ex post settling up}

• _{Risk aversion problem}

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Key terms and concepts

• _{Shareholder/manager agency problem} • _{Shareholder/debtholder agency problem} • _{Excessive dividend payment problem} • _{Asset substitution problem}

• _{Underinvestment problem} • _{Claim dilution problem}

• _{Ex post opportunism}

• _{Ex ante efficient contracting} • _{Signalling theory}

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