Slide AKT 405 Teori Akuntansi 12 Godfrey

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GODFREY HODGSON HOLMES TARCA

CHAPTER 12

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Philosophy of positive

accounting theory

• _{Seeks to explain and predict accounting practice} • _{Seeks to explain how and why capital markets}

react to accounting reports

• _{Does so by observing practice – empirical}

evidence

• _{Explanation means providing reasons for}

observed practice

– _{e.g. why do firms continue to use historic cost} • _{Prediction means that the theory predicts}

unobserved phenomena

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Philosophy of positive

accounting theory

• _{Positive theory is based on}

assumptions about the behaviour of individuals

– _{assumes investors and financial}

accounting users and preparers are rational utility maximisers

– _{rejects arguments based on anecdotal}

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Strengths of positive

theory

• _{In order to prescribe an appropriate}

accounting policy, it is necessary to know how the world actually

operates

• _{We can then normatively prescribe}

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Strengths of positive

theory

• _{Positive hypotheses are capable of}

falsification by empirical research

• _{Provides an understanding of how the world}

works rather than prescribing how it should work

– obtain an understanding about how

value-relevant accounting numbers are for share prices – attempt to understand the connection between

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Dissatisfaction with

prescriptive standards

• _{Normative standards}

• _{Prescriptions not based upon identified,}

empirical observations or methods

• _{Theories are not falsifiable}

• _{Do not explain and predict accounting}

practice

• _{Do not assess existing accounting}

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Scope of positive

accounting theory

Two stages of development

1. Capital market research – into the impact of accounting and the

behaviour of capital markets

– _{did not explain accounting practice}

– _{investigated connection between the}

accounting data and share prices/returns

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Scope of positive

accounting theory

2. Sought to explaining and predict accounting practices across firms

– _{ex post}_opportunism

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Capital market research

and the efficient markets

hypothesis

• _{Two types of capital markets research}

– _{the impact of the release of accounting}

information on share returns

– _{the effects of changes in accounting}

policy on share prices

• _{Most research in these areas relies}

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Capital market research

and the efficient markets

hypothesis

Efficient market: one ‘in which prices fully reflect available information’

3 Forms of Information Efficiency 1. Weak form

(past price information) 2. Semi-strong form

(publicly available information) 3. Strong form

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Capital market research

and the efficient markets

hypothesis

• _{Capital markets research in}

accounting assumes semi-strong form efficiency

• _{Financial statements and other}

disclosures form part of the

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Capital market research

and the efficient markets

hypothesis

• _{Based on dubious assumptions}

– _{there are no transaction costs in trading}

securities

– _{information is available cost-free to all}

market participants

– _{there is agreement on the implications}

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Capital market research

and the efficient markets

hypothesis

Market efficiency does not assume, mean or imply

– _{that every, or any, investor has}

knowledge of all information

– _{that all financial information has been}

correctly presented or interpreted by individual investors

– _{that managers make the best decisions} – _{that investors can predict the future}

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Capital market research

and the efficient markets

hypothesis

• _{Market efficiency simply means that}

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Market model

Market Model:

• _{Derives from CAPM}

• _{Used to estimate abnormal returns}

on shares when profits announced

• _{Share prices and returns are affected}

by both market-wide and firm-specific events

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Market model

• _{Based on dubious assumptions}

– _{investors are risk averse}

– _{returns are normally distributed and}

investors select their portfolios on this basis

– _{investors have homogeneous expectations} – _{markets are complete}

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Impact of accounting

profits announcements on

share prices

Ball & Brown (1968):

• _{Seminal work in positive accounting}

and finance literature

• _{Tested the usefulness of historical}

cost profit figure to investment decisions

• _{If the historical cost profit figure is}

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Impact of accounting profits

announcements on share

prices

Ball & Brown (1968) Results:

• _{Most of the information contained in}

the earnings announcement

(85-90%) was anticipated by investors

• _{Evidence of} _{information content at}

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Impact of accounting profits

announcements on share

prices

• _Magnitude

• _{Information asymmetry and firm size}

• _{Magnitude of profit releases from}

other firms

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Impact of accounting profits

announcements on share

prices

• Profit release event studies showed that

accounting profit does capture a portion of the information set that is reflected in security

returns

• The evidence also shows that competing sources of information pre-empted the

information in annual profits by about 70-85 per cent

• Annual accounting figures are not timely • _{Led to an another approach – association}

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Association studies and

earnings response

coefficients

• _{The objective is to test the impact of}

accounting variables and a wider information set that is reflected in securities returns over a longer

period

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Association studies and

earnings response

coefficients

Factors which can affect the association between profits and share prices:

– risk and uncertainty

– audit quality

– firm size

– industry

– interest rates

– financial leverage

– firm growth

– permanent and temporary profits

– non-linear modeling

– disaggregating profits

– cash flows

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Methodological issues

• _{To argue that the results of the research}

are supportive of EMH and that the form of accounting is not that important for

valuation purposes derives, in part, from the fact that the EMH is assumed to be descriptively valid

• _{This assumption may not be warranted}

• _{There is increasing evidence that markets}

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Methodological issues

• _{No attempt to discriminate EMH from}

competing hypothesis

– _{mechanistic hypothesis}

• _{managers use accounting to deliberately}

mislead the share market

• _{market participants can be fooled}

– _{no-effects hypothesis}

• _{the market ignores accounting changes that}

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Trading strategies

• _{Post-announcement drift}

• _{Winners/losers and over-confidence}

• _{Mechanistic or behavioural effect}

– _{no-effects hypothesis}

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Trading strategies

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Trading strategies

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Issues for auditors

• _{There is some evidence of an association}

between auditing and the cost of capital

• _{Lower cost when firms voluntarily}

purchase an audit or purchase a high quality audit

– _{investors value the deep resources of a large} auditor

– _{investors value the quality assurance}

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Summary

• _{Philosophical objective of positive}

accounting theory is to explain and predict current accounting practice

• _{Positive theory developed in two stages}

– capital market research

– contracting theory

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Key terms and concepts

• _{Prescriptive standards}

• _{Positive accounting theory} • _{Capital market research} • _EMH

• _CAPM • _CAR • _ERC

• _{Information asymmetry} • _{Market efficiency}

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