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20 Cards in this Set
- Front
- Back
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Econ consequences of accounting policy choices
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-accounting policy choice can affect firm value
-choices do matter, even if don't affect CF -conflicts with EMH -b/c policy choices matter to mgmt, and may change behaviour |
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Positive Accounting Theory
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concerned w/ predicting such actions as choices of accounting policies by mgmt and how managers will respond to new accounting standards
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Normative theory
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attempts to tell what should do
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Nexus of Contracts
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-Firm can be viewed as connected set of contracts
-wants to minimize K costs (negotiation/moral hazard/monitoring/etc) -PAT suggests that mgmt will select policies that achieve efficient (lower cost) K |
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Opportunistic Behaviour
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-mgmt is rational (self-interested)
-so will select policies that benefit themselves, which may increase King costs |
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Trade-off between prescribing policies and allowing some choice
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-prescribing: increases risk of violating contracts
-choice: increases possibility of opportunistic behaviour |
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Earnings Management: where?
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**revenue recognition: too early, fraudulent sales, gross v. net, channel stuffing
-capitalize v. expense (worldcom) -shifting income from this year to next -accelerating recognition of expenses (big bath/writedowns) -income smoothing to reduce perceived risk |
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Positive aspects of earnings mgmt (w/in GAAP)
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-reduces K-ing costs (gives flexibility)
-allows mgmt to send signals to mkt about firm value -reduces surprises about earnings, reducing perceived risk |
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Negative aspects of earnings mgmt
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-opportunistic behaviour is commonplace (increases K-ing costs)
-masks true income |
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Game theory
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attempts to model and predict outcome of conflict between rational individuals
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Agency Theory
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-version of game theory
-models process of K-ing between 2+ parties -both parties want best for themselves, so involves conflict |
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Alternatives to providing share of payoff
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-direct monitoring: best but impractical (moral hazard)
-indirect monitoring: impute effort by observing measurement base or metric. but many factors can affect, and cannot refund salary -rent firm to mgr: (landlord-tenant) shifts risk onto agent, but agent is risk-averse. But owner risk-neutral and prepared to take on more risk and thus gets no upside. |
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Holmstrom's agency model
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-base mgr's compensation on 2 variables: better than 1 unless perfectly correlated
-if net income & share price: -in competition for mkt share in compensation K -to maintain mkt share, NI should be highly informative about mgr effort. |
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Properties NI needs to be highly informative
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-sensitivity: NI responds to changes in mgr effort
-precision: NI has low noise re: effort *unfortunately, 2 must be traded off |
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Sensitivity and precision trade-off
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historical cost: (NI as measurement)
-low sensitivity due to recognition lag -high precision since relatively unaffected by mkt-wide factors Fair Value: (uses share price as measurement) -high sensitivity due to less recognition lag -low precision since affected mkt-wide factors |
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Fundamental problem financial accounting theory
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most useful net income for investors is not necessarily most informative about mgr effort
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Agency theory and lending Ks
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-conflicting parties are lender and mgr
-lender wants to charge appropriate i-rate for risk -BUT can't observe mgmt's efforts or choices in risky situations, so HIGH i-rate is charged -if mgr has K based on NI, wants lower i-rate |
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Solution for lending K agency problem
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restrictive covenants included in K
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Executive compensation: NI v Share price
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Should be combination : can control mgr's decision horizon by proportion NI to share price in K
> NI = shorter horizon >Share price = longer horizon |
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Executive compensation: stock options
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more sensitive (no recognition lag bc current prices) to mgmt effort but are less precise as numerous general mkt factors affect
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