Chapter 9_Notes

Chapter 9_Notes - Chapter 9 Notes 9.2 Understanding Game Theory Game Theory(or economic theory of games attempts to model and predict conflict

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Chapter 9 Notes 9.2 Understanding Game Theory Game Theory (or economic theory of games) attempts to model and predict conflict between rational individuals. The interaction occurs in the presence of uncertainty and information asymmetry. Each player maximizes his/her expected utility. The players formally take the actions of other players into account. Actions of other players are extremely difficult to predict. The actual number of players lies “in between” the number in single-person decision theory and in markets. At one extreme, in decision theory, there is a single player, playing a game against nature. At the other extreme, we can think of a market a as game with a large number of players. If the market works well, the number of players is so large that the actions of any one player cannot influence what happens on the market. One basis for classifying games is as cooperative and non-cooperative. Cooperative Game o The parties can enter into a binding agreement. o For example, a cartel: they enforce binding agreements on members not to bolt the cartel in favour of higher short-term profits. Non-cooperative Game o Binding agreements are not possible. o For example, oligopolistic industries such as the US automobile industry whose agreements in restraint of trade are illegal. 9.3 A Non-cooperative Game Model of Manager-Investor Conflict Conflict between constituencies (e.g., investors & managers) can be modeled as a game, since decision needs of different constituencies may not coincide. Investors will desire relevant and reliable financial statement information Managers may not wish to reveal all the information that investors desire for either efficient contracting or opportunistic purposes. For example: o They may prefer to omit certain liabilities from the balance sheet, on the grounds that this will make it easier to raise capital by facilitating contracts with lenders. o They may prefer not to reveal which accounting policies are being used so as to have room to manage reported profits by discretionary accruals or changes of accounting policy. o Management may fear that releasing too much information will benefit their competition. Investors will be aware of this possibility and will take it into account when making an investment decision. Page 1 of 10
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Chapter 9 Notes Firm management, in turn, will be aware of possible investor reactions when preparing the financial statement. The conflict between manager and investor is modeled as a non-cooperative game. Why? An agreement between manager and investor about what specific information would be supplied could be very costly. Similar agreements would have to be negotiated with all users. Different users have different information needs, so many different sets of financial statements would be needed. Example 9.1- Manager-Investor Relations as a Non-Cooperative Game
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This note was uploaded on 12/14/2010 for the course ACC 706 taught by Professor Shadifarshad during the Winter '09 term at Ryerson.

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Chapter 9_Notes - Chapter 9 Notes 9.2 Understanding Game Theory Game Theory(or economic theory of games attempts to model and predict conflict

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