Chapter 12_ Solutions

Chapter 12_ Solutions - Suggested Solutions to Assigned...

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Suggested Solutions to Assigned Problems in Chapter 12: 8, 12, 13 8. a. Managers may withhold bad news: To conceal evidence of shirking, if the bad news results from low manager effort. To delay a fall in share price, which would increase cost of capital and possibly affect manager compensation. To enable insider trading profits. To postpone damage to reputation. b. The disclosure principle will completely eliminate a manager’s incentive to withhold bad news if the following conditions hold: The information can be ranked from good to bad in terms of its implications for firm value. Investors know that the manager has the information. There is no cost to the firm of releasing the information. Market forces and/or penalties ensure that the information released is truthful. If the information affects variables used for contracting (e.g., share price or covenant ratios), release of the information does not impose increased contracting costs on the firm. Then, the market will interpret failure to disclose as indicating the worst possible information. To avoid the resulting impact on share price, all but the lowest-type manager will disclose. If one or more of the above requirements is violated, the disclosure principle may not completely eliminate the withholding of bad news. This will be the case when: The information is proprietary. Then, there is a threshold level below which the news will not be released (Verrecchia (1983)). Page  1  of  5
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If the market is not sure whether the manager has the information, there is a threshold below which the news will not be released, even though it is non-proprietary. The motivation to release non-proprietary information arises from its effect on firm value (Pae, 2005). When GAAP quality is not too high, information that goes beyond mandated information disclosure will only be disclosed voluntarily if it exceeds a threshold (Einhorn, 2005). If release of information may trigger the entry of competitors, the firm may only disclose a range
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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 12_ Solutions - Suggested Solutions to Assigned...

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