Chapter 12_Notes

Chapter 12_Notes - Chapter 12 Notes 12.2 Regulation of...

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Chapter 12 Notes 12.2 Regulation of Economic Activity Capital markets are affected by regulations. Information asymmetry is frequently used to justify regulations of capital markets to protect individuals who are at an information disadvantage. For example, insider trading rules; regulations of full disclosure in prospectuses. In addition to protecting ordinary investors, such regulations are also intended to improve the operation of capital markets by enhancing public confidence in their fairness. Accounting practice is also strongly affected by regulations designed to protect against information asymmetry. An important role of accounting and auditing is to report useful information, thereby reducing information asymmetry between firm insiders, the investing public, and other users. However, this role requires that accountants and auditors be credible and competent. Thus, there are laws to regulate accounting professions that control entry and maintain high standards. Many other regulations also affect accountants. For example: o Minimum disclosure requirements for annual reports are required by corporations’ acts. o Governmental statistical agencies and taxation authorities require financial information. o Quasi-governmental bodies such as securities commissions (e.g. SEC) require a variety of information disclosures from firms whose shares are publicly traded. o Private bodies (e.g. IASB, AcSB, FASB) set accounting and auditing standards Governments are directly (e.g., through laws to control the creation of professional accounting bodies and their rights to public practice) or indirectly (e.g., through securities commissions’ standards) involved in accounting regulation. Thus, firms are not completely free to control the amount and timing of the information they produce about themselves. Rather, they must do so under a host of regulations called standards, laid down by some central authority. Central authority refers to any of these regulatory bodies. Standard setting is the regulation of firm’s external information production decisions by some central authority.
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Chapter 12 Notes Two types of information that a manager may possess: Proprietary information: Information that, if released, will directly affect cash flows (e.g., plans for takeover; information about valuable patents). Non-proprietary information: Information that, if released, will not directly affect future cash flows (e.g., earnings forecasts). 12.3 Ways to Characterize Information Production Finer information adds more detail to the existing financial statements (e.g., expanded note disclosure, additional line items, segment reporting). The information approach to decision usefulness implies finer information productions since
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Chapter 12_Notes - Chapter 12 Notes 12.2 Regulation of...

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