cacc 706_ch 05

cacc 706_ch 05 - IF the efficient markets theory and the...

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Unformatted text preview: IF the efficient markets theory and the decision theories underlying it are reasonable descriptions of reality on average, WE SHOULD OBSERVE THE MARKET VALUES OF SECURITIES RESPONDING IN PREDICTABLE WAYS TO NEW INFORMATION This leads to an examination of empirical research in accounting Accounting research has established that security market prices do respond to accounting info Information is useful if it leads investors to change their beliefs and actions : The degree of usefulness for investors can be measured by the extent of volume or price change following release of the information This equating of usefulness to information content is called the information approach to decision usefulness of financial reporting The information approach implies that EMPIRICAL RESEARCH CAN HELP ACCOUNTANTS TO FURTHER INCREASE USEFULNESS by letting market response guide them as to what information is and is not valued by investors The information approach to decision usefulness IS AN APPROACH TO FINANCIAL REPORTING that: 1. Recognizes individual responsibility for predicting future firm performance and and 2. Concentrates on providing useful information for this purpose 3. Assumes securities market efficiency, recognizing that the market will react to useful information from any source, including financial statements When equating usefulness with the extent of security price change: While investors, and accountants, may benefit from useful information, it does not follow that society will necessarily be better off Information is a very complex commodity and its private and social values are not the same. One reason is cost: Financial statement users do not generally pay directly for this information As a result, they may find information useful even though it costs society more 5.2 OUTLINE OF THE RESEARCH PROBLEM 5.2.1 R EASONS FOR M ARKET R ESPONSE Consider the following predictions about investor behaviour, in response to different financial statement information : 1. Based on investors prior beliefs about a firms future performance (i.e., its dividends, cash flows, and/or earnings, which affect the expected returns and risk of the firms shares) 2. Upon release of current years net income (Certain investors will decide to become more informed by analyzing the income number) 1) If net income is high, or higher than expected investors, by means of Bayes theorem , would revise upward their beliefs about future firm performance Investors who have revised their beliefs about future firm performance UPWARD will be inclined to buy the firms shares at their current market price 2) Other investors, who perhaps had overly high expectations for what current NI might interpret the same net income number as bad news evaluations of the riskiness of these shares may also be revised 3) We would expect to observe the volume of shares traded to INCREASE This volume should be greater the greater are the differences in investors prior...
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This note was uploaded on 03/27/2012 for the course ACC 706 taught by Professor Shadifarshad during the Spring '09 term at Ryerson.

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cacc 706_ch 05 - IF the efficient markets theory and the...

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