Positive Accounting Theory
Positive accounting researchers developed theories of accounting practice by applying
economic theories that assume nonzero contracting and information costs. This cost
assumption allows accounting procedures to affect the firm'
Capital Asset Pricing Model (CAPM)
The CAPM builds on portfolio theory, but extends it to incorporate a measure of the relationship
between risk and return. Essentially it suggests that the required rate of return of a security is a
function of its riskin
Abnormal Earnings Valuation
Abnormal Earnings Model: Valuation Using (Equity) Book Value and Earnings
Denoting abnormal earnings as A, we have
A1 = B0 * (R1 k)
Since earnings are equal to book value multiplied by the ROE (i.e., E 1 = B0 * R1), the
Dividend Discount Model (DDM):
The Dividend Discount Model (DDM) is the fundamental equity valuation model. Any
theoretical valuation model must be reconcilable with DDM otherwise it is conceptually
To see why the DDM is of such central importance
The stewardship function of management was dominant in early views of the purpose of
financial statements. Under this view, management is the steward to whom capital
suppliers (i.e., shareholders and creditors) entrust control over
Information in a Multi-person Exchange Setting
Information Asymmetry occurs when one or more parties to a business transaction have
an information advantage over other parties.
More Informed management Versus Less Informed Investors:
It is often assumed
In the late 1960s the perspective shifted from economic income measurement to an
informational approach. This is reflected in financial accounting research in
information economics, securities prices, and behavioral science.
Firms with low P/B is called value stocks, empirical evidence suggests that forming a portfolio
consists of firms with low P/B can beat the market over long run.
The relationship between a company's stock market price and its book value is call
R2s and ERC monotonically increase as interval increase.
An Earnings Response Coefficient (ERC) measures the extent of a security's abnormal market
return in response to the unexpected component of reported earnings of the firm issuing that
Properties of Security Analyst Forecasts
A. Forecast Revision Evidence
1. Analysts provide forecasts one to three quarters, one-year, two-year, and five-year ahead.
2. A minority of analysts revise their forecasts in any calendar month. Less than 25% (20%