ch04 (1).ppt

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Chapter 4

Research Methodology And

Theories On The Uses Of

Accounting Information

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Introduction To have a science is to have a recognized domain and a set of

phenomena in that domain Theory describes the underlying reality of that domain through input

(observations) and outputs (predictions)

ery little behavior is e!plained through e!isting accounting theory Theory vs theorizing "hapter introduces methods of developing theory and some theories on

outcomes of providing accounting information

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Research Methodology #eductive approach

Inductive approach

$ragmatic Approach %cientific Method

Other

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Deductive Approach It is essentially an &armchair' approach hich is described from

going from the general to the specific egins ith the establishment of ob*ectives +e!t definitions and assumptions are stated

A logical structure for accomplishing the ob*ectives based onthe definitions and assumptions is developed

Attempts to &theorize are generally based on the deductiveapproach

alidity of this approach lies in the ability to relate components

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Inductive Approach Ma,ing observations and

draing conclusions

-eneralizations are made about

the universe based upon limited

observations

A$ %tatement +o. / utilized

the inductive approach

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Pragmatic

Approach ased upon the concept of utility or usefulness

0hen a problem is found1

an attempt to find a solution is underta,en Most accounting theory as developed using this

approach

A Statement of Accounting Principles as apragmatic approach

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The Scientifc

Method Involves the folloing steps2

Most accounting research found in academic *ournals uses

the scientific method

Identify and state the problem to be studied

State the hypotheses to be tested

Collect data necessary to test the hypotheses

Analyze and evaluate data

Draw a tentative conclusion

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Other Research

Approaches 3thical approach

4 #eveloped by #R %cott and involves the

concepts of truth5 *ustice and fairness

ehavioral approach 4 The study of ho accounting information

affects the behavior of users

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The Outcomes oProviding AccountingInormation 6undamental analysis

The efficient mar,et hypothesis

The capital asset pricing model Agency theory

7uman information processing

"ritical perspective research

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!undamental Analysis

Investor decisions uy

7old

%ell

The goal of fundamental analysis

Investment analysis

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The "#icient Mar$et%ypothesis

7olds that 6undamental analysis is not a useful tool1 because individual investors are not able to identify

mispriced securities

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ased on the free mar,et supply and demandmodel ith the folloing assumptions2 4 All economic units have complete ,noledge of the

economy 4 All goods and services are completely mobile 4 All buyers and sellers are so small in relation to total

supply and demand that neither has an influence onsupply or demand

4

+o artificial restrictions on demand5 supply or prices ofgoods and services

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The

The Supply and Demand

Supply

Demand

P r i c e

P r i c e

QuantityQuantity

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The Supply and Demand

Model est illustrated in the securities mar,et Information available from many

sources including28 $ublished financial reports9 :uarterly earnings reports; +es reports/ $ublished competitor information

< "ontract aardings= %toc,holder meetings

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According to the supply and demandmodel5 the price of a product is

determined by ,noledge of

relevant information

The securities mar,et is vieed as

efficient if it reflects all available

information and reactsimmediately to ne

information

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The 3M7 indicates that an investor

ith a diversified portfolio cannot ma,e an

e!cess return by ,noledge of availableinformation

There are three forms of the 3M7 hich differ in

respect to the definition

of available information 4 0ea, form

4 %emi>strong form

4 %trong form

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&ea$ !orm An e!tension of the random al, theory in the

financial management literature

The historical price of a stoc, provides an unbiased

estimated of its future price "onse?uently5 an investor cannot

ma,e an e!cess return by

,noledge of past prices

This form of the 3M7 has beensupported by several studies

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Semi'Strong

!orm All publicly available information including past prices is

assumed to be incorporated into the determination of

security prices

An investor cannot ma,e an e!cess return by ,noledgeof any publicly available information

Implication is that the form of disclosure5 hether in the

financial statements5 the footnotes5 or financial press

information is not important This form of the 3M7 has been generally supported in the

literature

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The Capital Asset PricingModel

The goal of investors is to minimize ris, and ma!imize

returns.

The rate of return on stoc, is calculated2

Dividends + increases (or - decreases) in value

urchase rice

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Strong !orm All available information5

including insider information isimmediately incorporated into the

price of securities as soon as it is,non leaving no room fore!cess returns

Most available evidence suggest

that this form of the 3M7 is notvalid

Implications

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Ris,2 The possibility that actual returns ill deviate from e!pected

returns

U. %. treasury bills A ris, free investment

Return on these investments is the ris, free return

Diversification Stoc,s can be combined into a portfolio that is less ris,y than any

of the individual stoc,s

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Types of ris, are company specific and

environmental

Unsystematic risk The ris, that is company specific

and can be diversified aay

Systematic risk The nondiversifiable ris, that is related to

overall movements in the stoc, mar,et

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The Capital Asset

Pricing Model Assumption is that investors are ris,

aversive and ill demand higher returns

for ta,ing greater ris,s eta (β)

The measure of the relationship of a particular stoc, ith the

overall movement of the stoc, mar,et vieed as a measure of volatility > a measure of ris,

%ecurities ith higher βs offer greater returns than

securities ith relatively loer βs

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The Relationship(et)een Ris$ andReturn

Rs @ Rt Rp

0here2

Rs @ 3!pected return on a given ris,y

security

Rt @ The ris, free return rate

Rp @ The ris, premium

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The Relationship(et)een Ris$ and

Return

Investors ill not be compensated for

bearing unsystematic ris, since it can bediversified aay

The only relevant ris, is systematic ris,

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Incorporating Ris$ Into the"*uation

Rs @ Rt $s (Rm > Rt)

0here2

Rs @ 3!pected return on a given ris,y security

Rt @ The ris, free return rate

Rm @ The e!pected mar,et rate as a hole

$s @ The stoc,Bs beta

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Implications o

CAPM A securityBs price ill not be

impacted by unsystematic ris, %ecurities ith higher βs (higher ris,) ill be priced relatively

loer than securities offering less ris,

Research has indicated that past

βs are a good predictor of future

stoc, prices

"riticized because it causes

managers to see, only safe

investments

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+ormative vs, Positive theory

+ormative theory 4 based upon a set of goals

that its proponents maintain prescribe the

ays things should be.

Must be accepted by the entire universe to beuseful

$ositive theory 4 attempts to e!plain

observed phenomena One positive theory is termed agency theory

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Positive Theory

Agency theory

Based on economic theories of $rices

Agency relationships

$ublic choice

3conomic regulation

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Positive Theory Agency theory is based on the

assumption that individuals act toma!imize their on e!pected utilities.

As a result the relevant ?uestion is2

What is a particular individual’s expected benefitfrom a particular course of action

An agency is a consensual relationship beteen to parties herebyone agrees to act on behalf of the other

Inherent in this theory is that there is a conflict of interest beteen theshareholders and the managers of a corporation

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Positive Theory

Agency relationships involve costs to the principles8 Monitoring e!penditures by the

principal

9 onding e!penses by the agent; Residual loss

Agency theory holds that all

individuals ill act to ma!imize their on utility Monitoring and bonding costs ill be incurred as long as they

are less than the residual loss

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%uman Inormation

Processing Annual reports provide vast amounts of information

#isclosure of information is intended to help

investors ma,e buy > hold > sell decisions

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%uman Inormation

Processing 7I$ studies %tudies attempting to assess an individualBs ability to use

accounting information

Results > individuals have limited ability to process largeamounts of information

"onse?uences2%elective perception

#ifficulty in ma,ing optimal decisions

%e?uential processing

Implications > e!tensive disclosures no re?uired maybe having opposite effect

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Critical Perspectives

Research $revious theories assumed that ,noledge of

facts can be gained by observation

elief in indeterminacy ! the history ofaccounting is a comple! eb of economic5political and accidental conse?uences

This area of research contests the vie that,noledge of accounting is grounded inob*ective principles

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Critical PerspectivesResearch

Accountants have been unduly

influenced by utility based marginal

economics that holds2

$rofit @ efficiency in using scarce resources

"onventional accounting theory e?uates normativeand positive theory.

0hat should be and hat is are the same

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Critical Perspectives

Research "ritical perspective research concerns

itself ith the ays societies and

institutions have emerged. Three assumptions2

8 %ociety has the potential to be hat

it isnBt

9 7uman action can help this process

; "ritical theory can assist human action

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Accounting Research

"ducation and Practice 7o are research5 education and practice

related in most disciplinesC 6or e!ample5 medicineC

7o are they related in accountingC

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repared by 5athryn 6arbrou!h 78A

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ch04 (1).ppt