Slide AKT 405 Teori AKuntansi 11 Godfrey
GODFREY
HODGSON
HOLMES
TARCA
CHAPTER 11
POSITIVE THEORY OF
ACCOUNTING POLICY AND
DISCLOSURE
Early demand for theory
• Capital markets research tried to explain
the effects of accounting
– was ultimately inconclusive and inconsistent
• mechanistic and no-effects hypotheses
• This research relied upon the EMH
– ultimately there were too many departures
• Led to the development of a positive
theory of accounting policy choice
2
Early demand for theory
• Positive theory incorporated a number
of observations
– many firms voluntarily provided
accounting reports
– firms lobbied in relation to accounting
standards
– firms made consistent policy choices
– firms tended toward conservatism
3
Contracting theory
• The firm is seen as a ‘nexus’ of
contractual relationships
• The firm is seen as an efficient way
of organising economic activity to
reduce contracting costs
– equity (management) contracts (an
agency contract)
– debt contracts (an agency contract)
4
Agency theory
• An agency contract is one where one party
(the principal) engages another (the agent) to
act on their behalf
– e.g. where there is a separation of management
and ownership
• Both parties are utility maximisers
– agent may therefore act from self-interest
• divergence of interests is the agency problem
– contracts incorporating accounting numbers can
be used to align the interests of both parties
5
Agency theory
• The agency problem in turn gives
rise to agency costs spent to
overcome it
– monitoring costs
– bonding costs
– residual loss
6
Agency theory
•
Monitoring Costs – the cost of monitoring
the agent’s behaviour; initially borne by the
principal but passed on to the agent through
an adjustment to their remuneration (price
protection)
•
•
auditing costs, operating rules…
Bonding Costs – the cost borne by the agent
as a result of them taking action to align their
interests with those of the principal
•
•
providing more regular financial reports (a cost
to the manager in terms of time and effort)
constraints on their activities…
7
Agency theory
• The agents incur bonding costs in
order to reduce the monitoring costs
they eventually bear
• Agents stop spending on bonding
costs when the marginal cost equals
the marginal reduction in the
monitoring costs they bear
– $1 = $1
8
Agency theory
• Residual Loss – the loss associated with
not being able to fully align the interests of
the agent with those of the principal
• Ex post settling up – (ex post = at the
end of each period)
– agent’s future remuneration based on
observed agent performance
– the principal changes the remuneration to be
paid to the agent to align it with their
performance
9
Agency theory
• In the real world, price protection and
settling up are not perfect or complete
• Agents perceive that they will therefore not
be fully penalised for their divergent
behaviour
• They have incentives to act opportunistically
• This increases the residual loss
• This loss is borne by the principal as well as,
or instead of, the agent
10
Agency theory
• Agency theory attributes a role for
accounting
• Accounting is part of the monitoring
and bonding mechanisms
• Accounting numbers are used in
contracts
11
Price protection and
shareholder/manager agency
problems
• The separation of ownership and
management leads to divergent
behaviour by agents
• Divergence comes about because of
– the risk-aversion problem
– the dividend-retention problem
– the horizon problem
12
Price protection and
shareholder/manager agency
problems
• Risk aversion
– managers prefer less risk than do
shareholders
• different degrees of diversification affecting
risk
• limited liability accorded to shareholders
13
Price protection and
shareholder/manager agency
problems
• Dividend-retention
– managers prefer to pay out less of the
profits as dividends than shareholders
prefer
• pay their remuneration
• empire building
14
Price protection and
shareholder/manager agency
problems
• Horizon
– managers have a shorter time horizon
with respect to their association with the
firm than do shareholders
• shareholders are interested in future cash
flows
• managers have a time horizon only as long
as they intend to remain with the firm
15
Price protection and
shareholder/manager agency
problems
• Contracting can be used to reduce
the severity of these problems
– manager remuneration is usually tied to firm
performance in some way to motivate
managers to act in the shareholders’ interest
• performance can be related to accounting numbers
such as sales, profits, return on assets, net asset
growth, cash flow, etc
• performance can be related to the firm’s share price
16
Shareholder-debtholder
agency problems
• In this context, the manager is
assumed to be either the sole owner
of the firm, or has interests that are
totally aligned with the interests of
the shareholders
– the principal is the debtholder
– the agent is the manager acting on
behalf of shareholders
17
Shareholder-debtholder
agency problems
• Firm value is the value of debt plus
the value of equity
• The value of equity can be increased
by
– either increasing the value of the firm
(efficient contracting); or
– transferring wealth away from
debtholders (opportunistic behaviour)
18
Shareholder-debtholder
agency problems
• Varieties of opportunistic behaviour
– excessive dividend payments
– asset substitution
– underinvestment
– claim dilution
19
Shareholder-debtholder
agency problems
• Excessive dividend payments
– reduces the asset base securing the debt
– shareholders have received cash but limited
liability protects them from being personally
liable for the debts of the firm in the event of
bankruptcy
– the debt becomes mispriced
– reduces the value of the debt
20
Shareholder-debtholder
agency problems
• Asset substitution
– firm invests in higher risk projects to
benefit shareholders
• no benefit to debtholders
• but do share in possible losses
– shareholders are able to diversify and
have limited liability
– debt becomes mispriced
21
Shareholder-debtholder
agency problems
• Underinvestment
– in some circumstances, shareholders
have incentives not to undertake
positive NPV projects because to do so
would increase the funds available to
the debtholders but not to the
shareholders
22
Shareholder-debtholder
agency problems
• Claim dilution
– occurs when the firm issues debt of a
higher priority than the debt already on
issue
– decreases the relative security and
value of the existing debt
23
Shareholder-debtholder
agency problems
• Lenders will price protect
– through interest rates, the withholding
of funds and the length of the loan
• The interests of shareholders can be
bonded to those of debtholders via
restrictions in lending agreements
– loan covenants
24
Ex post opportunism
versus ex
ante efficient
contracting
Ex post opportunism
– occurs when, once a contact is in place,
agents take actions that transfer wealth
from principals to themselves
25
Ex post opportunism
versus ex
ante efficient
contracting
Ex ante efficient contracting
– occurs when agents take actions that
maximise the amount of wealth
available to distribute between
principals and agents
– ex ante – before contracts are finalised
26
Signalling theory
• Managers voluntarily provide
information to investors - signals - to
assist in their decision making
• Similar to efficient contracting
• Aligned with the information hypothesis
• Managers signal expectations and
intentions regarding the future
• Incentives to signal good, neutral and
bad news
27
Political processes
• Often firms try to avoid public
attention that is costly to them
– financially
– in terms of public perception and
reputation
• They reduce their reported profit or
its volatility
– e.g. banking sector in Australia
28
Conservatism,
accounting standards and
agency costs
• Conservatism shows a bias by
accountants accelerating recognition
of expenses and decelerating
recognition of revenue
• IASB argues this does not reveal the
real financial picture and reduces
information available to users
29
Additional empirical tests
of the theory
• Testing the opportunistic and political
cost hypothesis
• Tests using contract details
• Refining the specification of political
costs
• Testing the efficient contracting
hypothesis
30
Additional empirical tests
of the theory
• Evidence that managers use
accounting numbers to
– counter political pressure
– gain political advantages
– set management targets related to
remuneration
– minimise breaching debt covenants
– provide dividend constraints
– constrain management manipulation
31
Evaluating the theory
• Mixed support for positive accounting
theory
• Two categories of major criticism
– methodological and statistical criticism
• empirical evidence is weak and inconclusive
– philosophical criticism
• contrary to its claims, it is laden with value
judgments
• focuses on human behaviour and not the behaviour
and measurement of accounting entities
• positivism is no longer taken seriously
32
Issues for auditors
• The demand for auditing can be
explained by agency theory as part
of the monitoring and bonding
activity and costs
– higher quality auditors
– industry specialist auditors
33
Summary
• Positive accounting theory has been a major
force in academic accounting research
• Incorporates a theoretical model of
contractual exchange between persons who
use accounting numbers to effect their payoffs
• Provides an explanation as to why accountants
account as they do
– minimises the cost of agency relationships
– yet opportunistic behaviour by agents is the norm
– but some efficient ex ante behaviour by agents
34
Key terms and concepts
•
•
•
•
•
•
•
•
•
•
•
•
Positive theory
Contracting theory
Agency theory
Agents
Principals
Monitoring costs
Bonding costs
Residual loss
Ex post settling up
Risk aversion problem
Dividend retention problem
Horizon problem
35
Key terms and concepts
•
•
•
•
•
•
•
•
•
•
•
Shareholder/manager agency problem
Shareholder/debtholder agency problem
Excessive dividend payment problem
Asset substitution problem
Underinvestment problem
Claim dilution problem
Ex post opportunism
Ex ante efficient contracting
Signalling theory
Political processes
Conservatism
36
37
HODGSON
HOLMES
TARCA
CHAPTER 11
POSITIVE THEORY OF
ACCOUNTING POLICY AND
DISCLOSURE
Early demand for theory
• Capital markets research tried to explain
the effects of accounting
– was ultimately inconclusive and inconsistent
• mechanistic and no-effects hypotheses
• This research relied upon the EMH
– ultimately there were too many departures
• Led to the development of a positive
theory of accounting policy choice
2
Early demand for theory
• Positive theory incorporated a number
of observations
– many firms voluntarily provided
accounting reports
– firms lobbied in relation to accounting
standards
– firms made consistent policy choices
– firms tended toward conservatism
3
Contracting theory
• The firm is seen as a ‘nexus’ of
contractual relationships
• The firm is seen as an efficient way
of organising economic activity to
reduce contracting costs
– equity (management) contracts (an
agency contract)
– debt contracts (an agency contract)
4
Agency theory
• An agency contract is one where one party
(the principal) engages another (the agent) to
act on their behalf
– e.g. where there is a separation of management
and ownership
• Both parties are utility maximisers
– agent may therefore act from self-interest
• divergence of interests is the agency problem
– contracts incorporating accounting numbers can
be used to align the interests of both parties
5
Agency theory
• The agency problem in turn gives
rise to agency costs spent to
overcome it
– monitoring costs
– bonding costs
– residual loss
6
Agency theory
•
Monitoring Costs – the cost of monitoring
the agent’s behaviour; initially borne by the
principal but passed on to the agent through
an adjustment to their remuneration (price
protection)
•
•
auditing costs, operating rules…
Bonding Costs – the cost borne by the agent
as a result of them taking action to align their
interests with those of the principal
•
•
providing more regular financial reports (a cost
to the manager in terms of time and effort)
constraints on their activities…
7
Agency theory
• The agents incur bonding costs in
order to reduce the monitoring costs
they eventually bear
• Agents stop spending on bonding
costs when the marginal cost equals
the marginal reduction in the
monitoring costs they bear
– $1 = $1
8
Agency theory
• Residual Loss – the loss associated with
not being able to fully align the interests of
the agent with those of the principal
• Ex post settling up – (ex post = at the
end of each period)
– agent’s future remuneration based on
observed agent performance
– the principal changes the remuneration to be
paid to the agent to align it with their
performance
9
Agency theory
• In the real world, price protection and
settling up are not perfect or complete
• Agents perceive that they will therefore not
be fully penalised for their divergent
behaviour
• They have incentives to act opportunistically
• This increases the residual loss
• This loss is borne by the principal as well as,
or instead of, the agent
10
Agency theory
• Agency theory attributes a role for
accounting
• Accounting is part of the monitoring
and bonding mechanisms
• Accounting numbers are used in
contracts
11
Price protection and
shareholder/manager agency
problems
• The separation of ownership and
management leads to divergent
behaviour by agents
• Divergence comes about because of
– the risk-aversion problem
– the dividend-retention problem
– the horizon problem
12
Price protection and
shareholder/manager agency
problems
• Risk aversion
– managers prefer less risk than do
shareholders
• different degrees of diversification affecting
risk
• limited liability accorded to shareholders
13
Price protection and
shareholder/manager agency
problems
• Dividend-retention
– managers prefer to pay out less of the
profits as dividends than shareholders
prefer
• pay their remuneration
• empire building
14
Price protection and
shareholder/manager agency
problems
• Horizon
– managers have a shorter time horizon
with respect to their association with the
firm than do shareholders
• shareholders are interested in future cash
flows
• managers have a time horizon only as long
as they intend to remain with the firm
15
Price protection and
shareholder/manager agency
problems
• Contracting can be used to reduce
the severity of these problems
– manager remuneration is usually tied to firm
performance in some way to motivate
managers to act in the shareholders’ interest
• performance can be related to accounting numbers
such as sales, profits, return on assets, net asset
growth, cash flow, etc
• performance can be related to the firm’s share price
16
Shareholder-debtholder
agency problems
• In this context, the manager is
assumed to be either the sole owner
of the firm, or has interests that are
totally aligned with the interests of
the shareholders
– the principal is the debtholder
– the agent is the manager acting on
behalf of shareholders
17
Shareholder-debtholder
agency problems
• Firm value is the value of debt plus
the value of equity
• The value of equity can be increased
by
– either increasing the value of the firm
(efficient contracting); or
– transferring wealth away from
debtholders (opportunistic behaviour)
18
Shareholder-debtholder
agency problems
• Varieties of opportunistic behaviour
– excessive dividend payments
– asset substitution
– underinvestment
– claim dilution
19
Shareholder-debtholder
agency problems
• Excessive dividend payments
– reduces the asset base securing the debt
– shareholders have received cash but limited
liability protects them from being personally
liable for the debts of the firm in the event of
bankruptcy
– the debt becomes mispriced
– reduces the value of the debt
20
Shareholder-debtholder
agency problems
• Asset substitution
– firm invests in higher risk projects to
benefit shareholders
• no benefit to debtholders
• but do share in possible losses
– shareholders are able to diversify and
have limited liability
– debt becomes mispriced
21
Shareholder-debtholder
agency problems
• Underinvestment
– in some circumstances, shareholders
have incentives not to undertake
positive NPV projects because to do so
would increase the funds available to
the debtholders but not to the
shareholders
22
Shareholder-debtholder
agency problems
• Claim dilution
– occurs when the firm issues debt of a
higher priority than the debt already on
issue
– decreases the relative security and
value of the existing debt
23
Shareholder-debtholder
agency problems
• Lenders will price protect
– through interest rates, the withholding
of funds and the length of the loan
• The interests of shareholders can be
bonded to those of debtholders via
restrictions in lending agreements
– loan covenants
24
Ex post opportunism
versus ex
ante efficient
contracting
Ex post opportunism
– occurs when, once a contact is in place,
agents take actions that transfer wealth
from principals to themselves
25
Ex post opportunism
versus ex
ante efficient
contracting
Ex ante efficient contracting
– occurs when agents take actions that
maximise the amount of wealth
available to distribute between
principals and agents
– ex ante – before contracts are finalised
26
Signalling theory
• Managers voluntarily provide
information to investors - signals - to
assist in their decision making
• Similar to efficient contracting
• Aligned with the information hypothesis
• Managers signal expectations and
intentions regarding the future
• Incentives to signal good, neutral and
bad news
27
Political processes
• Often firms try to avoid public
attention that is costly to them
– financially
– in terms of public perception and
reputation
• They reduce their reported profit or
its volatility
– e.g. banking sector in Australia
28
Conservatism,
accounting standards and
agency costs
• Conservatism shows a bias by
accountants accelerating recognition
of expenses and decelerating
recognition of revenue
• IASB argues this does not reveal the
real financial picture and reduces
information available to users
29
Additional empirical tests
of the theory
• Testing the opportunistic and political
cost hypothesis
• Tests using contract details
• Refining the specification of political
costs
• Testing the efficient contracting
hypothesis
30
Additional empirical tests
of the theory
• Evidence that managers use
accounting numbers to
– counter political pressure
– gain political advantages
– set management targets related to
remuneration
– minimise breaching debt covenants
– provide dividend constraints
– constrain management manipulation
31
Evaluating the theory
• Mixed support for positive accounting
theory
• Two categories of major criticism
– methodological and statistical criticism
• empirical evidence is weak and inconclusive
– philosophical criticism
• contrary to its claims, it is laden with value
judgments
• focuses on human behaviour and not the behaviour
and measurement of accounting entities
• positivism is no longer taken seriously
32
Issues for auditors
• The demand for auditing can be
explained by agency theory as part
of the monitoring and bonding
activity and costs
– higher quality auditors
– industry specialist auditors
33
Summary
• Positive accounting theory has been a major
force in academic accounting research
• Incorporates a theoretical model of
contractual exchange between persons who
use accounting numbers to effect their payoffs
• Provides an explanation as to why accountants
account as they do
– minimises the cost of agency relationships
– yet opportunistic behaviour by agents is the norm
– but some efficient ex ante behaviour by agents
34
Key terms and concepts
•
•
•
•
•
•
•
•
•
•
•
•
Positive theory
Contracting theory
Agency theory
Agents
Principals
Monitoring costs
Bonding costs
Residual loss
Ex post settling up
Risk aversion problem
Dividend retention problem
Horizon problem
35
Key terms and concepts
•
•
•
•
•
•
•
•
•
•
•
Shareholder/manager agency problem
Shareholder/debtholder agency problem
Excessive dividend payment problem
Asset substitution problem
Underinvestment problem
Claim dilution problem
Ex post opportunism
Ex ante efficient contracting
Signalling theory
Political processes
Conservatism
36
37