Slide AKT 405 Teori Akuntansi 12 Godfrey
GODFREY
HODGSON
HOLMES
TARCA
CHAPTER 12
CAPITAL MARKET RESEARCH
Philosophy of positive
accounting theory
• Seeks to explain and predict accounting practice
• Seeks to explain how and why capital markets
react to accounting reports
• Does so by observing practice – empirical
evidence
• Explanation means providing reasons for
observed practice
– e.g. why do firms continue to use historic cost
• Prediction means that the theory predicts
unobserved phenomena
• Has an economic focus
2
Philosophy of positive
accounting theory
• Positive theory is based on
assumptions about the behaviour of
individuals
– assumes investors and financial
accounting users and preparers are
rational utility maximisers
– rejects arguments based on anecdotal
evidence and naïve acceptance of
political or academic prescriptions
3
Strengths of positive
theory
• In order to prescribe an appropriate
accounting policy, it is necessary to
know how the world actually
operates
• We can then normatively prescribe
accounting practice
4
Strengths of positive
theory
• Positive hypotheses are capable of
falsification by empirical research
• Provides an understanding of how the world
works rather than prescribing how it should
work
– obtain an understanding about how valuerelevant accounting numbers are for share prices
– attempt to understand the connection between
accounting information, managers, firms and
markets, and analyse those relationships
5
Dissatisfaction with
prescriptive standards
• Normative standards
• Prescriptions not based upon identified,
empirical observations or methods
• Theories are not falsifiable
• Do not explain and predict accounting
practice
• Do not assess existing accounting
practices
6
Scope of positive
accounting theory
Two stages of development
1. Capital market research – into the
impact of accounting and the
behaviour of capital markets
– did not explain accounting practice
– investigated connection between the
accounting data and share prices/returns
– efficient markets hypothesis (EMH)
– capital asset pricing model
7
Scope of positive
accounting theory
2. Sought to explaining and predict
accounting practices across firms
– ex post opportunism
– ex ante efficient contracting
8
Capital market research
and the efficient markets
hypothesis
• Two types of capital markets research
– the impact of the release of accounting
information on share returns
– the effects of changes in accounting
policy on share prices
• Most research in these areas relies
upon the EMH
9
Capital market research
and the efficient markets
hypothesis
Efficient market: one ‘in which prices
fully reflect available information’
3 Forms of Information Efficiency
1. Weak form
(past price information)
2. Semi-strong form
(publicly available information)
3. Strong form
(all information – public and private)
10
Capital market research
and the efficient markets
hypothesis
• Capital markets research in
accounting assumes semi-strong
form efficiency
• Financial statements and other
disclosures form part of the
information set that is publicly
available
11
Capital market research
and the efficient markets
hypothesis
• Based on dubious assumptions
– there are no transaction costs in trading
securities
– information is available cost-free to all
market participants
– there is agreement on the implications
of current information for the current
price and distributions of future prices
12
Capital market research
and the efficient markets
hypothesis
Market efficiency does not
assume, mean or imply
– that every, or any, investor has
knowledge of all information
– that all financial information has been
correctly presented or interpreted by
individual investors
– that managers make the best decisions
– that investors can predict the future
precisely
13
Capital market research
and the efficient markets
hypothesis
• Market efficiency simply means that
share prices reflect the aggregate
impact of all relevant information,
and do so in an unbiased and rapid
manner
14
Market model
Market Model:
• Derives from CAPM
• Used to estimate abnormal returns
on shares when profits announced
• Share prices and returns are affected
by both market-wide and firmspecific events
• Market-wide events must first be
controlled for
15
Market model
16
Market model
• Based on dubious assumptions
– investors are risk averse
– returns are normally distributed and
investors select their portfolios on this basis
– investors have homogeneous expectations
– markets are complete
•
•
•
•
all participants are price takers
there are no transaction costs
there are no taxes
there are rational expectations by investors
17
Impact of accounting
profits announcements on
share prices
Ball & Brown (1968):
• Seminal work in positive accounting
and finance literature
• Tested the usefulness of historical
cost profit figure to investment
decisions
• If the historical cost profit figure is
useful the share price will react
18
Impact of accounting profits
announcements on share
prices
19
Impact of accounting profits
announcements on share
prices
Ball & Brown (1968) Results:
• Most of the information contained in
the earnings announcement (8590%) was anticipated by investors
• Evidence of information content at
time of historical cost earnings
announcement
20
Impact of accounting profits
announcements on share
prices
• Magnitude
• Information asymmetry and firm size
• Magnitude of profit releases from
other firms
• Volatility
21
Impact of accounting profits
announcements on share
prices
• Profit release event studies showed that
accounting profit does capture a portion of the
information set that is reflected in security
returns
• The evidence also shows that competing
sources of information pre-empted the
information in annual profits by about 70-85 per
cent
• Annual accounting figures are not timely
• Led to an another approach – association
studies
22
Association studies and
earnings response
coefficients
• The objective is to test the impact of
accounting variables and a wider
information set that is reflected in
securities returns over a longer
period
– earnings response coefficient (ERC)
23
Association studies and
earnings response
coefficients
Factors which can affect the association
between profits and share prices:
–
–
–
–
–
–
–
–
–
–
–
–
risk and uncertainty
audit quality
firm size
industry
interest rates
financial leverage
firm growth
permanent and temporary profits
non-linear modeling
disaggregating profits
cash flows
balance sheet and balance sheet components
24
Methodological issues
• To argue that the results of the research
are supportive of EMH and that the form
of accounting is not that important for
valuation purposes derives, in part, from
the fact that the EMH is assumed to be
descriptively valid
• This assumption may not be warranted
• There is increasing evidence that markets
can be fooled by accounting numbers
25
Methodological issues
• No attempt to discriminate EMH from
competing hypothesis
– mechanistic hypothesis
• managers use accounting to deliberately
mislead the share market
• market participants can be fooled
– no-effects hypothesis
• the market ignores accounting changes that
have no cash flow consequences
26
Trading strategies
• Post-announcement drift
• Winners/losers and over-confidence
• Mechanistic or behavioural effect
– no-effects hypothesis
– cosmetic accounting
27
Trading strategies
Two viewpoints of accounting
manipulation
28
Trading strategies
Detecting the quality and
probability of accounting
management
29
Issues for auditors
• There is some evidence of an association
between auditing and the cost of capital
• Lower cost when firms voluntarily
purchase an audit or purchase a high
quality audit
– investors value the deep resources of a large
auditor
– investors value the quality assurance
regarding accounting data provided by the
auditor
30
Summary
• Philosophical objective of positive
accounting theory is to explain and
predict current accounting practice
• Positive theory developed in two stages
– capital market research
– contracting theory
• Significant issues relating to the
validity of capital market research
31
Key terms and concepts
•
•
•
•
•
•
•
•
•
•
•
•
Prescriptive standards
Positive accounting theory
Capital market research
EMH
CAPM
CAR
ERC
Information asymmetry
Market efficiency
Impact of behaviour
Mechanistic hypothesis
No-effects hypothesis
32
33
HODGSON
HOLMES
TARCA
CHAPTER 12
CAPITAL MARKET RESEARCH
Philosophy of positive
accounting theory
• Seeks to explain and predict accounting practice
• Seeks to explain how and why capital markets
react to accounting reports
• Does so by observing practice – empirical
evidence
• Explanation means providing reasons for
observed practice
– e.g. why do firms continue to use historic cost
• Prediction means that the theory predicts
unobserved phenomena
• Has an economic focus
2
Philosophy of positive
accounting theory
• Positive theory is based on
assumptions about the behaviour of
individuals
– assumes investors and financial
accounting users and preparers are
rational utility maximisers
– rejects arguments based on anecdotal
evidence and naïve acceptance of
political or academic prescriptions
3
Strengths of positive
theory
• In order to prescribe an appropriate
accounting policy, it is necessary to
know how the world actually
operates
• We can then normatively prescribe
accounting practice
4
Strengths of positive
theory
• Positive hypotheses are capable of
falsification by empirical research
• Provides an understanding of how the world
works rather than prescribing how it should
work
– obtain an understanding about how valuerelevant accounting numbers are for share prices
– attempt to understand the connection between
accounting information, managers, firms and
markets, and analyse those relationships
5
Dissatisfaction with
prescriptive standards
• Normative standards
• Prescriptions not based upon identified,
empirical observations or methods
• Theories are not falsifiable
• Do not explain and predict accounting
practice
• Do not assess existing accounting
practices
6
Scope of positive
accounting theory
Two stages of development
1. Capital market research – into the
impact of accounting and the
behaviour of capital markets
– did not explain accounting practice
– investigated connection between the
accounting data and share prices/returns
– efficient markets hypothesis (EMH)
– capital asset pricing model
7
Scope of positive
accounting theory
2. Sought to explaining and predict
accounting practices across firms
– ex post opportunism
– ex ante efficient contracting
8
Capital market research
and the efficient markets
hypothesis
• Two types of capital markets research
– the impact of the release of accounting
information on share returns
– the effects of changes in accounting
policy on share prices
• Most research in these areas relies
upon the EMH
9
Capital market research
and the efficient markets
hypothesis
Efficient market: one ‘in which prices
fully reflect available information’
3 Forms of Information Efficiency
1. Weak form
(past price information)
2. Semi-strong form
(publicly available information)
3. Strong form
(all information – public and private)
10
Capital market research
and the efficient markets
hypothesis
• Capital markets research in
accounting assumes semi-strong
form efficiency
• Financial statements and other
disclosures form part of the
information set that is publicly
available
11
Capital market research
and the efficient markets
hypothesis
• Based on dubious assumptions
– there are no transaction costs in trading
securities
– information is available cost-free to all
market participants
– there is agreement on the implications
of current information for the current
price and distributions of future prices
12
Capital market research
and the efficient markets
hypothesis
Market efficiency does not
assume, mean or imply
– that every, or any, investor has
knowledge of all information
– that all financial information has been
correctly presented or interpreted by
individual investors
– that managers make the best decisions
– that investors can predict the future
precisely
13
Capital market research
and the efficient markets
hypothesis
• Market efficiency simply means that
share prices reflect the aggregate
impact of all relevant information,
and do so in an unbiased and rapid
manner
14
Market model
Market Model:
• Derives from CAPM
• Used to estimate abnormal returns
on shares when profits announced
• Share prices and returns are affected
by both market-wide and firmspecific events
• Market-wide events must first be
controlled for
15
Market model
16
Market model
• Based on dubious assumptions
– investors are risk averse
– returns are normally distributed and
investors select their portfolios on this basis
– investors have homogeneous expectations
– markets are complete
•
•
•
•
all participants are price takers
there are no transaction costs
there are no taxes
there are rational expectations by investors
17
Impact of accounting
profits announcements on
share prices
Ball & Brown (1968):
• Seminal work in positive accounting
and finance literature
• Tested the usefulness of historical
cost profit figure to investment
decisions
• If the historical cost profit figure is
useful the share price will react
18
Impact of accounting profits
announcements on share
prices
19
Impact of accounting profits
announcements on share
prices
Ball & Brown (1968) Results:
• Most of the information contained in
the earnings announcement (8590%) was anticipated by investors
• Evidence of information content at
time of historical cost earnings
announcement
20
Impact of accounting profits
announcements on share
prices
• Magnitude
• Information asymmetry and firm size
• Magnitude of profit releases from
other firms
• Volatility
21
Impact of accounting profits
announcements on share
prices
• Profit release event studies showed that
accounting profit does capture a portion of the
information set that is reflected in security
returns
• The evidence also shows that competing
sources of information pre-empted the
information in annual profits by about 70-85 per
cent
• Annual accounting figures are not timely
• Led to an another approach – association
studies
22
Association studies and
earnings response
coefficients
• The objective is to test the impact of
accounting variables and a wider
information set that is reflected in
securities returns over a longer
period
– earnings response coefficient (ERC)
23
Association studies and
earnings response
coefficients
Factors which can affect the association
between profits and share prices:
–
–
–
–
–
–
–
–
–
–
–
–
risk and uncertainty
audit quality
firm size
industry
interest rates
financial leverage
firm growth
permanent and temporary profits
non-linear modeling
disaggregating profits
cash flows
balance sheet and balance sheet components
24
Methodological issues
• To argue that the results of the research
are supportive of EMH and that the form
of accounting is not that important for
valuation purposes derives, in part, from
the fact that the EMH is assumed to be
descriptively valid
• This assumption may not be warranted
• There is increasing evidence that markets
can be fooled by accounting numbers
25
Methodological issues
• No attempt to discriminate EMH from
competing hypothesis
– mechanistic hypothesis
• managers use accounting to deliberately
mislead the share market
• market participants can be fooled
– no-effects hypothesis
• the market ignores accounting changes that
have no cash flow consequences
26
Trading strategies
• Post-announcement drift
• Winners/losers and over-confidence
• Mechanistic or behavioural effect
– no-effects hypothesis
– cosmetic accounting
27
Trading strategies
Two viewpoints of accounting
manipulation
28
Trading strategies
Detecting the quality and
probability of accounting
management
29
Issues for auditors
• There is some evidence of an association
between auditing and the cost of capital
• Lower cost when firms voluntarily
purchase an audit or purchase a high
quality audit
– investors value the deep resources of a large
auditor
– investors value the quality assurance
regarding accounting data provided by the
auditor
30
Summary
• Philosophical objective of positive
accounting theory is to explain and
predict current accounting practice
• Positive theory developed in two stages
– capital market research
– contracting theory
• Significant issues relating to the
validity of capital market research
31
Key terms and concepts
•
•
•
•
•
•
•
•
•
•
•
•
Prescriptive standards
Positive accounting theory
Capital market research
EMH
CAPM
CAR
ERC
Information asymmetry
Market efficiency
Impact of behaviour
Mechanistic hypothesis
No-effects hypothesis
32
33