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Class Announcements
Assignment #10 due March 31st; available on-line Research Paper Part #4 and bonus due April 3rd
Business Banquet - April 2nd – 5:45-8pm, Catering - Gabrieau's Bistro; Keynote Speaker - Annette Verschuren, Past President of Home Depot for Canada and Asia
Final Exam 7:00pm April 19th, Main Gym, Oland Centre
Class Objectives
1. Information asymmetry is reduced through regulation
2. Information production considerations3. Standard setting as a form of regulation4. The costs and justification of regulation
Standard Setting: Regulation Firms are not completely free to control the
amount and timing of the information they produce about themselves Information asymmetry used to justify regulation
Accounting is a highly regulated area of economic activity Regulation includes: minimum disclosure, GAAP, GAAS,
audits The extent of regulation is increasing all the time
as more and more accounting standards are promulgated
“Standard setting is the regulation of firms external information production decisions by a regulator” (p. 462) The standard setter is a mediator between the
conflicting interests of investors and managers
Standard Setting: Information Production
Information is a commodity Type
Proprietary Non-proprietary
Benefits Improved Individual Decisions
Investors Managers
Improved Operation of Capital markets Managerial labour markets
Costs
Out-of- Pocket Costs Time & effort, more paperwork
Proprietary Costs May reveal information to competitors
Standard Setting: Types of Information Production Finer Information (more detail)
Expanded note disclosure Additional line items
Additional Information (not necessary inclusions) Fair value accounting supplementary info MD&A
More Credible Information Audit Fines/charges
Standard Setting: Securities Market Response
Securities market will respond positively to increased disclosure Better disclosure greater analyst following (Lang
& Lundholm 1996) Better disclosure improved share price (Healy et
al. 1999) Better disclosure more institutional ownership
(Healy et al. 1999) Better disclosure narrower bid-ask spread
(Wellar 1995) Better disclosure lower cost of capital (Botosan
& Plumlee 2002)
Standard Setting: Incentives for Information Production Contractual
Compensation contracts IPO
Market-Based (non-contractual) Securities markets (firm value) Managerial labour markets (Reputation) Takeover market (corporate control) Coarse Theorm
Too many parties to negotiate information production efficiently
Other Disclosure Principle Signaling Private information Search
Standard Setting: The Disclosure Principle
Disclosure principle – manager will release all information good or bad Market knows manager has the information Manager does not release the information market
fears the worst To avoid, manager releases the information
Problems: Information asymmetry Cost of disclosure Conflict between information desired by investors
and information needed for contracting purposes
Standard Setting: Signaling “A signal is an action taken by a high-type
manager that would not be rational if that manager was low-type” (p. 475)
For signals to be applicable, the manager must have a choice
Examples of signaling: Direct disclosure Proportion of equity retained Audit quality Forecast Analysts following Dividend policy Accounting policy choice
Standard Setting: Private Information Prodcution Many investors will be active in seeking
out information particularly in the presence of noise traders or securities market(s) inefficiencies
Private information search is costly from society’s perspective since more than one investor incurs costs to discover the same information
Standard Setting: Justification Accounting is a public good Market failure supports arguments for regulation
Externalities – “an action taken by a firm or individual that impose costs or benefits on the firms or individuals for which the entity creating the externality is not charged or doe not receive revenue.” (p. 464)
Free Riding – “is the receipt by a firm or individual of a benefit from an externality” (p. 464)
Disclosure Principle - ineffective Information Asymmetry
Adverse Selection Problem Insider trading Delay in information release
Moral Hazard Problem Earnings management to disguise shirking
Lack of unanimity between investors and managers about amount of information production