ACCT10003 Lecture Notes - Lecture 1: Information Asymmetry, Adverse Selection, Net Income
17 May 2018
School
Department
Course
Professor
Economics of Accounting Information
•Data: raw facts/numbers that describe the characteristics of an event = input
•Information: data organised in a way to be meaningful/useful to user = output!
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Quality information has:
•Relevance
-Predictive value: used to forecast the future cash flows
-Feedback value: confirms/corrects predictions
-Timeliness: info available when needed
•Reliability
-Verifiable: can be confirmed by third party (i.e. audit)
-Representational faithfulness: capturing economic reality accurately
-Neutrality: objective, unbiased
Above is the undying assumption of Traditional (neoclassical) economic view of information
-Markets are efficient, information is perfect and cordless (incorrect, oversimplified view)
•Economics of information (modern, the reality)
-Information asymmetry exists, information costly and imperfect
-Information has value - allows individuals to make choices that increases payoffs
“Market for lemons”:
•Lemons v cherries - don’t know what you are going to get
•Conditions for a lemon market (applicable to accounting info):
-Information asymmetry: lemons should be priced low, cherries high
-Incentives for seller to pass off low-quality product as high-quality (buyers will usually pay
average price)
-Sellers have no credible disclosure
-Continuum of seller quality (variety of qualities)
-Deficiency of effective public quality assurances (e.g. roadworthy certificate)
The economic environment is characterised by information asymmetry:
•Adverse selection: A type of information asymmetry whereby one or more parties to a business
transaction or potential transaction, have an information advantage over other parties
-E.g. Financial accounting and reporting a mechanism to control adverse selection by timely
and credible conversion inside information into outside information
-Before transaction
•Moral hazard: A type of of information asymmetry whereby one or more parties to a contract can
observe their actions in fulfilment of the contract but other parties cannot
-Accounting net income is a measure of managerial performance
-Net income is an input to executive compensation
-Net income can inform the managerial labour market (reputation effect)
-After transaction
•We use accounting information to reduce information asymmetry
•Problem: best accounting measure to inform investors is not the same as the best accounting
measures of managerial performance
Arrow’s Impossibility Theorem
•No one set of accounting rules that will please everyone - not possible to combine different
preferences of individuals
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Document Summary
Economics of accounting information: data: raw facts/numbers that describe the characteristics of an event = input, information: data organised in a way to be meaningful/useful to user = output. Predictive value: used to forecast the future cash ows. Timeliness: info available when needed: reliability. Veri able: can be con rmed by third party (i. e. audit) Above is the undying assumption of traditional (neoclassical) economic view of information. Markets are ef cient, information is perfect and cordless (incorrect, oversimpli ed view: economics of information (modern, the reality) Information asymmetry exists, information costly and imperfect. Information has value - allows individuals to make choices that increases payoffs. Market for lemons : lemons v cherries - don"t know what you are going to get, conditions for a lemon market (applicable to accounting info): Information asymmetry: lemons should be priced low, cherries high. Incentives for seller to pass off low-quality product as high-quality (buyers will usually pay average price)
