ACCT10003 Lecture Notes - Lecture 1: Horizon Problem, Agency Cost, Net Income
19 Jun 2018
School
Department
Course
Professor
Accounting Processes and Analysis
Lecture 1
LO #1: Define the nature of data and information
Data: raw facts/ numbers = inputs
Information: data organised in a meaningful way = outputs
Primary qualities of information should include:
1. Relevance
i. Predictive value ii. Feedback value iii. Timeliness
2. Reliability
i. Verifiable ii. Neutrality iii. Representational faithfulness
LO #2: Define the problems created by information asymmetry in accounting
When one party has more or more useful information than the other. Has greater material knowledge.
E.g. Lemons vs. Cherries.
Buyers do not know the value and so will settle to pay the average price. Cherry owners will not take the
lower price and so eventually only lemons will be left.
- Sellers have no credible disclosure technology
- Deficiency of effective public quality assurances
Two major types of information asymmetry:
1. Adverse selection: one or more parties to a potential transaction or business transaction have an
information advantage over other parties. Controlled by timely and credible conversion of inside
information to outside information.
2. Moral hazard: 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 an input to executive compensation contracts to motivate manager performance
-Net income can inform the managerial labour market (reputation effect).
Arrows impossibility theorem: It is not possible to combine differing preferences of individuals into
a societal preference ordering that satisfies reasonable conditions.
LO #3: Describe techniques firms can use to signal the quality of their accounting information
There are high and low quality firms. Each firm knows their true quality however outsiders do not. Should
firms signal or not?
High Low
Signal A C
Don’t signal B D
Signalling is a viable strategy for high quality firms when A>B and D>C. A separating equilibrium: high
quality firms should signal and low quality firms should not.
“Cheap talk” can be reduced through cost-less non-binding and unverifiable information and through
reducing pay-off (increase the cost) of false signalling.
There are benefits to honest signals and costs to dishonest signals. A signal is an action taken by a high-
type manager that would not be rational if that manager was low-type.
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Document Summary
Lo #1: define the nature of data and information. Information: data organised in a meaningful way = outputs. Primary qualities of information should include: relevance, predictive value, feedback value, timeliness, reliability, verifiable, neutrality, representational faithfulness. Lo #2: define the problems created by information asymmetry in accounting. When one party has more or more useful information than the other. Buyers do not know the value and so will settle to pay the average price. Cherry owners will not take the lower price and so eventually only lemons will be left. Two major types of information asymmetry: adverse selection: one or more parties to a potential transaction or business transaction have an information advantage over other parties. Controlled by timely and credible conversion of inside information to outside information: moral hazard: 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.
