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chapter 5 feb acc6 lecture notes.docx

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ACC 706
Shadi Farshadfar

Feb 6 Recap ch 4 Investors have prior probabilities of future firm performance -> investors obtain new info from fs - >investors revise their probability and make buy/sell decisions -> The volume of shares traded and the market price of the firm’s shares will be changed Ch 5  Information approach: - Assumptions: securities markets are efficient - Investors are responsible for predicting future firm performance - Role of fin reporting is to provide useful info for this purpose. Thus, the form of disclosure doesn’t not matter - How to evaluate the usefulness of fin info?  Assuming market efficiency, the market will react to useful information from any source. It means our info is useful. Decision usefulness = info content = market reacting (the extent of volume or price change) to F.S.  The research problem: - GN or BN in net income -> security price (volume) change - Market reacts not to net income, but to gn or bn. Explains change in chare price – benchmark of market reaction  Finding the market response - As a researcher you need to know the exact date of release of info, because we believe in market efficiency. Share prices fully reflect new info very quickly; market digests new info within 1 or two days. - The researcher should know when current year’s reported net income first became publicly known - ... - The researcher must obtain a proxy for what investors expected net income to be  This is because efficient market will only react to that portion of an earnings announcement that it did not expect  The gn or bn in reported net income is usually evaluated relative to what investors expected  Investors’ earnings expectations unobservable *accounting researchers info is outdated *we can change expectations based on net income changes, but it is not enough information. If our investors are informed, they will not only look at evidence (change in net income) they would look at information system of the company – earnings quality. Based on the history, quality of fin statements, you can make a decision.  Finding the market response - Estimation of inv’s earnings expectations
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