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BU457 Final: Exam Review

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Wilfrid Laurier University
Bixia Xu

Exam Review Efficient Market Securities • One implication of efficient securities market theory is that supplementary information in financial statement notes or elsewhere is just as useful as information in the financial statements proper • Another is that efficiency is defined relative to a stock of publicly known information • MD&A is an important example of a full disclosure standard o Superior disclosure signals a confident, well-planned management approach, suggesting that good performance will continue • Full disclosure has two main benefits, which can be attained simultaneously o Enable investors to make better decisions o Improve the ability of security markets to direct investment to its most productive uses • Another implication of efficient securities market theory is that the specific accounting policies adopted by firms do not matter as they have no differential cash flow effects across those policies, full disclosure is made of the particular policies used, and investors have sufficient information to convert from one policy to another o Investors as a whole will look through the reported net income to its underlying implications for future cash flows • If price is fully informative, no one would bother to collect additional, costly, information but there are two factors that prevent this from happening: o Noise and liquidity traders introduce random component to market price that prevents it from being fully informative about future value o Information asymmetry allows investors to potentially earn extra profits if they manage to ferret out some inside information • Accountants are in competition with other information sources o The answer is full disclosure o By increasing the information content of financial reporting, including information in notes and MD&A, not only do accountants help preserve their competitive advantage, but also improve social welfare by reducing the adverse market impacts of inside information Game Theory • Non-cooperative
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