Textbook Notes (368,432)
Canada (161,877)
Accounting (74)
ACTG 4P11 (6)
Brown (6)
Chapter 12

Chapter 12 Textbook Notes (Key takeaways from the chapter) - .docx

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Department
Accounting
Course
ACTG 4P11
Professor
Brown
Semester
Winter

Description
Chapter 12 – Standard Setting: Economic Issues Overview - Information asymmetry between firms and investigators is mitigated by disclosure - Financial disclosure is regulated by public bodies (government agencies) and private bodies (stock exchanges, AcSB, FASB) - Accountants should not take the extent of regulation for granted - Information as a commodity o Demand: information demanded by decision makers o Supply: information supplied by firms, managers, analysts - From society’s perspective, firms should produce information until the marginal social benefit equals marginal social cost - In practice, firms face a mixture of private and regulatory incentives to produce information Regulation of EconomicActivity - Proprietary information – information that, if released, would directly affect future cash flows of the firm - Non-proprietary information – information that, if released, does not directly affect firm cash flows - Sources of regulation in financial report o Professional accounting bodies (code of ethics, discipline committees) o Standard setters o GAAP o Securities commissions Ways to Characterize Information Production - Finer information – expanded note disclosure, additional line items - Additional information – current value accounting, MD&A - Credible information – “Big Four” audit is more credible than a “non-Big Four” audit First-Best Information Production - Better informed investment decisions - Possible lower costs of capital for firms producing the information - Lower estimation risk for investors o Adverse selection o Moral hazard - Reduction of monopoly power due to improved ability of potential entrants - Timely identification of failing firms - Information externalities (information released by one firm generates information about the other) - Social costs of information production o Direct costs of information production o Possible release of proprietary information o Possible increased contracting costs Market Failures in the Production of Information - Externalities – action taken by a firm or individual that imposes costs or benefits on other firms or individuals for which the entity creating the externality is not charged or does not receive revenue - Free-riding – the receipt by a firm or individual of a benefit from an externality - Adverse selection – insider trading, manager may delay information release Chapter 12 – Standard Setting: Economic Issues - Moral hazard – opportunistic earnings management to disguise shirking - Lack of unanimity – managers and investors may want different amounts of information Contractual Incentives for Information Production - To control shirking, managerial incentive contracts require performance measures - Debt contracts require monitoring of covenants with ratios - Prior to the IPO, owner-manager has a motivation to increase shirking as they will not bear all the costs subsequent to the new issue o Agency cost to the new owners of the firm - Coarse Theorem – conditions under which the problem of externalities can be internalized, thereby reducing the need for regulation o E.g. firm’s release of information o Contracts may break down  Only feasible when there are a few parties i
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