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Decision Decision Usefulness Usefulness Approach Approach to to Financial Financial Reporting Reporting Week Week 9
Decision Decision Usefulness Usefulness Approach Approach to to Financial Financial Reporting Reporting Week Week 9
Decision Decision Usefulness Usefulness Approach Approach to to Financial Financial Reporting Reporting Week Week 9
Decision Decision Usefulness Usefulness Approach Approach to to Financial Financial Reporting Reporting Week Week 9
Decision Decision Usefulness Usefulness Approach Approach to to Financial Financial Reporting Reporting Week Week 9
Decision Decision Usefulness Usefulness Approach Approach to to Financial Financial Reporting Reporting Week Week 9
Decision Decision Usefulness Usefulness Approach Approach to to Financial Financial Reporting Reporting Week Week 9

DecisionDecision UsefulnessUsefulness ApproachApproach toto FinancialFinancial ReportingReporting

Approach Approach to to Financial Financial Reporting Reporting Week Week 9 9 Fauziah Fauziah Md. Md.
Approach Approach to to Financial Financial Reporting Reporting Week Week 9 9 Fauziah Fauziah Md. Md.
Approach Approach to to Financial Financial Reporting Reporting Week Week 9 9 Fauziah Fauziah Md. Md.

WeekWeek 99 FauziahFauziah Md.Md. TaibTaib

Approach Approach to to Financial Financial Reporting Reporting Week Week 9 9 Fauziah Fauziah Md. Md.
Approach Approach to to Financial Financial Reporting Reporting Week Week 9 9 Fauziah Fauziah Md. Md.
Overview Overview of of Capital Capital Market Market Research Research Explores the role of accounting
Overview Overview of of Capital Capital Market Market Research Research Explores the role of accounting
Overview Overview of of Capital Capital Market Market Research Research Explores the role of accounting
Overview Overview of of Capital Capital Market Market Research Research Explores the role of accounting
Overview Overview of of Capital Capital Market Market Research Research Explores the role of accounting
Overview Overview of of Capital Capital Market Market Research Research Explores the role of accounting

OverviewOverview ofof CapitalCapital MarketMarket ResearchResearch

Explores the role of accounting and other financial information in equity markets. • Often involves examining statistical relations between financial information and share price or returns. • Favourable/unfavourable reactions are evidenced by price increase/decrease in the particular security.

price increase/decrease in the particular security. • • Conclusions are made about the market’s reaction
price increase/decrease in the particular security. • • Conclusions are made about the market’s reaction
price increase/decrease in the particular security. • • Conclusions are made about the market’s reaction
price increase/decrease in the particular security. • • Conclusions are made about the market’s reaction
price increase/decrease in the particular security. • • Conclusions are made about the market’s reaction

• Conclusions are made about the market’s reaction to particular information releases or events, which determine if the information was relevant and useful for investment decision making.

or events, which determine if the information was relevant and useful for investment decision making.
or events, which determine if the information was relevant and useful for investment decision making.
or events, which determine if the information was relevant and useful for investment decision making.
or events, which determine if the information was relevant and useful for investment decision making.
Capital Capital Market Market Research Research Assesses the aggregate aggregate effect effect of financial
Capital Capital Market Market Research Research Assesses the aggregate aggregate effect effect of financial
Capital Capital Market Market Research Research Assesses the aggregate aggregate effect effect of financial
Capital Capital Market Market Research Research Assesses the aggregate aggregate effect effect of financial
Capital Capital Market Market Research Research Assesses the aggregate aggregate effect effect of financial

CapitalCapital MarketMarket ResearchResearch

Assesses the aggregateaggregate effecteffect of financial reporting, particularly the reporting of accounting earnings, on investors. • By analysing share price reactions to financial information releases, the sum of individual investor decisions is captured in aggregate. • Questions that are of interest:

in aggregate. • Questions that are of interest: • – Is that particular information useful? –
in aggregate. • Questions that are of interest: • – Is that particular information useful? –
in aggregate. • Questions that are of interest: • – Is that particular information useful? –
in aggregate. • Questions that are of interest: • – Is that particular information useful? –
in aggregate. • Questions that are of interest: • – Is that particular information useful? –
in aggregate. • Questions that are of interest: • – Is that particular information useful? –

– Is that particular information useful?

interest: • – Is that particular information useful? – Is that particular information relevant to

– Is that particular information relevant to investors?

• – Is that particular information useful? – Is that particular information relevant to investors?
Capital Capital Market Market Research Research Assumptions Assumptions • Equity markets are efficient – Market
Capital Capital Market Market Research Research Assumptions Assumptions • Equity markets are efficient – Market
Capital Capital Market Market Research Research Assumptions Assumptions • Equity markets are efficient – Market
Capital Capital Market Market Research Research Assumptions Assumptions • Equity markets are efficient – Market

CapitalCapital MarketMarket ResearchResearch AssumptionsAssumptions

• Equity markets are efficient

Assumptions Assumptions • Equity markets are efficient – Market adjusts rapidly to impound fully

– Market adjusts rapidly to impound fully information into share prices when the information is released.
– Assumes that markets are semi strong form efficient.

that markets are semi ‐ strong form efficient . • All publicly available information (including those
that markets are semi ‐ strong form efficient . • All publicly available information (including those
that markets are semi ‐ strong form efficient . • All publicly available information (including those
that markets are semi ‐ strong form efficient . • All publicly available information (including those
that markets are semi ‐ strong form efficient . • All publicly available information (including those
that markets are semi ‐ strong form efficient . • All publicly available information (including those

• All publicly available information (including those available in financial statements and other financial disclosures)is rapidly and fully impounded into share prices in an unbiased manner as it is released.

disclosures)is rapidly and fully impounded into share prices in an unbiased manner as it is released.
disclosures)is rapidly and fully impounded into share prices in an unbiased manner as it is released.
Why Why assume assume market market is is efficient? efficient? Unless such an assumption is
Why Why assume assume market market is is efficient? efficient? Unless such an assumption is
Why Why assume assume market market is is efficient? efficient? Unless such an assumption is

WhyWhy assumeassume marketmarket isis efficient?efficient?

Unless such an assumption is accepted, it is hard to justify efforts to link security price movements to information releases. If that particular information leads to a price change, then the information was usefuluseful and caused investors to revise their expectations about future earnings.

caused investors to revise their expectations about future earnings. P 0 = Future Expected Cash Flow
caused investors to revise their expectations about future earnings. P 0 = Future Expected Cash Flow

P 0 = Future Expected Cash Flow

caused investors to revise their expectations about future earnings. P 0 = Future Expected Cash Flow
caused investors to revise their expectations about future earnings. P 0 = Future Expected Cash Flow

caused investors to revise their expectations about future earnings. P 0 = Future Expected Cash Flow
•
caused investors to revise their expectations about future earnings. P 0 = Future Expected Cash Flow
caused investors to revise their expectations about future earnings. P 0 = Future Expected Cash Flow
caused investors to revise their expectations about future earnings. P 0 = Future Expected Cash Flow
caused investors to revise their expectations about future earnings. P 0 = Future Expected Cash Flow
ImplicationsImplications ofof thethe assumptionassumption • • If markets are efficient, investors will use
ImplicationsImplications ofof thethe assumptionassumption
If markets are efficient, investors will use
information from various sources when predicting
future earnings, hence determining current share
prices.
If accounting information does not impact on share
prices then, it does not provide any information
over and above that currently available.
any information over and above that currently available. – If there is share price reaction, the
any information over and above that currently available. – If there is share price reaction, the
any information over and above that currently available. – If there is share price reaction, the
any information over and above that currently available. – If there is share price reaction, the
any information over and above that currently available. – If there is share price reaction, the

– If there is share price reaction, the financial information is deemed to have informationinformation contentcontent’.

price reaction, the financial information is deemed to have ‘ information information content content ’.
price reaction, the financial information is deemed to have ‘ information information content content ’.
Why Why Decision Decision Usefulness Usefulness is is Important? Important? • It is often argued
Why Why Decision Decision Usefulness Usefulness is is Important? Important? • It is often argued
Why Why Decision Decision Usefulness Usefulness is is Important? Important? • It is often argued
Why Why Decision Decision Usefulness Usefulness is is Important? Important? • It is often argued

WhyWhy DecisionDecision UsefulnessUsefulness isis Important?Important?

Usefulness Usefulness is is Important? Important? • It is often argued that: – More informed choices

• It is often argued that: often argued that:

is Important? Important? • It is often argued that: – More informed choices choices between accounting

– More informed choiceschoices between accountingaccounting and disclosuredisclosure alternativesalternatives can be made if the expected impacts on share prices are anticipated when making financial reporting decisions.

be made if the expected impacts on share prices are anticipated when making financial reporting decisions.
be made if the expected impacts on share prices are anticipated when making financial reporting decisions.
be made if the expected impacts on share prices are anticipated when making financial reporting decisions.
be made if the expected impacts on share prices are anticipated when making financial reporting decisions.
be made if the expected impacts on share prices are anticipated when making financial reporting decisions.
• Ball Ball and and Brown Brown (1968) (1968) First major capital market research publication
• Ball Ball and and Brown Brown (1968) (1968) First major capital market research publication
• Ball Ball and and Brown Brown (1968) (1968) First major capital market research publication
• Ball Ball and and Brown Brown (1968) (1968) First major capital market research publication
• Ball Ball and and Brown Brown (1968) (1968) First major capital market research publication
• Ball Ball and and Brown Brown (1968) (1968) First major capital market research publication
• Ball Ball and and Brown Brown (1968) (1968) First major capital market research publication

• Ball Ball and and Brown Brown (1968) (1968) First major capital market research publication in
• Ball Ball and and Brown Brown (1968) (1968) First major capital market research publication in
• Ball Ball and and Brown Brown (1968) (1968) First major capital market research publication in
• Ball Ball and and Brown Brown (1968) (1968) First major capital market research publication in
• Ball Ball and and Brown Brown (1968) (1968) First major capital market research publication in
• Ball Ball and and Brown Brown (1968) (1968) First major capital market research publication in

BallBall andand BrownBrown (1968)(1968)

First major capital market research publication in accounting, investigated the usefulness of accounting earnings under a historical cost model. PriorPrior to their research, it was widely viewed that historical cost accounting methods resulted in meaninglessmeaninglessinformation that was not useful for investors and other users of financial statements. Their study found evidence that suggest the information contained in the annual report is used in investment decision making, despite the limitations of the historical cost accounting systems.

is used in investment decision making, despite the limitations of the historical cost accounting systems. •
is used in investment decision making, despite the limitations of the historical cost accounting systems. •
is used in investment decision making, despite the limitations of the historical cost accounting systems. •
is used in investment decision making, despite the limitations of the historical cost accounting systems. •
• • Other Other Findings Findings by by Research Research in in Capital Capital Market.
• • Other Other Findings Findings by by Research Research in in Capital Capital Market.
• • Other Other Findings Findings by by Research Research in in Capital Capital Market.

• • Other Other Findings Findings by by Research Research in in Capital Capital Market. Market.
• • Other Other Findings Findings by by Research Research in in Capital Capital Market. Market.
• • Other Other Findings Findings by by Research Research in in Capital Capital Market. Market.
•

• • Other Other Findings Findings by by Research Research in in Capital Capital Market. Market.
• • Other Other Findings Findings by by Research Research in in Capital Capital Market. Market.
• • Other Other Findings Findings by by Research Research in in Capital Capital Market. Market.
• • Other Other Findings Findings by by Research Research in in Capital Capital Market. Market.

OtherOther FindingsFindings byby ResearchResearch inin CapitalCapital Market.Market.

Prior to an earnings release, investors obtain much of the information they need from other sources (Ball and Brown, 1968). Information content of earnings [ ICoE ] announcements depends on the extent of alternative sources of information.

– ICoE varies between countries and between companies within a country (Brown, 1970). E.g. Different speed of share price adjustment between US and Australian markets.

a country (Brown, 1970). E.g. Different speed of share price adjustment between US and Australian markets.
a country (Brown, 1970). E.g. Different speed of share price adjustment between US and Australian markets.
a country (Brown, 1970). E.g. Different speed of share price adjustment between US and Australian markets.
a country (Brown, 1970). E.g. Different speed of share price adjustment between US and Australian markets.
a country (Brown, 1970). E.g. Different speed of share price adjustment between US and Australian markets.
a country (Brown, 1970). E.g. Different speed of share price adjustment between US and Australian markets.
• Other Other Findings Findings by by Research Research in in Capital Capital Market. Market.
• Other Other Findings Findings by by Research Research in in Capital Capital Market. Market.
• Other Other Findings Findings by by Research Research in in Capital Capital Market. Market.

• Other Other Findings Findings by by Research Research in in Capital Capital Market. Market. There
• Other Other Findings Findings by by Research Research in in Capital Capital Market. Market. There
• Other Other Findings Findings by by Research Research in in Capital Capital Market. Market. There
• Other Other Findings Findings by by Research Research in in Capital Capital Market. Market. There
• Other Other Findings Findings by by Research Research in in Capital Capital Market. Market. There
• Other Other Findings Findings by by Research Research in in Capital Capital Market. Market. There
• Other Other Findings Findings by by Research Research in in Capital Capital Market. Market. There
• Other Other Findings Findings by by Research Research in in Capital Capital Market. Market. There

OtherOther FindingsFindings byby ResearchResearch inin CapitalCapital Market.Market.

There are benefits associated with the voluntary disclosure of information [Lang and Lundholm,

1996].

• Recognition is perceived differently to mere footnote disclosure.
• Size

– Earnings announcements have been found generally to have a greater impact on the share prices of smaller firms relative to larger firms [Freeman, 1987]

to have a greater impact on the share prices of smaller firms relative to larger firms
to have a greater impact on the share prices of smaller firms relative to larger firms
to have a greater impact on the share prices of smaller firms relative to larger firms
to have a greater impact on the share prices of smaller firms relative to larger firms
to have a greater impact on the share prices of smaller firms relative to larger firms
to have a greater impact on the share prices of smaller firms relative to larger firms
• Implications Implications of of Efficient Efficient Securities Securities Market Market for for Financial
• Implications Implications of of Efficient Efficient Securities Securities Market Market for for Financial
• Implications Implications of of Efficient Efficient Securities Securities Market Market for for Financial
•

• Implications Implications of of Efficient Efficient Securities Securities Market Market for for Financial
• Implications Implications of of Efficient Efficient Securities Securities Market Market for for Financial
• Implications Implications of of Efficient Efficient Securities Securities Market Market for for Financial
• Implications Implications of of Efficient Efficient Securities Securities Market Market for for Financial
• Implications Implications of of Efficient Efficient Securities Securities Market Market for for Financial

ImplicationsImplications ofof EfficientEfficient SecuritiesSecurities MarketMarket forfor FinancialFinancial ReportingReporting

•

Beaver, W.H., (1973), “What should be the FASB’s Objectives?”, The Journal of Accountancy, (August, 1973), pp. 4956. Among the implications mentioned:

1) Accounting policies adopted by firms do not affect their security prices, as long as no cash flow effects , policies used are disclosed, and sufficient information is given. EfficientEfficient marketmarket isis notnot fooledfooledbyby differingdiffering accountingaccounting choiceschoices

market is is not not “ “ fooled fooled ” ” by by differing differing accounting
market is is not not “ “ fooled fooled ” ” by by differing differing accounting
market is is not not “ “ fooled fooled ” ” by by differing differing accounting
market is is not not “ “ fooled fooled ” ” by by differing differing accounting
market is is not not “ “ fooled fooled ” ” by by differing differing accounting
market is is not not “ “ fooled fooled ” ” by by differing differing accounting
Implications Implications of of Efficient Efficient Securities Securities Market Market (Beaver, (Beaver, 1973)
Implications Implications of of Efficient Efficient Securities Securities Market Market (Beaver, (Beaver, 1973)
Implications Implications of of Efficient Efficient Securities Securities Market Market (Beaver, (Beaver, 1973)
Implications Implications of of Efficient Efficient Securities Securities Market Market (Beaver, (Beaver, 1973)

ImplicationsImplications ofof EfficientEfficient SecuritiesSecurities MarketMarket (Beaver,(Beaver, 1973)1973)

Securities Market Market (Beaver, (Beaver, 1973) 1973) 2) Efficient Securities market go hand in hand with

2) Efficient Securities market go hand in hand with full disclosure.

market go hand in hand with full disclosure. – As long as benefits exceed the costs,
market go hand in hand with full disclosure. – As long as benefits exceed the costs,
market go hand in hand with full disclosure. – As long as benefits exceed the costs,
market go hand in hand with full disclosure. – As long as benefits exceed the costs,
market go hand in hand with full disclosure. – As long as benefits exceed the costs,
market go hand in hand with full disclosure. – As long as benefits exceed the costs,
market go hand in hand with full disclosure. – As long as benefits exceed the costs,

– As long as benefits exceed the costs, firms should disclose on timely basis
– Reason: Investors use all available, relevant information to improve predictions of returns.

– As more information is made available, investors’ confidence in the market is enhanced .

of returns. – As more information is made available, investors’ confidence in the market is enhanced
of returns. – As more information is made available, investors’ confidence in the market is enhanced
Implications Implications of of Efficient Efficient Securities Securities Market Market (Beaver, (Beaver, 1973)
Implications Implications of of Efficient Efficient Securities Securities Market Market (Beaver, (Beaver, 1973)
Implications Implications of of Efficient Efficient Securities Securities Market Market (Beaver, (Beaver, 1973)
Implications Implications of of Efficient Efficient Securities Securities Market Market (Beaver, (Beaver, 1973)

ImplicationsImplications ofof EfficientEfficient SecuritiesSecurities MarketMarket (Beaver,(Beaver, 1973)1973)

Securities Market Market (Beaver, (Beaver, 1973) 1973) 3) Market efficiency implies that firms should not be

3) Market efficiency implies that firms should not be overly concerned with naïve investors.

should not be overly concerned with naïve investors. – Financial statements need not be presented in
should not be overly concerned with naïve investors. – Financial statements need not be presented in
should not be overly concerned with naïve investors. – Financial statements need not be presented in
should not be overly concerned with naïve investors. – Financial statements need not be presented in
should not be overly concerned with naïve investors. – Financial statements need not be presented in
should not be overly concerned with naïve investors. – Financial statements need not be presented in
should not be overly concerned with naïve investors. – Financial statements need not be presented in

– Financial statements need not be presented in a simple manner. So long there is enough investors who understand the disclosed information, the price will move towards its efficient level.
– Naïve investors can hire professionals to interpret for them or can mimic the buy and sell decision of more knowledgeable investors.

and sell decision of more knowledgeable investors. – Investors are being price protected by the
and sell decision of more knowledgeable investors. – Investors are being price protected by the

– Investors are being price protected by the efficient market.

Final Final Implications Implications (Beaver, (Beaver, 1973) 1973) 4) Accountants are in competition with other
Final Final Implications Implications (Beaver, (Beaver, 1973) 1973) 4) Accountants are in competition with other
Final Final Implications Implications (Beaver, (Beaver, 1973) 1973) 4) Accountants are in competition with other

FinalFinal ImplicationsImplications (Beaver,(Beaver, 1973)1973)

Implications Implications (Beaver, (Beaver, 1973) 1973) 4) Accountants are in competition with other

4) Accountants are in competition with other information providers (financial analysts, media, company officials, etc.).

(financial analysts, media, company officials, etc.). – If accountants do not provide useful, cost
–
analysts, media, company officials, etc.). – If accountants do not provide useful, cost effective
analysts, media, company officials, etc.). – If accountants do not provide useful, cost effective
analysts, media, company officials, etc.). – If accountants do not provide useful, cost effective
analysts, media, company officials, etc.). – If accountants do not provide useful, cost effective

If accountants do not provide useful, cost effective information, the usefulnessusefulness of accounting information will declinedecline, hence, accountants cannot survive in the market place.

of accounting information will decline decline , hence, accountants cannot survive in the market place.
of accounting information will decline decline , hence, accountants cannot survive in the market place.