Professional Documents
Culture Documents
8.1 Introduction
Apply theories you learned to date and
discuss:
Summary (8.9)
Shareholders
Managers assumed rational and will act in their own
interest, which may conflict with shareholders interests
As a result, shareholders demand information to
encourage responsible manager effort and limit
opportunistic actions
Note this contracting demand differs from demand under
market efficiency/inefficiency
Conservatism
For lenders: help predict financial distress
Reporting potential losses but not gains
For shareholders: help assess manager stewardship
Conservatism makes it difficult for manager to increase
reported earnings and compensations
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Economic Consequences
A concept that asserts that, despite the implications of
market efficiencies, accounting policy choice can affect
the decision making behavior of business
Hence accounting choices do matter, even without consideration
of market efficiency
1972: APB 25
1993: FASB Exposure Draft
1994: SFAS 123
2005: SFAS 123R
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Economic consequences
Large scale of manager abuses of ESO
Firms overdosed on ESO compensation (since no
effect on net income)
Manipulate share price up before exercising option
(e.g. pump and dump p.326)
Manipulate ESO grant date (e.g. spring loading, late
timing -p.327)
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Economic consequence
FV of ESOs granted by the top 500 US firms
2000: $104 billion
2005: $30 billion
(Source: The Economist 2006)
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Efficiency?
Manager chooses accounting policies to maximize
contract efficiency
Manager benefits align with investor benefits
8.9 Conclusion
Efficient contracting theory (ECT) focuses on the
role of financial reporting in moderating information
asymmetry between contracting parties
Debt and managerial compensation contracts emphasized
Management stewardship
Should this be the primary goal of financial reporting as
well?
Existing conceptual framework puts this goal as secondary to
decision usefulness goal
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