Capital Market Research

Capital Market Research

1. Strength of Positive Theory

   • To prescribe an appropriate accounting policy
     • Necessary to know how the world actually operates
   • Dissatisfaction with prescriptive standards
     • Normative standards
     • Prescriptions not based upon identified, empirical observations or methods
     • Theories are not falsifiable
     • Do not explain and predict accounting practice
     • Do not assess existing accounting practices
   • Strengths
     • Positive hypotheses are capable of falsification by empirical research
     • Positive hypotheses are capable of falsification by empirical research
       • obtain an understanding about how value-relevant accounting numbers are for share prices
       • attempt to understand the connection between accounting information, managers, firms and markets, and analyse those relationships

2. Scope of Positive accounting theory

   • Two Stages of Development
     • 1. Capital Market Research
       • didn't explain accounting practice
       • accounting data -- share price
       • efficient market hypothesis
       • capital asset pricing model
     • 2. Predict accounting practices across firm
       • opportunistic reason (ex post)
       • efficiency reason (ex ante)

3. Philosophy of Positive accounting Theory

   • Observing practices
     • Explain and predict accounting practice
     • Explain how & why capital market react to accounting reports
   • Based on assumptions
     • Managers, investors, lenders are assumed to be rational, evaluative financial utility maximizers
     • Managers choose accounting policies that will maximize their utility
     • Managers will take actions that maximize the value of firm

4. Trading Strategies

   • Post-announcement drift
     • occurs where abnormal returns continue after a profit announcement
       • the information content of the profit announcement id noy fully incorporated into the share price at the annoucement date
   • Winners/Losers and over-confidence
     • example of a long-term association anomaly
     • long-term returns reversals attributed to investor overconfidence and biased self-attribution
     • past winners tend to be future losses and vice versa
   • Mechanistic or behavioural effect
     • consider the behaviour of abnormal rates of return at and around the time of change in accounting policy
     • The Mechanistic Hypothesis
       • expect to see abnormal returns even though the change has no effect on cash flow
     • The "No-Effects" Hypothesis
       • ignores accounting changes which have no cash flow consequences
       • the joint hypothesis of the EMH
   • Two viewpoints of accounting manipulation
     • Opportunistic Persepctive
       • Fraud
       • Industry Regulation
       • Equity Offerings
       • Debt Covenants
       • Management Compensation
     • International Perspective
       • SIganlling
       • Fair Value
   • Detecting Earning Management
     • Share price reaction
     • Financial Analysts' reaction
     • Auditors
     • BoD
     • Discretionary accruals
     • Inside trading reaction

5. Issues for Auditors

   • Association between auditing and cost of capital
     • Lower cost when firms purchase high quality audit
       • Large audit firms = higher quality
       • Investors value the deep resources of large auditor
       • quality assurance regarding accounting data

6. Capital Market Reseacrh & efficient market hypothesis

   • capital Maket Research
     • the effects of changes in accounting policy on share prices
     • the impact of the release of accounting information on share returns
     • Most research is relies upon the EMfficient Market Hypothesis
     • Capital markets research in accounting assumes semi-strong form efficiency
     • there are no transaction costs in trading securities
     • information is available cost-free to all market participants
     • Financial statements and other disclosures form part of the information set that is publicly available
   • Efficent Market Hypothesis
     • Strong
     • Semi strong
     • Weak
     • Market efficiency simply means that share prices reflect the aggregate impact of all relevant information, and do so in an unbiased and rapid manner
   • Market Model
     • Derives from CAPM
     • Used to estimate abnormal returns on shares
     • Share prices and returns are affected by market-wide and firm-specific events
     • Market-wide events must first be controlled

7. Impact of accounting profits announcements on share price

   • Magnitude
   • Information asymmetry and firm size
   • Magnitude of profit releases from other firms
   • Volatility