Economic Consequences and Positive Accounting Theory. Financial Accounting Theory: Chapter 8 Cathy Phung Jaspreet Sidhu Neil Ganatra Yashar Davarpanah. Economic Consequences. Conflict Resolution. Accountants need to understand and appreciate management’s interest in financial reporting
Financial Accounting Theory: Chapter 8
“A concept that asserts, that despite the implications of efficient securities market theory, accounting policy choice can affect firm value.”
Accounting policies and changes in policies MATTER
“ The impact of accounting reports on the decision-making behaviour of business, government and creditors.”
What would the efficient market argument be?
Exercise price 8
Expense recorded 2
Recognizing ESO as an expense increases relevance, since future dividends per share will be reduced since they are now diluted over a larger number of shares
All 3 characteristics lean towards waiting until maturity to exercise the option. So in what circumstances would the employee exercise the option early? Two circumstances!
The Black/Scholes model has a tendency to overstate ESO cost. Fair value estimates, including the Black/Scholes model, are unreliable
The common theme of these tactics is to increase the likelihood that ESOs will be deep-in-the-money early exercise more likely
Many contracts involve accounting variables:
The Bonus Plan Hypothesis:
-All other things being equal, the closer a firm is to violation of accounting based debt covenants, the higher the chance of managers to choose accounting procedures that shift reported earnings from future to current period.
-This will reduce the probability of technical default.
-The greater the political costs faced by a firm, the more likely the manager is to choose accounting procedures that defer reported earnings from current to future.
- Ex: High profitability of a firm may attract
media & consumer attention. New taxes or other regulations may occur if certain firms have very high profits
= α +βΔREV + β(2)PPE + ε
= TA – (α + βΔREV + βPPE)