ACCT 332 Lecture 4 (Noted)
-
Upload
amos-lim-wei-jun -
Category
Documents
-
view
255 -
download
2
description
Transcript of ACCT 332 Lecture 4 (Noted)
-
Lecture 4ACCT 332 Accounting Thought and PracticeACCT 332 Accounting Thought and Practice
Efficient Securities Markets
- Chapter 4p- Concept No. 6 Elements of Financial Statements- Beaver (1973) What should be the FASBs objectives?
S (1978) Th i t f i i th- Sprouse (1978) The importance of earnings in the conceptual framework
-
Objectives for Todays Class
Concept of Market Efficiency
D d f A ti I f ti i Effi i t Demand for Accounting Information in Efficient Markets
Implications of Market Efficiency for Financial Implications of Market Efficiency for Financial Reporting (Beaver)
-
Where are we?
No true incomeHow do we make accounting choices about financial reporting?How do we make accounting choices about financial reporting?
Look at decision usefulness- Focus on investors and creditorsFocus on investors and creditors
What is decision usefulness?- Revision of subjective probabilities by the decision makerj p y- Improvement of main-diagonal probabilities in the information system
How would revision of subjective probabilities manifest itself?j p- Potential changes in investment decisions
What visible impact would changes in investment decisions have?- Possible changes in security prices
What drives security prices and how are price changes related to information? - Chapter 4
Amos Lim
Amos LimThe subjective probabilities formed by the decision maker are adjusted based on the objective information provided by the financial statements.
-
Efficient Markets
Markets are quick and efficient processors of information even though individuals are fallibleinformation even though individuals are fallible.
It can be visualized as individuals continuously revising their probabilities as new information comes in from pany source.
Individual errors cancel out- Provided that there is no systematic bias.
Example: GDP forecasts for four largest economies in p gEurope
Amos Lim
Amos Lim
-
Amos LimBlue Dots: Individual forecastsRed Dot: Consensus ForecastGreenline: Actual GDP return
Amos LimSystematic bias (e.g. everyone is optimistic), evident in difference between consensus forecast and actual return
-
Share Price in an Efficient Market
CAPM required return E(R ) = R + (E(R ) R )E(Rjt) = Rf+ j(E(RMt)- Rf)
Market sets share price so that expected return E(Rjt) (i e firms cost of equity capital) is given by right side of(i.e., firm s cost of equity capital) is given by right side of equation.
Note that only firm-specific component is jy p p j- How is the expected return defined?
Expected priced at t plus any dividends expected, divided by the current price p p p y p , y pin t-1.
Or, jt jtjt
j 1
E(P +D )E(R )= -1
P
In an efficient market where prices reflect all publicly available information the req ired ret rn sho ld eq al the e pected
j,t-1P
information, the required return should equal the expected return.
Amos Lim
Amos Lim
-
Numerical Example
Current situation- Current price per share: $10; assume no dividendsCurrent price per share: $10; assume no dividends- = 1.2, Rf = .03, E(Rmt) = .05- by CAPM, the expected return E(Rjt) will be: ?by C , t e e pected etu ( jt) be- Everything else constant, the expected price at the end of the period will
be: ?
Changes:- Then some firm-specific financial report is released, an investor
assesses it as good news and changes her expectation of the futureassesses it as good news and changes her expectation of the future price to $11
- The expected return will still be 5.4%. Why?- The new price - $X will be such that ($11 - $X)/$X = .054, or
We have now established a link between information (through its impact on t ti ) d i texpectations) and price movements
What about information related to the cost of capital?
Amos Lim0.03 + 1.2 (0.05 - 0.03) = 0.054
Amos Lim10 * (1 + 0.054) = $10.54
Amos LimExpected return does not as a result of this new information. Rf, Beta, and Rm remain the same. All that changes is therefore that the current stock price is adjusted.
Amos Lim$10.43
-
The Informativeness of Price
Fully informative share pricesy p- If share prices are fully informative, no one would bother to gather
information, since no one can beat the market
- If no one gathers information, share prices will not reflect all publicly available information
- If share prices do not reflect all publicly available information investorsIf share prices do not reflect all publicly available information, investors will gather information. Share price will quickly become fully informative
- Then, none would bother to gather information, etc., etc.- Hence the logical inconsistency
-
The Informativeness of Price (contd)
A way out of the logical inconsistencyN i t di- Noise trading Expected value of noise = 0 Share prices still efficient, but in an expected value
sense
Sh i ti ll i f ti i f- Share prices are partially informative in presence of noise trading
Share price may deviate from its efficient value due to Share price may deviate from its efficient value due to noise trading
Restores incentive of investors to gather informationRestores incentive of investors to gather information Dynamic concept of market efficiency
e g gravity and the oceane.g. gravity and the ocean
Amos LimOcean should be flat due to gravity. But this doesnt mean there arent waves.
Amos LimTrading w/o the use of fundamental data.
Amos Limi.e. they are expected to be efficient, not that they always are
Amos Lim
Amos Lim
Amos Lim
Amos Lim
Amos Lim
Amos Lim
-
EfficientSecuritiesMarkets
A relative conceptEffi i i d fi d l ti t bli l il bl- Efficiency is defined relative to publicly available information.
- If the information that is available is of poor quality if- If the information that is available is of poor quality, if there is not enough of it, or if it is simply wrong, then prices will reflect this poor information.
- Thus, accounting has a role to play even in efficient markets, by improving the quality of information, and
ti i id i f ti t bli i f ticonverting inside information to public information
Amos Lim(semi-strong)
Amos Lim
Amos Lim
Amos Lim
Amos Lim
Amos Lim
Amos Lim
Amos Lim
-
Amos LimI.e. to move the market from semi-strong form efficiency to strong form efficiency.
Amos LimSemi-strong efficient market
-
Social Significance of Markets that Work Well
In a capitalist economy, allocation of scarce capital is accomplished by market pricesp y p- Firms with productive capital projects should be rewarded
with high share prices (low cost of capital) and vice versa
Capital allocation is the most efficient if share prices reflect fundamental valuefundamental value
Social role of financial reporting- To help markets work well
Maximize amount of publicly available information Subject to a cost-benefit constraint
Amos Lim
Amos Lim
Amos Lim
Amos Lim
Amos Lim
-
Implications for Financial Reporting
W. Beaver, What Should Be the FASBs Objectives,, j ,Journal of Accountancy (1973) Full disclosure, including acc. policies Accounting policies do not matter (unless with cash flow
effects).Nave investors are price protected Nave investors are price-protected.
Accountants are in competition with other information providers .p
Amos Lim
Amos Lim
-
Some Examples
Letsreflectonsomeexamplesoffinancialreportinginefficient markets:efficientmarkets:
- MD&A,Footnotes
What role do they play Whatroledotheyplay
Voluntary/Mandated
h l ? OtherExamples?
-
Earnings Opacity Around the World (Bhattacharya et al. TAR 2003)
-
Earnings Opacity Around the World (Bhattacharya et al. TAR 2003)
-
Earnings Opacity Around the World (Bhattacharya et al. TAR 2003)
-
Summary
Effi i t iti k t i l ti t hi h Efficient securities market is a relative concept, which allows for informative financial reporting to play a role in improving the accuracy, timing, and amount of a p g y, g,companys stock.
Full disclosure allows investors to make better decisions and improves the ability of securities markets to allocate resources more efficiently.
Fi ti li h i h ld t ff t th i Firms accounting policy choices should not affect their cash flows or their stock prices, provided they are applying the full disclosure principle.pp y g p p
Amos Lim
-
Group Questions
40 minutes to complete group questions A i t f di i l di Assignment of discussion-leading groups