Scope of Positive Accounting Theory

1. Capital market research - into the impact of

accounting and the behavior of capital
markets
– Did not explain accounting practice
– Investigated connection between the accounting
data and the sahre prices/returns
– Efficient Market Hypothesis
– Capital asset pricing model
 Scope of Positive Accounting Theory

2. Sought to explain and predict accounting

practices across firms
– Ex post opportunism
– Ex ante efficient contracting
 Efficient Market Hypothesis
• Two types of capital market research
– The impact of the release of accounting
information on share returns
– The effect of changes in accounting policy on
share prices
• Most research in these areas relies upon the
EMH
 Efficient Market Hypothesis
• Efficient Market : one in which prices fully
reflect available information

• 3 Forms of Information Efficiency

1. Weak form (past price information)
2. Semi strong form (publicly available information)
3. Strong form (all information - public and private)
 Capital market research and the efficient
markets hypothesis
• Capital market research in accounting
assumes semi-strong form efficiency
• Financial statements and other disclosures
form part of the information set that is
publicly available.
 Capital market research and the efficient
markets hypothesis
• Based on dubios assumptions
– There are no transaction cost in trading securities
– Information is available cost-free to all market
participants
– There is agreement on the implication of current
information for the current price and distributions
of future price
 Capital market research and the efficient
markets hypothesis
• Market efficiency doesn’t assume, mean, or
imply
– That every, or any, investor has knowledge of all
information
– That all financial information has been correctly
presented or interpreted by individual investors
– That managers make the best decisions
– That investors can predict the future precisely
 Capital market research and the efficient
markets hypothesis
• 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
• Market model :
– Derives from CAPM
– Used to estimates abnormal retuns on shares
when profits announced
– Share prices and returs are affected by both
market-wide and firm-specific events
– Market-wide events must first be controlled for
Market Model
 Market Model
• Based on dubious assumptions
– Investors are risk averse
– Returns are normally distributed and investors
select their portfolios on this basis
– Investors have homogeneous expectations
– Markets are complete
• All participants are price takers
• There are no transaction costs
• There are no taxes
• There are rational expectations by investors