CHAPTER 12

CAPITAL MARKET RESEARCH

KELOMPOK 2
ADRI ASWIN AZHARI (1506798863)
AGRIT HASTUBINAWAN
(1506798882)
CHRISTIAN VALENTINO
(1506799115)
GHANI YAHYA
(1506799304)
IRVAN SYAVIQ N
(1506799405)
REZKI HENDRAWAN (1506799834)

Philosophy of positive
accounting theory

Seeks to explain and predict accounting practice

Seeks to explain how and why capital markets
react to accounting reports
Does so by observing practice empirical
evidence
Explanation means providing reasons for
observed practice

e.g. why do firms continue to use historic cost

Prediction means that the theory predicts

unobserved phenomena
Has an economic focus

Philosophy of positive
accounting theory

Positive theory is based on assumptions

about the behaviour of individuals

assumes investors and financial accounting

users and preparers are rational utility
maximisers
rejects arguments based on anecdotal
evidence and nave acceptance of political
or academic prescriptions

Strengths of positive
theory

In order to prescribe an appropriate

accounting policy, it is necessary to
know how the world actually operates
We can then normatively prescribe
accounting practice

Strengths of positive
theory

Positive hypotheses are capable of

falsification by empirical research
Provides an understanding of how the world
works rather than prescribing how it should
work

obtain an understanding about how valuerelevant accounting numbers are for share prices
attempt to understand the connection between
accounting information, managers, firms and
markets, and analyse those relationships

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

Scope of positive accounting

theory
Two stages of development
1.
Capital market research into the
impact of accounting and the
behaviour of capital markets

did not explain accounting practice

investigated connection between the
accounting data and share prices/returns
efficient markets hypothesis (EMH)
capital asset pricing model

Scope of positive accounting

theory

Sought to explaining and predict

accounting practices across firms

2.

ex post opportunism
ex ante efficient contracting

Capital market research and

the
efficient markets
Two types of capital markets research
hypothesis

the impact of the release of accounting

information on share returns
the effects of changes in accounting policy
on share prices

Most research in these areas relies upon

the EMH

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Capital market research and

the
efficient markets
hypothesis
Efficient
market: one in which prices
fully reflect available information

3 Forms of Information Efficiency

1.

2.

3.

Weak form
(past price information)
Semi-strong form
(publicly available information)
Strong form
(all information public and private)

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Capital market research and

the
efficient markets

hypothesis
Capital markets research in accounting

assumes semi-strong form efficiency

Financial statements and other
disclosures form part of the information
set that is publicly available

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Capital market research and

the
efficient markets

hypothesis
Based on dubious assumptions

there are no transaction costs in trading

securities
information is available cost-free to all
market participants
there is agreement on the implications of
current information for the current price
and distributions of future prices

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Capital market research and

the
efficient markets
Market
efficiency does not assume, mean or
hypothesis
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

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
14

Market Model:
Derives from CAPM
Used to estimate abnormal returns on
shares when profits announced
Share prices and returns are affected by
both market-wide and firm-specific
events
Market-wide events must first be
controlled

Market model
15

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

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Impact of accounting profits

announcements on share prices
Ball & Brown (1968):
Seminal work in positive accounting and
finance literature
Tested the usefulness of historical cost
profit figure to investment decisions
If the historical cost profit figure is useful
the share price will react

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Impact of accounting profits

announcements on share prices

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Impact of accounting profits

announcements on share prices
Ball & Brown (1968) Results:
Most of the information contained in the
earnings announcement (85-90%) was
anticipated by investors
Evidence of information content at time
of historical cost earnings announcement

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Impact of accounting profits

announcements on share prices

Magnitude

Information asymmetry and firm size

Magnitude of profit releases from other

firms

Volatility

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Impact of accounting profits

announcements on share prices

Profit release event studies showed that

accounting profit does capture a portion of the
information set that is reflected in security
returns
The evidence also shows that competing
sources of information pre-empted the
information in annual profits by about 70-85 per
cent
Annual accounting figures are not timely
Led to an another approach association
studies

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Association studies and

earnings
response coefficients

The objective is to test the impact of

accounting variables and a wider
information set that is reflected in
securities returns over a longer period

earnings response coefficient (ERC)

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Association studies and

earnings
response coefficients
Factors which can affect the association
between profits and share prices:

risk and uncertainty

audit quality
firm size
industry
interest rates
financial leverage
firm growth
permanent and temporary profits
non-linear modeling
disaggregating profits
cash flows
balance sheet and balance sheet components

Methodological issues
23

To argue that the results of the research

are supportive of EMH and that the form
of accounting is not that important for
valuation purposes derives, in part, from
the fact that the EMH is assumed to be
descriptively valid
This assumption may not be warranted
There is increasing evidence that markets
can be fooled by accounting numbers

Methodological issues
24

No attempt to discriminate EMH from

competing hypothesis

mechanistic hypothesis
managers

use accounting to deliberately

mislead the share market
market participants can be fooled

no-effects hypothesis

the market ignores accounting changes that

have no cash flow consequences

Trading strategies
25

Post-announcement drift
Winners/losers and over-confidence
Mechanistic or behavioural effect

no-effects hypothesis

cosmetic accounting

Trading strategies
26

Two viewpoints of accounting

manipulation

Issues for auditors

27

There is some evidence of an association

between auditing and the cost of capital
Lower cost when firms voluntarily
purchase an audit or purchase a high
quality audit

investors value the deep resources of a

large auditor
investors value the quality assurance
regarding accounting data provided by the
auditor

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