Measurement Approach to Decision Usefulness

Topics: Stock market, Fundamental analysis, Stock Pages: 13 (1486 words) Published: March 7, 2014
MEASUREMENT APPROACH TO
DECISION USEFULNESS


(184) MEASUREMENT APPROACH:

i.
ii.
iii.

Accountants (not investors) “undertake a responsibility” To incorporate CURRENT VALUE ACCOUNTING directly in to the F/S Provided “reasonable (37) reliability”

iv.
v.
a.
b.

As part of an “increased obligation” of the accounting profession “To assist investors to predict future performance and value” Performance = N.I.
Value = share price

vi.

Via a “more informative information system”



QUALIFIERS

i.
ii.

(185) “Beta is the only relevant risk measure according to the CAPM” “there is evidence that accounting variables … do a better job than beta in predicting share return”



RISK vs. RETURN

i.

“Perhaps accountants should take more responsibility for reporting on firm risk”

1

JUSTIFICATION FOR THE MEASUREMENT APPROACH


4 point rationale for adopting the measurement approach

i.

iii.
iv.

“ … conclude that securities markets are close enough to full efficiency (161 ‘partly informative’) that the theory can serve as a guide to accountants”
“ … suggest that the extent of inefficiency and NON RATIONAL INVESTOR BEHAVIOUR can be reduced by a measurement approach”
“ … a low proportion of share price variability explained by historical cost-based net income” (186) “the legal liability to which accountants are exposed when firms become financially distressed”



The justification for current value accounting is actually based on three theories:

i.
ii.
iii.

(68) Rational investor theory (single person decision theory) (78) Utility theory (“to model risk aversion”)
(156) The efficient markets theory (the CAPM)



Chapter 6 discusses

i.
ii.
iii.

Irrational investor behaviour
Empirical studies of changes in the price a share of stock
Alternative explanations (tending towards theories) of the causes of these price movements



The chapter does not discuss current value accounting.

ii.

2

INVESTOR BEHAVIOUR
Is It Really ‘Rational’?





In an efficient securities market (110) “prices of securities fully reflect all information that is publicly known at all times”
In fact, they don’t
This raises (186) “questions of investor rationality and market efficiency”



AVERAGE INVESTOR BEHAVIOUR

1.
2.
3.
4.
5.

LIMITED ATTENTION: time and ability required to “process all available information” OVERCONFIDENCE: over estimation of the accuracy of their own analyses and therefore estimates (subjective probabilities); then ‘under react’ to new information REPRESENTATIVENESS: rely on information that is consistent with estimates (prior probabilities) and discount data that is inconsistent. People dislike discrepancies (cognitive dissonance)

(187) SELF-ATRRIBUTION BIAS: link positive outcomes to decisions because this indicates ability; but consider that negative outcomes “are due to unfortunate (40) realizations of states of nature, hence not their fault” (subjective estimates, incomplete markets) MOTIVATED REASONING: Accept data that is consistent with ‘preference’ e.g. GN; but skeptical about data that is inconsistent e.g. BN

3

INVESTOR BEHAVIOUR
Does It Effect Capital Markets?


(187) “Behavioural characteristics can produce a wide variety of share price behaviours”



(188) BEHAVIOURAL FINANCE: “the study of behavioural-based securities market inefficiencies”



PROSPECT THEORY – A behaviour based alternative to Rational Decision Theory

1.

2.
3.
4.
5.
6.

(189) Narrow framing: “separate evaluation of gains and losses” within several days, plus and minus, of the release of new information
The diagram is an alternative UTIILITY FUNCTION. It suggests that investors perceive risk and return differently from the (77,78) square root function that is assumed to apply to efficient capital markets

In Prospect Theory (190) “The rate at which investor utility decreases for small losses is greater that...
Continue Reading

Please join StudyMode to read the full document

You May Also Find These Documents Helpful

  • Decision Usefulness Approach Research Paper
  • Measurement and Decision Making Essay
  • A Systematic Approach to Decision Making Essay
  • Measurements Essay
  • Essay on Measurements
  • measurement Essay
  • Philosophical Approach to Ethical Decision-Making Research Paper
  • Approach Essay

Become a StudyMode Member

Sign Up - It's Free