HISTORY AND PHILOSOPHY OF ACCOUNTING THEORY

MARYAM P64537 & SUHAILI BIN MOHD P61277

THE DECISION-USEFULNESS/DECISION-MAKER/

AGGREGATE-MARKET BEHAVIOR PARADIGM

Better known as the market paradigmAttempts to assess the usefulness of accounting information to decision makers by an evaluation of the market behaviour following the release of the information.The market paradigm, focuses on market valuation as a guide to the assessment of the effect of accounting information and its decision usefulness.

(by Ahmed Riahi-Belkaoui, Accounting , A multiparadigmatic science

Introduction

market response to accounting numbers Should

the evaluation of the informational content of : these numbers the procedure used to produce them Also he Developed the aggregate market paradigm which implies that accounting procedures numbers have informational content dictated by market responses.

govern

Arguing

Gonedes

To the counterarguments:

1-that the procedures used to produce the numbers may induce market inefficiencies

2-that recipients may be conditioned to respond to accounting numbers in particular manner

He argued that if they were true , the opportunity for those who possess this knowledge to earn an abnormal profit would provide a basis for the dissolution of the market paradigm within the context of an efficient capital market .

Gonedes & Dopuch

Relies the use of prices of firms’ ownership shares .

They concluded that the price-domain analyses is sufficient for assessing the effects of alternative accounting procedures .

on

Gonedes & Dopuch

This conclusion is based generally on one case of market failure in which information of a public good nature cannot be excluded from no purchasers (the free-rider problem); in such a case , the prices of firm’ shares cannot be used to assess desirability of alternative accounting procedures or regulations.Among the market – failure possibilities is :

The issue of adverse selection

The effect of information on the completeness of markets and

efficient risk-sharing arrangement

• The basic subject matter is the aggregate-market response to accounting variables.

• Decision usefulness of accounting variables can be

derived from aggregate market behavior, (Beaver)or

• Only the effect of alternatives accounting

procedures /speculations can be assessed from

aggregate-market behavior (Gonedes and Dopuch).

• The selection of the accounting information system

is determined by aggregate-market behavior

(Gonedes and Dopuch).

IMAGE OF THE SUBJECT MATTER

According to this theory , the market for securities is determined efficient In :

1- market prices “ fully reflect “ all publicly available information2- market prices are unbiased and respond instantaneously to new information

THEORY OF CAPITAL – MARKET EFFICIENCY

Abnormal return

Earned from employing a set of extant information in

conjunction with any trading scheme

Is zero

In fact the theories confirming the market behavior paradigm include :

The Efficient Market Model.

The Efficient Market Hypothesis (EMH)

The Capital Asset Pricing Model (CAPM)

The Arbitrage Pricing Theory (APT)

The Equilibrium Theory of Option Pricing.

THEORIES

Assumption :

•costless access to available information•capable analysis skills by participants•close attention to market prices which adjust appropriately.

THE EFFICIENT MARKET MODEL

EMH holds that security prices fully reflect all available information at any time.

Individual and professional investors buy and sell stocks under assumption that intrinsic value differs from market price.

Perfectly competitive securities market:New information arrives at market independently and randomly.

Both buyers and sellers adjust rapidly to new info.

Current security prices reflect all relevant risk/return info

THE EFFICIENT MARKET HYPOTHESIS (EMH)

Level of Market Efficiency :• Weak-Form Hypothesis

current prices reflect all stock market information; trading rules based on past stock market return

•Semi-strong Form Hypothesis current prices reflect all public information;

•Strong-Form Hypothesis current prices reflect all public information and non-public information.

Definition :Method for predicting how investment returns are determined in an efficient capital market.

Assumption:

•Investors hold efficient portfolios; higher expected returns involve higher risk.•Unlimited borrowing & lending are available at risk-free rate.•Investors have homogeneous expectations.•There is a one-period time horizon.•Investments are infinitely divisible.•No taxes or transaction costs exist.•Inflation is fully anticipated.•Capital markets are in equilibrium

THE CAPITAL ASSET PRICING MODEL (CAPM)

Based on the law of one price. Two items that are the same cannot sell at different prices.

If they sell at a different price, arbitrage will take place in which arbitrageurs buy the good which is cheap and sell the one which is higher priced till all prices for the goods are equal.In APT, the assumption of investors utilizing a mean-variance framework is replaced by an assumption of the process of generating security returns.APT requires that the returns on any stock be linearly related to a set of indices.In APT, multiple factors have an impact on the returns of an asset in contrast with CAPM model that suggests that return is related to only one factor, i.e., systematic risk

THE ARBITRAGE PRICING THEORY (APT)

1. The Market Model2. The Beta Estimation Model3. The Event Study Methodology4. The Ohlson’s Valuation Model5. The Price-level Balance Sheet Evaluation

Model6. The Models of the Relation between

Earnings and Return.

METHODS

•The Ohlson (1995) approach to the problem of stock valuation relates securities prices to accounting data, and provides a structure for applicable modeling.

•The Ohlson (1995) Valuation Model has been widely adopted by researchers and practitioners on profitability analysis as a framework for the fundamental valuation of equities.

•It also has been developed into several versions, e.g., Feltham-Ohlson (1995)Valuation Model, Bernard’s (1995) Ohlson Approximation Model, Liu-Ohlson (2000) Valuation Model and Callen’s (2001) Ohlson AR(2) Valuation Model.

THE OHLSON’S VALUATION MODEL