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Chapter 4
Research Methodology And
Theories On The Uses Of
Accounting Information
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Introduction To have a science is to have a recognized domain and a set of
phenomena in that domain Theory describes the underlying reality of that domain through input
(observations) and outputs (predictions)
ery little behavior is e!plained through e!isting accounting theory Theory vs theorizing "hapter introduces methods of developing theory and some theories on
outcomes of providing accounting information
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Research Methodology #eductive approach
Inductive approach
$ragmatic Approach %cientific Method
Other
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Deductive Approach It is essentially an &armchair' approach hich is described from
going from the general to the specific egins ith the establishment of ob*ectives +e!t definitions and assumptions are stated
A logical structure for accomplishing the ob*ectives based onthe definitions and assumptions is developed
Attempts to &theorize are generally based on the deductiveapproach
alidity of this approach lies in the ability to relate components
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Inductive Approach Ma,ing observations and
draing conclusions
-eneralizations are made about
the universe based upon limited
observations
A$ %tatement +o. / utilized
the inductive approach
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Pragmatic
Approach ased upon the concept of utility or usefulness
0hen a problem is found1
an attempt to find a solution is underta,en Most accounting theory as developed using this
approach
A Statement of Accounting Principles as apragmatic approach
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The Scientifc
Method Involves the folloing steps2
Most accounting research found in academic *ournals uses
the scientific method
Identify and state the problem to be studied
State the hypotheses to be tested
Collect data necessary to test the hypotheses
Analyze and evaluate data
Draw a tentative conclusion
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Other Research
Approaches 3thical approach
4 #eveloped by #R %cott and involves the
concepts of truth5 *ustice and fairness
ehavioral approach 4 The study of ho accounting information
affects the behavior of users
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The Outcomes oProviding AccountingInormation 6undamental analysis
The efficient mar,et hypothesis
The capital asset pricing model Agency theory
7uman information processing
"ritical perspective research
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!undamental Analysis
Investor decisions uy
7old
%ell
The goal of fundamental analysis
Investment analysis
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The "#icient Mar$et%ypothesis
7olds that 6undamental analysis is not a useful tool1 because individual investors are not able to identify
mispriced securities
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The "#icient Mar$et%ypothesis
ased on the free mar,et supply and demandmodel ith the folloing assumptions2 4 All economic units have complete ,noledge of the
economy 4 All goods and services are completely mobile 4 All buyers and sellers are so small in relation to total
supply and demand that neither has an influence onsupply or demand
4
+o artificial restrictions on demand5 supply or prices ofgoods and services
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The
The Supply and Demand
Supply
Demand
P r i c e
P r i c e
QuantityQuantity
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The Supply and Demand
Model est illustrated in the securities mar,et Information available from many
sources including28 $ublished financial reports9 :uarterly earnings reports; +es reports/ $ublished competitor information
< "ontract aardings= %toc,holder meetings
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The "#icient Mar$et%ypothesis
According to the supply and demandmodel5 the price of a product is
determined by ,noledge of
relevant information
The securities mar,et is vieed as
efficient if it reflects all available
information and reactsimmediately to ne
information
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The "#icient Mar$et%ypothesis
The 3M7 indicates that an investor
ith a diversified portfolio cannot ma,e an
e!cess return by ,noledge of availableinformation
There are three forms of the 3M7 hich differ in
respect to the definition
of available information 4 0ea, form
4 %emi>strong form
4 %trong form
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&ea$ !orm An e!tension of the random al, theory in the
financial management literature
The historical price of a stoc, provides an unbiased
estimated of its future price "onse?uently5 an investor cannot
ma,e an e!cess return by
,noledge of past prices
This form of the 3M7 has beensupported by several studies
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Semi'Strong
!orm All publicly available information including past prices is
assumed to be incorporated into the determination of
security prices
An investor cannot ma,e an e!cess return by ,noledgeof any publicly available information
Implication is that the form of disclosure5 hether in the
financial statements5 the footnotes5 or financial press
information is not important This form of the 3M7 has been generally supported in the
literature
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The Capital Asset PricingModel
The goal of investors is to minimize ris, and ma!imize
returns.
The rate of return on stoc, is calculated2
Dividends + increases (or - decreases) in value
urchase rice
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Strong !orm All available information5
including insider information isimmediately incorporated into the
price of securities as soon as it is,non leaving no room fore!cess returns
Most available evidence suggest
that this form of the 3M7 is notvalid
Implications
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The Capital Asset PricingModel
Ris,2 The possibility that actual returns ill deviate from e!pected
returns
U. %. treasury bills A ris, free investment
Return on these investments is the ris, free return
Diversification Stoc,s can be combined into a portfolio that is less ris,y than any
of the individual stoc,s
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The Capital Asset PricingModel
Types of ris, are company specific and
environmental
Unsystematic risk The ris, that is company specific
and can be diversified aay
Systematic risk The nondiversifiable ris, that is related to
overall movements in the stoc, mar,et
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The Capital Asset
Pricing Model Assumption is that investors are ris,
aversive and ill demand higher returns
for ta,ing greater ris,s eta (β)
The measure of the relationship of a particular stoc, ith the
overall movement of the stoc, mar,et vieed as a measure of volatility > a measure of ris,
%ecurities ith higher βs offer greater returns than
securities ith relatively loer βs
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The Relationship(et)een Ris$ andReturn
Rs @ Rt Rp
0here2
Rs @ 3!pected return on a given ris,y
security
Rt @ The ris, free return rate
Rp @ The ris, premium
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The Relationship(et)een Ris$ and
Return
Investors ill not be compensated for
bearing unsystematic ris, since it can bediversified aay
The only relevant ris, is systematic ris,
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Incorporating Ris$ Into the"*uation
Rs @ Rt $s (Rm > Rt)
0here2
Rs @ 3!pected return on a given ris,y security
Rt @ The ris, free return rate
Rm @ The e!pected mar,et rate as a hole
$s @ The stoc,Bs beta
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Implications o
CAPM A securityBs price ill not be
impacted by unsystematic ris, %ecurities ith higher βs (higher ris,) ill be priced relatively
loer than securities offering less ris,
Research has indicated that past
βs are a good predictor of future
stoc, prices
"riticized because it causes
managers to see, only safe
investments
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+ormative vs, Positive theory
+ormative theory 4 based upon a set of goals
that its proponents maintain prescribe the
ays things should be.
Must be accepted by the entire universe to beuseful
$ositive theory 4 attempts to e!plain
observed phenomena One positive theory is termed agency theory
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Positive Theory
Agency theory
Based on economic theories of $rices
Agency relationships
$ublic choice
3conomic regulation
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Positive Theory Agency theory is based on the
assumption that individuals act toma!imize their on e!pected utilities.
As a result the relevant ?uestion is2
What is a particular individual’s expected benefitfrom a particular course of action
An agency is a consensual relationship beteen to parties herebyone agrees to act on behalf of the other
Inherent in this theory is that there is a conflict of interest beteen theshareholders and the managers of a corporation
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Positive Theory
Agency relationships involve costs to the principles8 Monitoring e!penditures by the
principal
9 onding e!penses by the agent; Residual loss
Agency theory holds that all
individuals ill act to ma!imize their on utility Monitoring and bonding costs ill be incurred as long as they
are less than the residual loss
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%uman Inormation
Processing Annual reports provide vast amounts of information
#isclosure of information is intended to help
investors ma,e buy > hold > sell decisions
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%uman Inormation
Processing 7I$ studies %tudies attempting to assess an individualBs ability to use
accounting information
Results > individuals have limited ability to process largeamounts of information
"onse?uences2%elective perception
#ifficulty in ma,ing optimal decisions
%e?uential processing
Implications > e!tensive disclosures no re?uired maybe having opposite effect
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Critical Perspectives
Research $revious theories assumed that ,noledge of
facts can be gained by observation
elief in indeterminacy ! the history ofaccounting is a comple! eb of economic5political and accidental conse?uences
This area of research contests the vie that,noledge of accounting is grounded inob*ective principles
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Critical PerspectivesResearch
Accountants have been unduly
influenced by utility based marginal
economics that holds2
$rofit @ efficiency in using scarce resources
"onventional accounting theory e?uates normativeand positive theory.
0hat should be and hat is are the same
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Critical Perspectives
Research "ritical perspective research concerns
itself ith the ays societies and
institutions have emerged. Three assumptions2
8 %ociety has the potential to be hat
it isnBt
9 7uman action can help this process
; "ritical theory can assist human action
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Accounting Research
"ducation and Practice 7o are research5 education and practice
related in most disciplinesC 6or e!ample5 medicineC
7o are they related in accountingC
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repared by 5athryn 6arbrou!h 78A