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Sixth Edition
William R. Scott
Chapter 8
8-1
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Chapter 8
Economic Consequences and Positive Accounting Theory
8-2
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What Are Economic Consequences?
8-3
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8.3, 8.4 Economic Consequences in
Action
• Employee stock options (ESOs)
– APB 25 applied until 2004/2005
– No expense need be recorded if intrinsic value = zero
• Are ESOs an expense?
– Dilution
– Opportunity cost
» Continued
8-4
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Economic Consequences in Action
(continued)
» Continued
8-5
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Economic Consequences in Action
(continued)
• June, 1993
– FASB exposure draft to expense ESOs
• Intense opposition from managers
• Claimed reasons for manager opposition
– Lower reported net income
– Low reliability
8-6
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Economic Consequences in Action
(continued)
» Continued
8-7
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Economic Consequences in Action
(continued)
» Continued
8-8
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Economic Consequences in Action
(continued)
8-9
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8.5 Positive Accounting Theory
(PAT)
>> Continued
8 - 10
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Positive Accounting Theory (continued)
• Assumptions of PAT
– Managers are rational (like investors)
– Efficient securities markets
>> Continued
8 - 11
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Positive Accounting Theory (continued)
» Continued
8 - 12
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Positive Accounting Theory (continued)
>> Continued
8 - 13
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Positive Accounting Theory (continued)
8 - 14
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Positive Accounting Theory (continued)
>> Continued
8 - 15
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Positive Accounting Theory (continued)
8 - 16
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Positive Accounting Theory (continued)
8 - 17
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Positive Accounting Theory (continued)
• Distinguishing opportunistic v. efficiency
versions of PAT
– Are managers’ accounting policy choices (e.g.,
amounts of discretionary accruals) driven by
• Opportunism: manager benefits at expense of investors
• Efficiency: manager chooses accounting policies to
maximize contract efficiency
» Continued
8 - 18
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Positive Accounting Theory (continued)
» Continued
8 - 19
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Positive Accounting Theory (continued)
– Some research consistent with contracting efficiency,
(continued)
• Dechow (1994)
– Net income more highly associated than cash flows with
share returns
• Guay (1999)
– Limit firm risk using derivatives
• Armstrong, Jagolinzer, and Larcker (2010)
– No evidence that opportunistic behaviour increases with
manager portfolio delta
– Conclude: significant evidence for efficiency version
8 - 20
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Conclusions
8 - 21
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