\"accepted assumptions about market efficiency mean that it is the information c
ID: 2445756 • Letter: #
Question
"accepted assumptions about market efficiency mean that it is the information content of disclosure, and not the form of the disclosure, that is valued by the market. Therefore, it should not matter whether information is disclosed within the notes to the financial statements, or in the financial statements themselves."
if the above statement is true, then why would managers care if something - such as lease liability - is disclosed only in the notes, or included within the liabilities disclosed within balance sheet? Discuss this issue drawing on capital markets theory, agency theory and behavioural perspectives.
Explanation / Answer
Effeciency of a market will mean how the market price is reflecting the changes in information content. In developed capital market whatever information is forme it is immediately reflected in the price. as a result scope of making speculative gain is low.
Main point of effeciancy is that information should be disclosed immediately. Nothing should be concealed. Also it should be costless. It is immaterial how it is disclosed.
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If the effeciency criteria of capital market is taken into consideration, then financial statement should be prepared to reflect all information. How such informations are disclosed is immaterial. But it is not so. Purpose of operation of a capital market and purpose of preparing financial statement are totally different. Capital market is formed to transact already issued stock. Main objective is to introduce liquidity so that investor can buy or sale his holdings whenever it is needed.
But financial statement is totally different. It is a document prepared with the objective of ascertaining:
1. Profit earned or loss suffered by an organization at the end of the year.
2.Ascertain asset and liabilities at the end of a year.
Records are prepared in such a manner that it can reflect true ad fair view of states af affairs of the concern. So for satisfying this objective all iformation should be disclosed in the financial statement. Also the manner of their disclosure is very significant. Suppose your company has incurred a libility in the current year. Then it should be reflected in the Balance sheet of the financial statement. If instead of shwing this libility in balace sheet it is covered by a note, then financial statement will not be effecient. However there can be a liability which will occur subject to the fulfilmet of certai conditions in futurre, then such liabilities shuld not appear in the balance sheet. It will be covered by a note. Thus positioning of information disclosure in the right place of financial statement is very significant.
Taking above discussion into consideration, lease liability which has occured in the current fiancial year, should be reflected in the balance sheet. Otherwise liabilities will not reflect true and fair view of states of affairs of the concern..
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Agency point of view:
Another important aspect in the company is principal agency relation. Compaies are owned by stockholders. They are scattered in different parts of the economy. It is not possible for such owners to to participate in the daily operations of the concern. For operating the concern, hired professionals are appointed. They are salaried people.
Due to separation of principal owner and operating persons considerrable deviations may take place in the actual objective and the object used in their operation. Owners wants to maximize profit. But agent managers may operate the concern to maximze sale subject to the fulfilment of target profit. Thus it is necessary to prepare financial statement with proper disclosure in proper place, so that owners can be assured that no such deviations are not taking place.
Also remember ther are many other stakeholders who are interested in the financial statement. They include customers, investors, governments etc. For satisfying their objective they use the financial information. If it is not properly prepared with proper disclosure, then they will not get a clear picture. Investors are more interested in the future prospects of the concern. Financial statement analysis will help them to get this idea. Thus for the interest of all such stakeholders operatng managers should maintain the quality of statement content through proper disclosure.
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Behavioral perspective:
Fnally consider the behavioral aspect. stakeholders are interested in actual profit or loss made. Also they wants to know how they are earned. If it is earned without taking much risk, then it is good for the future. suppose a company has made a very high profit. It is observed that a major portion of profit is from exchange rate fluctuation. If the amount from such fluctuation is removed, then operatinng profit is nominal. So from behavioral point of view it is not good. A reasonable profit with minimum risk is more satisfying than a high profit with a very high risk. In order to get an idea on this behavioral aspect, financial statement must dosclose everything correctly at correct place.
Result; In conclusion it can be said that for satisfaying basic objective of a financial statement all information should be properly reflected i the financial statement in proper maner at proper place.
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