Deck 4: Research Methodology and Theories on the Uses of Accounting Information

Question 1

Which of the following cognitive biases in finance suggests that people tend to be overconfident in their predictions of the future

A) Mental accounting
B) Biased expectations
C) Reference dependence
D) Representativeness heuristic:

Answer 1

B

Question 2

Which of the following outcomes of providing accounting information is an attempt to identify individual securities that are mispriced by reviewing all available financial information?

A) Agency theory
B) Efficient markets
C) Fundamental analysis
D) Capital asset pricing model

Answer 2

C

Question 3

Which of the following anomalies are related to investing techniques that attempt to forecast security prices by studying past prices and other related statistics?

A) Calendar anomalies
B) Value anomalies
C) Technical anomalies
D) Other anomalies

Answer 3

C

Question 4

Which of the following is not viewed as a cost to the principal in an agency relationship?

A) Monitoring expenditures by the principal
B) Monitoring expenditures by the agent
C) Bonding expenditures by the agent
D) The residual loss

Question 5

Which of the following anomalies are related to particular time periods?

A) Calendar anomalies
B) Value anomalies
C) Technical anomalies
D) Other anomalies

Question 6

Which of the following is not a conclusion that has been drawn from human information processing research?

A) An individual's perception of information is quite selective. That is, since individuals are capable of comprehending only a small part of their environment, their anticipation of what they expect to perceive about a particular situation will determine to a large extent what they do perceive.
B) Since individuals make decisions on the basis of a small part of the total information available, they do not have the capacity to make optimal decisions
C) Individuals are able to process and integrate large amounts of information simultaneously
D) Since individuals are incapable of integrating a great deal of information, they process information in a sequential fashion.

Question 7

Which of the following research approaches is based on the concept of utility or usefulness?

A) Deductive
B) Behavioral
C) Inductive
D) Pragmatic

Question 8

Which of the following anomalies are related to strategies designed to outperform the market?

A) Calendar anomalies
B) Value anomalies
C) Technical anomalies
D) Other anomalies

Question 9

Which of the following research approaches emphasizes going from the specific to the general?

A) Deductive
B) Behavioral
C) Inductive
D) Pragmatic

Question 10

Which of the following cognitive biases in finance suggests that people tend to judge Event A to be more probable than Event B when A appears more representative than
B)

A) Mental accounting
B) Biased expectations
C) Reference dependence
D) Representativeness heuristic

Question 11

Which of the following outcomes of providing accounting information is based on the supply and demand model?

A) Agency theory
B) Efficient markets
C) Fundamental analysis
D) Capital asset pricing model

Question 12

Which of the following outcomes of providing accounting information is an attempt to deal with both risks and returns?

A) Agency theory
B) Efficient markets
C) Fundamental analysis
D) Capital asset pricing model

Question 13

The efficient market hypothesis holds that that financial markets price assets at their intrinsic worth, given all available information. Which of the following forms of the efficient market hypothesis defines all available information as knowledge of past security prices?

A) Weak
B) Semi-weak
C) Semi-strong
D) Strong

Question 14

The efficient market hypothesis holds that that financial markets price assets at their intrinsic worth, given all available information. Which of the following forms of the efficient market hypothesis defines all available information as all publicly available information including past stock prices?
E) Weak
F) Semi-weak
G) Semi-strong h. Strong

Question 15

What theory on the outcomes of providing accounting information attempts to answer the question: What is an individual's expected benefit from a particular course of action?

A) Agency theory
B) Efficient markets
C) Fundamental analysis
D) Capital asset pricing model

Question 16

What theory on the outcomes of providing accounting information rejects the view that knowledge of accounting is grounded in objective principles

A) Agency theory
B) Critical perspective
C) Fundamental analysis
D) Capital asset pricing model

Question 17

Which of the following research approaches is attributed to DR Scott?

A) Deductive
B) Ethical
C) Inductive
D) Pragmatic

Question 18

The efficient market hypothesis holds that that financial markets price assets at their intrinsic worth, given all available information. Which of the following forms of the efficient market hypothesis defines all available information as information, including security price trends, publicly available information, and insider information? i. Weak
J) Semi-weak
K) Semi-strong
L) Strong

Question 19

What theory on the outcomes of providing accounting information attempts to assess an individual's ability to use information?

A) Agency theory
B) Efficient markets
C) Human information processing
D) Capital asset pricing model

Question 20

Which of the following cognitive biases in finance suggests that the majority of people perceive a dividend dollar differently from a capital gains dollar?

A) Mental accounting
B) Biased expectations
C) Reference dependence
D) Representativeness heuristic:

Question 21

Describe the efficient market hypothesis and its three forms.

Question 22

Discuss the concept of critical perspectives research in accounting.

Question 23

What is the goal of human information processing studies? What are the general findings of these studies and what is the implication for accounting?
a. An individual's perception of information is quite selective. That is, since individuals are capable of comprehending only a small part of their environment, their anticipation of what they expect to perceive about a particular situation will determine to a large extent what they do perceive.
b. Since individuals make decisions on the basis of a small part of the total information available, they do not have the capacity to make optimal decisions.
c. Since individuals are incapable of integrating a great deal of information, they process information in a sequential fashion.
In summary, individuals use a selective, stepwise information processing system. This system has limited capacity, and uncertainty is frequently ignored.
These findings may have far-reaching disclosure implications for accountants. The current trend of the FASB and SEC is to require the disclosure of more and more information. But if the tentative conclusions of the HIP research are correct, these additional disclosures may have an effect opposite to what was intended. The goal of the FASB and SEC is to provide all relevant information so that individuals may make informed decisions about a company. However, the annual reports may already contain more information than can be adequately and efficiently processed by individuals.

Question 24

What is the basic assumption of agency theory? Why is the relationship between shareholders and management an agency relationship?

Question 25

Discuss the relationship among research, education, and practice in accounting.

Question 26

Briefly describe the following research approaches:
a. Deductive
The deductive approach to the development of theory begins with the establishment of objectives. Once the objectives have been identified, certain key definitions and assumptions must be stated. The researcher must then develop a logical structure for accomplishing the objectives, based on the definitions and assumptions. This methodology is often described as "going from the general to the specific
b. Inductive
The inductive approach to research emphasizes making observations and drawing conclusions from those observations. Thus, this method is described as "going from the specific to the general" because the researcher generalizes about the universe on the basis of limited observations of specific situations.
c. Scientific method
The scientific method of inquiry, as the name suggests, was developed for the natural and physical sciences and not specifically for social sciences such as accounting. There are some clear limitations on the application of this research methodology to accounting; for example, the influence of people and the economic environment make it impossible to hold the variables constant. Nevertheless, an understanding of the scientific method can provide useful insights as to how research should be conducted.
Conducting research by the scientific method involves five major steps, which may also have several substeps:

Question 27

In their book, "The End of Accounting and the Path Forward for Investors and Managers," Baruch Lev and Feng Gu maintain that flaws in generally accepted accounting principles severely limit the usefulness of financial reporting. What are the three major reasons the authors indicate why accounting reports have lost relevance? What is their solution to this perceived problem?

Question 28

According to finance theory, a financial market anomaly occurs when the performance of a stock or a group of stocks deviates from the assumptions of the efficient market hypothesis. Katz has classified anomalies into four basic types.
a. What are these four types of anomalies?
b. Give examples of each.
d. The four types of anomalies identified by Katz are calendar anomalies, value (fundamental) anomalies, technical anomalies, and other anomalies.
Examples of Calendar Anomalies
Weekend Effect
Stock prices are likely to fall on Monday; consequently, the Monday closing price is less than the closing price of previous Friday.
Turn‐of‐the‐Month Effect
The prices of stocks are likely to increase on the last trading day of the month and the first three days of the next month.
Turn‐of‐the‐Year Effect
The prices of stocks are likely to increase during the last week of December and the first half month of January
January Effect
Small‐company stocks tend to generate greater returns than other asset classes and the overall market in the first two to three weeks of January.
Examples of Value Anomalies
Low Price‐to‐Book Ratio
Stocks with a low ratio of market price to book value generate greater returns than stocks having a high ratio of book value to market value.
High Dividend Yield
Stocks with high dividend yields tend to outperform low dividend yield stocks.
Low Price‐to‐Earnings Ratio (P/E)
Stocks with low price‐to‐earnings ratios are likely to generate higher returns and outperform the overall market, whereas the stocks with high market price‐to‐earnings ratios tend to underperform the overall market
Examples of Technical Anomalies
Moving Average
Moving average is a trading strategy that involves buying stocks when short‐term averages are higher than long‐term averages and selling stocks when short‐term averages fall below their long‐term averages.
Trading Range Break
Trading range break is a trading strategy based on resistance and support levels. A buy signal is created when the prices reaches a resistance level. A sell signal is created when prices reach the support level
Neglected Stocks
Prior neglected stocks tend to generate higher returns than th overall market in subsequent periods, and the prior best performers tend to underperform the overall market.
Trading Range Break
Trading range break is a trading strategy based on resistance and support levels. A buy signal is created when the prices reaches a resistance level. A sell signal is created when prices reach the support level.
Examples of Other Anomalies
The Size Effect
Small firms tend to outperform larger firms.
Announcement‐Based Effects and Post‐Earnings Announcement Drift
Price changes tend to persist after initial announcements. Stocks with positive surprises tend to drift upward, and those with negative surprises tend to drift downward.
IPOs, Seasoned Equity Offerings, and Stock Buybacks
Stocks associated with initial public offerings (IPOs) tend to underperform the market, and there is evidence that secondary offerings also underperform, whereas stocks of firms announcing stock repurchases outperform the overall market in the following years.
Insider Transactions
There is a relationship between transactions by executives and directors in their firm's stock and the stock's performance. These stocks tend to outperform the overall market.
The S&P Game
Stocks rise immediately after being added to the S&P 500.

Question 29

Define the following cognitive biases:
B. In finance, the most common instance of the representativeness heuristic is that investors mistake good companies for good stocks. Good companies are well-known and in most cases fairly valued. Their stocks, therefore, might not have a significant upside potential.
a. Mental accounting:
The majority of people perceive a dividend dollar differently from a capital gains dollar. Dividends are perceived as an addition to disposable income; capital gains usually are not.
b. Biased expectations:
People tend to be overconfident in their predictions of the future. If security analysts believe with 80 percent confidence that a certain stock will go up, they are right about 40 percent of the time. Between 1973 and 1990, earnings forecast errors have been anywhere between 25 percent and 65 percent of actual earnings.
c. Reference dependence:
Investment decisions seem to be affected by an investor's reference point. If a certain stock was once trading for $20, then dropped to $5 and finally recovered to $10, the investor's propensity to increase holdings of this stock depends on whether the previous purchase was made at $20 or at $5.
d. Representativeness heuristic:
In cognitive psychology this term means simply that people tend to judge Event A to be more probable than Event B when A appears more representative than

Question 30

Agency relationships involve costs to the principals. Discuss these costs. Give some examples of each of these costs.

Question 31

Discuss the difference between normative and positive accounting theory.

Question 32

What is fundamental analysis and what is its goal?

Question 33

Kahneman and Tversky studied how people manage risk and uncertainty and developed a theory to describe it they termed prospect theory. Discuss the characteristics of prospect theory.
A.
Loss aversion: People tend to give losses more weight than gains: They're loss‐averse. So, if you gain $100 and lose $80, it may be considered a net loss in terms of satisfaction, even though you came out $20 ahead, because you tend to focus on how much you lost, not on how much you gained.
Relative positioning: People tend to be most interested in their relative gains and losses as opposed to their final income and wealth. If your relative position doesn't improve, you won't feel any better off, even if your income increases dramatically. In other words, if you get a 10 percent raise and your neighbor gets a 10 percent raise, you won't feel better off. But if you get a 10 percent raise and your neighbor doesn't get a raise at all, you'll feel rich.
Small probabilities: People tend to underreact to low‐probability events. For example, you might completely discount the probability of losing all your wealth if the probability is very small. This tendency can result in people making very risky choices.

Question 34

Discuss the capital asset pricing model including the concepts of unsystematic risk, systematic risk and beta.