Compare and Contrast Capital Market

Topics: Economics, Rational choice theory, Sociology Pages: 7 (1888 words) Published: May 4, 2011
Contrast to Capital market research and Behaviour research
Positive theories explain and predict the behaviour of users of accounting information: i)Reactions of investors to accounting information ii)Association between accounting numbers and share prices

Capital market research and Behaviour research both positive theories. Research question: Capital market research investigates the impact of accounting information (especially earnings) on share prices. It is concerns with investor reactions to accounting information. Behaviour research explains how to use and process the accounting information. Objective: The main objective of capital market research is to examine relationship between accounting information and share prices. Behaviour research’s main purposes are to model the decision-making and uncovering the cognitive and social biases. Disciplines: Capital market research refers to Economics and Finance, and behaviour research refers to Psychology. Focus: Refer to decision-making, capital market research at aggregate level. Behaviour research specifically on users, at individuals or groups level. Theories: Capital market research is based on rational choice theory and expected utility theory. Behaviour research is based on prospect theory, belief-adjustment model, and functional fixation hypothesis. Assumptions:

Capital Market Research is based on ‘homo economics’:
Semi-strong form of market efficiency – share prices incorporate information in a timely and unbiased manner, reflect all publicly available information. Decision maker: rationality; utility maximization-optical solutions; solutions found by applying mathematical models. Behaviour research is based on ‘homo heuristics:

i) Investors are not rational -Bounded rationality,
ii)Satisfactory, rather than optimal solutions
iii) Investors suffer from various cognitive, affective, and social biases iv)Markets are weakly efficient, inefficient

Market efficiency: Capital Market Research: Semi-strong form; Behaviour research: Market inefficiency.
Capital Market Research:
i) Event study: Examines the change in level/variability of share prices/trading volume around the time new information is released. Most event studies focus on earnings announcements. ii) Association study: Regression analysis, Examines the correlation between accounting performance measures and share returns; Impact of accounting measures on share prices over a longer event window Based on CAPM: Separates total returns into normal (market) and abnormal (firm-specific) returns Based on ‘scientific’ research:

i)Large samples, statistics, hypothesis testing; aim = universal truth claims ii)Share price movements used as a proxy of investor reactions iii)Association between accounting information (earrings) and share prices

Behaviour research:
i)Verbal protocol analysis-Requires subjects to verbalise their thought processes while making decisions or judgements ii)Experiments
iii) Participant observation

Capital Market Research: Impact of earnings announcements on share prices (Ball & Brown 1968) Behaviour research: Analysts’ reactions to warnings of negative earnings surprises (Libby & Tan 1999)

PAT vs. Systems-oriented theories:
Both are positive (predictive) theories seek to explain and predict managers’ behaviour rather than prescribe how managers should behave (normative/prescriptive theories). Accounting method choice; Disclosure choices Positive theory based on economic theories:

Agency theory: Conflict of interest and information asymmetries between managers and investors. Rational choice theory:i)Managers are rational;ii)Managers are self-interested. But: They differ in their disciplinary origins, assumptions of human behaviour and theory/role of the firm. Positive Accounting Theory

Positive accounting theories explain and predict accounting/financial reporting practice. Contrast with normative accounting theories...
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