6. Positive Accounting Theory Flashcards
Positive Accounting Theory (PAT)
- example of positive theory
- used to explain and predict who will use what accounting method
- focuses on relationships
Assumptions of PAT
Individuals actions are - self driven - opportunistic - increase own wealth Ignores morality and loyalty
Agency Problem is
Issues associated with aligning motivations of the agent with that of the principal
Agency Problems arise because
- inefficiencies and information asymmetry
- divergent behaviour
- consumption of perks
Agency Costs is
The cost inherent in the principal agent relationship
Contractual mechanism is
- an alignment mechanism
- clauses in the contract to align the interests
- bonus based on financial statement/performance
Price protection is
- where no contractual/alignment mechanism
- principal pays less to compensation for agency costs
- agent has incentive not to enter into detrimental contracts
Monitoring cost
Cost of monitoring agent’s behavior
E.g. audit costs
Bonding cost
- time and effort of agent
- cost to align interests
Residual loss
- cannot control all opportunistic behaviour
- cost of unaligned behaviour
Hypotheses of PAT
PAT assumes agent will be opportunistic when selecting an accounting method
- bonus plan
- debt
- political cost
Bonus plan hypothesis
Agents with bonuses more like to use accounting methods to increase current period income
Debt hypothesis
Where there are high debt/equity ratios agents more likely to use accounting methods to increase income
Political cost hypothesis
Larger firms more likely to attract attention than smaller firms so more likely to choose accounting methods to decrease income
Perspectives of PAT research
- Efficiency perspective
2. Opportunistic perspective
Efficiency perspective
- Ex ante perspective
- considers up front mechanisms to minimise future agency and contracting costs
Opportunistic perspective
- Ex post perspective
- actions after up front mechanisms contributing to agency costs
How are agents rewarded?
- Fixed basis
2. Bonus scheme
Fixed basis reward
Salary independent of performance, agent may not take on risk as there is no reward
Bonus scheme reward
Salary + bonus
Accounting based or market based
What are some incentives to manipulate?
- efficiency, to increase contract/efficiency based incentive
- opportunistic, to increase self wealth
- bonus, short term rather than long term focus
- take a bath, shift profit to future period to get bonus
- retirement, short term focus
Horizon problem
Difference between agent’s life with principal and life of principle, short term vs long term
Market based bonus
- may be more suitable where earnings fluctuate
- incentive to increase value of firm
- market price affected by external factors or senior managers
Criticisms of PAT
- does not prescribe
- asserts all action is self driven
- too negative and simplistic
- ignores organisation specific relationships
