Dev Flashcards
What does it mean that managers are ‘rational and self-interested’?
Managers are assumed to make decisions that benefit themselves, such as maximizing their own utility (e.g., pay, job security), not necessarily what benefits shareholders.
What is an efficient contract?
A contract that meets its goals (like reducing risk or incentivizing performance) at the lowest possible cost to the firm and stakeholders.
What is information asymmetry in contracting?
It refers to situations where one party (usually the manager) has more or better information than others (like investors or creditors), leading to potential inefficiencies.
What is moral hazard in agency theory?
A situation where the manager may shirk responsibilities or act in self-interest because their actions are not directly observable.
How does accounting help reduce information asymmetry?
By providing reliable and standardized financial information, accounting allows outsiders to monitor a firm’s performance and reduce the risk of being misled.
Why is reliability important in accounting for lenders?
Because lenders face downside risk, they care more about avoiding bad outcomes and thus value reliable (verifiable and objective) information.
What is accounting conservatism?
A principle of recognizing potential losses early and delaying recognition of gains, aiming to avoid overstating a firm’s financial health.
What is conditional conservatism?
It’s when bad news is recognized promptly in financial statements, but good news is either not recognized or delayed.
What is an implicit contract?
An unwritten understanding based on repeated interactions and trust, such as a firm’s reputation for fair reporting.
What is a non-cooperative game in finance?
A strategic interaction where each party (e.g., manager and investor) acts in their own interest without formal agreements.
What is a Nash Equilibrium?
A stable outcome in which no party can benefit by unilaterally changing their decision, given the other party’s decision.
What is the agency problem?
It arises from the separation of ownership and control—shareholders (owners) want managers (agents) to act in their interest, but managers may pursue their own goals.
Why does a fixed salary lead to shirking?
Because the manager gets paid regardless of effort, they might choose to minimize effort (work less) if it gives them higher personal utility.
What is indirect monitoring?
Instead of observing effort, the owner uses outcomes (like cash flow) to infer effort and create incentives.
What is a second-best contract?
A contract where outcomes are used to align incentives (like sharing profits), reducing agency costs even if effort isn’t directly observable.
What is earnings management (EM)?
The use of accounting techniques to manipulate reported earnings to meet targets or expectations.
What is the ‘Big Bath’ technique?
A strategy of taking large losses in one period to make future performance look better.
What is Real Activities Management (RAM)?
Manipulating operational decisions (like cutting R&D or overproducing) to influence reported earnings.
Why use a mix of salary, bonus, and equity in executive compensation?
To balance risk and incentives—aligning short- and long-term goals with shareholder interests.
What are the trade-offs in using Net Income vs. Share Price?
Net income is more precise but less sensitive; share price is more sensitive to effort but less precise.
What does ‘sensitivity’ mean in performance measurement?
How well a measure responds to changes in managerial effort (Effort ↑ → Measure ↑).
What does ‘precision’ mean in performance measurement?
How accurately a performance measure predicts actual future cash flows.
What is the public interest theory of regulation?
It sees regulation as a response to correct market failures, aiming to maximize societal welfare.
What is the interest group theory of regulation?
It views regulation as influenced by the interests of powerful stakeholders (e.g., corporations, auditors).
What are the key criteria for accounting standard setting?
Decision usefulness, reducing information asymmetry, economic consequences, and stakeholder acceptability.
