Economic Consequences Flashcards
What is a normative theory?
a theory that prescribes what should happen, what ought to be the case based on a specific goal or objective
What is a positive theory?
A theory that describes, explains or predicts what is happening in the world
What is a positive accounting theory?
A positive theory used to explain and predict accounting practice
What is the rational economic person assumption
Assumes that all individuals act to maximise their own utility (eg. maximising financial wealth)
What is contracting theory
a theory that organisations are characterised as a legal nexus of contracts, with contracting parties having rights and responsibilities under these contracts
What is agency theory?
A theory concerning the relationship between a principal and an agent of the principal (eg. company owner employer a CEO)
What is a moral hazard?
The risk that an agent might undertake actions that are detrimental to a principal
What is an agency relationship?
A relationship where one party (the principal) employs another (the agent) to perform some activity on their behalf. In doing so, the principal delegates the decision making authority to the agent.
What are monitoring costs?
Costs incurred by principals to measure, observe and control the agents behaviour. These costs however are usually passed on to the agent
What are bonding costs?
The restrictions placed on an agents actions deriving from linking the agents interests to those of the principals (eg. producing quarterly accounting reports to lenders)
What is residual loss?
The reduction in wealth of principals caused by their agents non-optimal behaviour (eg. cost/ benefit analysis will show that it may cost more than it is worth to monitor certain activities)
What is the horizon problem?
The differing time horizons between at the owners of an entity who are interesting in the long term and value of an entity and managers of an entity who are interested in the short term profitability
Give examples of ways that managers can demonstrate short term profitability
Delay undertaking maintenance or upgrades to plant and equipment, or reduce research and development expenditure
Why are managers more risk averse than shareholders
Shareholders are able to diversify their risk through investing in multiple entities, cash, property, etc. Higher risk also equals higher return, Whereas managers have more to lose if the company faces trouble, this is their primary source of income and their most valuable asset (their expertise) cannot be diversified
What is the dividend retention problem
The reduced incentive of managers to pay dividends or take on optimal levels of debt due to managers preferring to maintain a greater level of funds within the entity
