A current, positive tendency is the outlawing of abuse of flexible accounting. Creative accounting and weak accounting standard setting led to bad experience in the mid-80 s. Both conspired to erode significantly the integrity of financial reports. This demonstrates how insufficient standards lower the trust in accounting and its integrity. Further, creative accounting raises monitoring costs. Debt holder could require more often certain accounting methods (ex ante approach) and regular reports (ex post).
This is the reason, why even not ethically orientated managers should be interested in integer standards. Users are able to discover certain accounting alternatives to reduce agency costs. They discover differences due to the depreciation method but cannot recognize small-scale alternatives. This takes them too much time, costs exceed benefits; instead, They expect accountants to provide comparable standards. (Anthony; 1983; p. 14) Even financial analysts state that it is difficult to compare net income across companies because of the variety of methods and creative accounting.
If even the experts cannot gain enough useful information from financial statements, the market instead has to demand more monitoring mechanisms to determine the methods used by a firm. This increases costs of capital further. Lack of confidence in the pricing efficiency of the market tends to focus the attention of both investors and raisers of capital on potentially wasteful techniques of exploiting perceived inefficiencies, and away from a more positive recognition of the messages contained in the market price. (Keans; 1983; p. 3) According to EM more information leads to fairer prices and better decisions.
The economic forecasts will be closer to reality, raise trust, making the future more calculable and ultimately reducing agency cost. Better information allows a better resource allocation. However, since we do not have a strongly efficient market only a small group of users will benefit from the better information. The given more useful information do not reach all users. A lot of the mentioned arguments work in theory but not in practice. Not all users are skilled in accounting and do not know how to make information more relevant.
More information raises production expenses but derives no equal benefits. Further, we can already speak of an information overload. A potential investor cannot analyze the financial statements of all companies that are listed on the domestic stock exchange, not to speak of international companies or deriv ates like currency swaps. Furthermore, studies have shown that shareholders prefer steady growth, instead of abrupt changes in income even if the sum of income is equal. Regarding to this, companies need creative accounting. Then, future opportunities and expectations normally influence the share prices not historical results presented in financial statements.
In addition, the agency costs will only decrease if capital is too expensive at the moment. If this issue could be solved, accounting would have made a great step towards more accurate financial reports and performance evaluations, and would receive more trust by the public. Firstly, the benefits of the newly introduced accounting standards must at least equal the costs. Secondly, the consensus process must not be time consuming because of the fast-changing environment, which continuously produces new issues. Lastly, the influence of historical (accounting) information on share prices and interest rates must be determined, how strongly it influences agency costs. Sources: Anthony, R.
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