The article represents a survey of the key empirical papers in the market based accounting research field. Firstly the authors state the main aspects related to the corporate disclosure process. Obviously the efficient allocation of resources in a capital market economy depends to a high extent on the power of disclosure to overcome the so called information and agency problems.
The information or "lemons" problem refers to the conflict of interest and information differences between entrepreneurs and investors. This will eventually result in under and overvaluation of investments by capital markets, because in an information asymmetry context investors cannot distinguish between valuable and unworthy projects. There are some solutions used to overcome these differences such as the implementation of optimal contracts between parties in order to diminish the opposing incentives, the regulation of disclosure that force the managers to reveal private information and the emergence of the information intermediaries whose role is to further develop the information production. The agency problem is defined as the manifestation of agents self interest in detriment of principals largely due to the passive role investors have in a company. In this case the mechanisms of corporate governance are responsible of monitoring the agents' actions as well as optimal contracts such as debt and compensation agreements and the existence of a market for corporate control.
To assess the usefulness of these mechanisms the authors focus on 4 broad areas of research such as the regulation of disclosure, the role of intermediaries, the managers reporting decisions and the capital markets consequences of reporting and disclosure.
Firstly when analyzing the disclosure effectiveness in solving the above mentioned problems we must pay attention to the primary reasons for regulation of corporate reporting like the existence of market imperfections and the information gap between informed and uninformed. In the views of the authors a discussion about regulation should also refer to aspects such as potential negative consequences of disclosure, the types of disclosure that should be required by regulators and to what extent can regulators increase the economic efficiency and ease the functioning of capital markets. The relevance of accounting information for capital markets is one of the most researched issues in accounting and the evidence suggests that indeed regulated financial reports communicate new information to investors. This type of research examines the relations between accounting information and prices. Also by studying the relation between earnings and stock prices returns researches can evaluate the relevance of information proposed by new financial reporting standards.
Secondly an important part of accounting research focuses on the value brought by intermediaries, especially the financial analysts. In this case the conclusion of several studies is that they add value and improve market efficiency. The evidence behind this conclusion is based on the accurate forecasts that they make and that prices changes they determine through their analysis. However one must take into consideration the rewarding system of analysts that encourage them to provide the kind of information that generates trading volume thus bigger fees. In what concerns auditors the empirical studies test their ability to enhance credibility of financial reports. The evidence suggests that auditors' qualifications do not provide timely signals to market because they only assure the annual reports. Also they are believed to act in the managers' interest and they are also more concerned about their legal liabilities rather than focusing on the economic substance of reports.
The research on managers reporting decisions is divided in two broad areas. The positive accounting research focuses on management motives on making accounting choices. This type of research is based on three assumptions, the existence of semi strong form of efficiency, agency costs and information asymmetry. The main motives behind accounting decisions are considered to be the political implication such as taxes or regulatory actions and the possible benefits obtained from contracting like increases in earnings-based bonuses. For instance, high levered firms use accounting methods to accelerate earnings and compensation contracts represent one of the causes for accounting decisions.
The empirical papers in this area try to explain the market consequences and shareholders wealth effects of changes in accounting choices. Evidence suggests that there is a weak relation between stock returns and announcement of accounting changes. Some argue that there is no relation between accounting decisions and wealth effects. Other consider that tests do not take into consideration some aspects of standard setting process, which is known to be complex and lengthy making difficult to isolate the price effect of the accounting change.
The second broad area examines the management reasons behind voluntary disclosures. For instance managers voluntarily disclose information when they intend to make market transactions, therefore reducing the costs of external financing by reducing information risk. Another explanation is given by the existence of a market for corporate control in which managers use disclosures to explain possible poor profitability or to avoid undervaluation, protecting the company against hostile takeovers. Another motive can be explained by the way managers are rewarded. The stock based compensation plans determine managers to disclose private information because when trading their stocks managers have to comply with insider trading rules. Also management voluntary disclosures act as a signaling mechanism.
Obviously voluntary disclosure has an impact on the process of resource allocation. The magnitude of the impact is determined by the degree of credibility that characterizes these disclosures. It can be validated by comparing actual data with forecasts or by intermediaries' assurances. The empirical evidence certifies that management forecasts are similar to audited information and their accuracy is higher compared to intermediaries' forecasts.
Among the economic consequences of voluntary disclosure include an improved stock liquidity due to reductions in information asymmetries, reductions in cost of capital and an increased information intermediation.
After evaluating the past accounting papers the authors conclude that many of fundamental questions about accounting role in capital markets have not been answered yet and the future research should be undertaken considering the global changes in economic environment such as rapid technological innovations, the emergence of network organizations and globalization.
