The Measurement Approach on Decision Usefulness - Coursework Example

Running Header: The measurement approach on decision usefulness Student’s Name: Instructor’s Name: Course Code & Name: Date of Submission Table of Contents Student’s Name: 1 Table of Contents 2 Introduction 3 Security markets 3 Prospect theory 4 Volatility of the stock market 6 Anomalies of the securities market 6 Alternative Approach 7 Conclusion 8 Introduction The measurement approach on decision usefulness means the correct usage of reasonable values properly in the financial statements. The financial statements help the investors to predict the future of the organisation and at what position the company will be at if all the policies were followed. Generally the measurement approach is to help the investors to determine the firm value. Despite the fact that the measurement approach is to useful, it is not supposed to interfere with the cost reduction in reliability (Ackerlof & Kranton 2010, p.78). There are several areas that the investors are involved in and one of them is the efficiency in the security market. There has been a claim that securities cannot be efficient to support the position of the company in the future. The reliance of the securities cannot be fully used to value the company and hence the usefulness of decision making is threatened. For example the investors may not be very keen to process the information as it is stated in the theory of efficiency, so this can be improved by the using other values in the financial statements. The other factors that lead to the variability of the share price are illustrated in the Ohlson clean surplus theory (American Accounting Association 2006, p. 45). The theory gives a provision for support for measurement increment and also from any liability which is legal that the accountants can be subjected to when the company is suffering the financial constraints. Security markets The has been question whether the securities are to be believed in and relied upon when it comes to making decision regarding the market efficiency and whether it does convey the best information to the investors (Andreoni & Samuelson 2006, p. 143). Despite the fact that the securities are not efficient there can be an improvement in the financial reporting which will help to reduce the inefficiencies and hence improve the security market operations. That is, if the firm reports correctly about its accounts, the investors will be able to estimate the future of the company very easily by identification of the securities which have been mispriced (Ariely 2008, p. 45). The argument is that normal investor behaviour may not go hand in hand with rational decision theory and models of investment. The investor may not be in position to make a concrete decision after they have received the information. There a suggestion by the psychologists that the individuals normally tend to overestimate after they have received the information. The other characteristic that is portrayed by the individuals is that of self-attribution bias where the individuals feel that good results from a decision is because of the abilities of the individuals whereas the if the outcome is bad is as a result of realizations of nature which are unfortunate and hence not their fault (Ball 2008, p.430). Consider a scenario where an investor wants to buy a company shares and prices of the shares rises, and then the investor will have more faith but if the share price fall the faith of the investor will not fall and hence the price momentum will not change a lot. Prospect theory According to this theory an investor who is considering an investment which is risky will have to evaluate separately the prospective losses and gains. This contradicts with the decision theory where the evaluation of the decisions by investors is done in terms of their total wealth (Barth 2008, p. 1160). The separate evaluation of losses and gains is a psychological concept where the individuals do analyze the challenges in a manner which is isolated as a means to economize the mental effort which is used in decision making. The mental effort may be as a result of individual having more information which he cannot handle. In the prospect theory the individual utility is defined from the deviations from zero instead the deviation of the wealth as a whole (Beaver 2009, p. 67). The investors also portray the behaviour of aversion from small losses which leads to disposition effect where the investor will sell the winners and maintain the losers. The evaluation of losses and gains and also the weighting of the probabilities normally lead to irrational behaviours by the investors. When the investors fear losses they will tend not to trade in the stock market until the prices stabilises of the different organisations (Beaver & Demski 2004, p.65). They start trading if the market is expected to be positive in the near future. They also try to hold to loser to avoid losses. The reason for this is that they bought the shares when the prices were higher so they cannot agree to sell when the prices are low thus they try to keep the stock so long they are below the price they bought with and the trading will only occur only if the prices are above the initial public offering. The investors can also buy more shares when the prices are low and add them to what they already and have and hope that the prices will rise and sell them at a profit (Dyckman & Morse 2006, p. 98). The investor normally evaluate the losses and gains in reference to zero point thus if there are positive earnings the shares will have value and thus it will be a profit to the investor and if the earning are negative it will be a loss to the investor hence he will not be encouraged to invest more. The negative investor will react strongly to small losses while the positive investor will react positively to small earnings. The managers of the organisations are advised it is better to report smaller positive earnings the negative earnings because they will have a negative impact to the organisation (Granovetter 2002, p.9). Basically the companies should report positive growth in all areas ranging from increased sales to increased profit before tax. Volatility of the stock market The excess of the stock price volatility provides the evidence of the market efficiency. The market portfolio is the major contribution to the changes of the stocks. The dividends that are expected to be given to the shareholders determine how the investors will invest in the stock market and how many shares will be bought for that company (Ijiri 2001, p. 156). If the shareholders expect more dividends to be paid the there will be a higher demand for the shares of that company and the market index of the stock will rise. Despite the fact that the major determinant of the value of the firm is the dividends, the dividends should include all the distribution of the cash to the shareholders like ordinary dividends, takeovers distributions and repurchases of shares. The excess volatility may be in existence due to the efficiency consistent which is derived from non-stationarity. The capital market has both the positive and rational feedback investors. The investors who have positive feedback are investors who begin to buy shares when they start to rise while the negatives feedback investors are investors who begin to sell the shares when the prices of the shares begin to fall (Kay 2009, p.10). Both the investors are helpful to the organisation because they help it to which direction it is heading to. There can be a thought that the rational investor will have a loss because if the share prices increases the there is higher chances that many people will buy the shares and hence the prices will start to fall due to the high demand. The investor buy when the prices starts to go up because they think that the prices will continue to rise hence they will sell at a profit. This is what leads to excess volatility in the capital market. Anomalies of the securities market The market normally does not respond to the information given by the theories as they are and there are always some differences. An example of a difference may arise when the prices of the shares do not immediately reflect as the financial information is (Lee 2006, p.18). The securities do take some time to reflect the changes in the financial statement. These cases which appear not to be consistent are called the capital market anomalies. One of the anomalies which are common is the post announcement drift. When the current earning of the firm is known by the investors, the information should taken by the investors and the market prices should adjusted accordingly. Similarly for the firms that have bad results in their earnings it will take similar period to reflect so it acts positive to the firms which have been performing poorly. Alternative Approach The alternative approach is the clean surplus theory. It is used to estimate the value of the company shares rather than to using the lengthy cash flow/ discounted dividend approaches. It also used to give an estimate of the capital. The framework that the clean surplus theory provides is consistent in the perspective of measurement. For the theory to be used, ideal conditions are assumed. This theory has an advantage in that it very fast when calculating firm market value. The theory shows that it is possible to express the firm market value in terms of balance sheet variables and income statement (Staubus 2001, p.54). There has been a lot of empirical research which has been generated as a result of clean surplus theory. This research performs a comparison of the relative predictive ability of residual income models, cash flows and dividends. Better predictions of earnings provides a better estimate of goodwill which is unrecorded thus leading to good predictions of the value of the firm and helping in making good investment decisions. Conclusion The securities market is determined by the disclosure of the information to the investors. The more the investors are given information concerning the firms in the stock market the more they will be active in it. In normal cases, how the information is disclosed does not matter because the investors are assumed to be informed correctly and quickly and they are rational enough in their decision making. The investors will tend to buys shares for those companies that are performing very well both financially and in the stock market. The argument is that normal investor behaviour may not go hand in hand with rational decision theory and models of investment. The investor may not be in position to make a concrete decision after they have received the information (Young 2006, p. 590). There a suggestion by the psychologists that the individuals normally tend to overestimate after they have received the information. The practice is how the investors invest in the stock market. All investor do invest to get a return on their investment References Ackerlof, G, & Kranton, R 2010, Identity Economics, Princeton University Press, New Jersey American Accounting Association 2006, A Statement of Basic Accounting Theory, Evanston, Ilinois. Andreoni, J, & Samuelson, L, 2006, Building Rational Cooperation, Journal of Economic Theory, vol. 3, no. 8, pp.117-154. Ariely, D 2008, Predictably Irrational: the Hidden Forces that Shape our Decisions, Harper Collins, New York. Ball, R 2008, What Is the Actual Economic Role of Financial Reporting, Accounting Horizons, vol. 22, no. 4, pp.427-432. Barth, M 2008, Global financial reporting: Implications for U.S.Academics. The Accounting Review, vol. 83, no.5, pp.1159-1179. Beaver, W 2001, Financial Reporting: An Accounting Revolution, Prentice-Hall, New Jersey. Beaver, W & Demski, J 2004, The nature of financial accounting objectives: A summary and synthesis, Journal of Accounting Research. Vol.12, no. 4 pp.170-187. 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