Module 6 summary

Economic consequences

This module defines and illustrates the concept of economic consequences. According to this concept, changes in accounting policies, including changes resulting from new accounting standards, matter to firms and their managers, even if those accounting policy changes have no differential cash flow effects. This seems inconsistent with the theory of efficient securities markets, which predicts that the market will see through the financial statement impact of different accounting policies, with the result that firms’ share prices should be unaffected by accounting policy choice. In turn, this implies that accounting policy choice should not matter to firms and their managers.

Examples of economic consequences are described. Based on these examples, it seems that accounting policies do have economic consequences. Not only do accounting policy choices matter to managers, they may also matter to investors, since accounting policies can affect manager actions, hence firm value.

Positive accounting theory asserts that management concern about accounting policies is driven by the contracts that firms enter into, and, for very large firms, by political costs that result if these firms are seen to be highly profitable.

Explain the concept of economic consequences.

Apply the concept of economic consequences to employee stock options (ESOs).

Describe the concept of positive accounting theory and its predictions about manager reaction to compensation contracts, debt covenants, and political pressures.

Compare the opportunistic and efficient contracting versions of positive accounting theory.

Understand how positive accounting theory contributes to economic consequences.