a. Accounting information reduces information asymmetry. What two types of information
asymmetry are tackled by accounting information and what are the economic benefits
associated with each of these two types, respectively? (4 points)
b. Use the concept of ‘estimation risk’ to explain how a loss in trust in accounting figures may lead
to negative abnormal returns. (4 points)
c. Glaeson et al. (2008) study how restatements at firms affect stock prices of firms in the same
industry. Consider the following Table from this article. How do you explain the negative sign for
TACC (=Total Accruals) in Model 2? (4 points)
, d. Errors of auditors may affect trust in the financial statements of other clients of this auditor. The
effect of the errors of Arthur Anderson with respect to Enron’s audit are studied in Nelson et al.
(2008). Consider the right panel (‘Andersen only’) from Table 7 from Nelson et al. (2008) as
shown below.
i. Explain what effect the coefficient of UE x AAPOST captures. (3 points)
ii. What do you conclude with respect to the information content of earnings audited by
Arthur Anderson after the shredding announcement? [Explicitly indicate what statistics
you look at to come to your conclusion.] (3 points)
Answer
a. Adverse selection – economic benefits are lower cost of capital (reduced estimation risk); Moral
hazard – economic benefit is reduced agency costs (or more efficient contracting).
b. Estimation risk refers to whether the price is fair. Investors discount future cash flows based on
risk. If there is more doubt on the reliability of the prospects that are based on accounting, even with
unchanged cash flows the uncertainty about these cash flows increases. Higher discounting leads to a
loss in value or equivalently, a negative abnormal return.
c. The dependent variable is the return for non-restatement peer firms during the restatement of
the peer firm. Accruals are harder to verify than Cash flows and if peer firms’ earnings include higher
accruals, this indicates that it may be more likely that these firms’ figures are overly optimistic (or that
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