Accounting Theory

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10.3 If some research is undertaken that provides evidence that capital markets do not always behave in accordance with the Efficient Market Hypothesis, does this invalidate research that adopts an assumption that capital markets are efficient?

As Chapter 10 questions, if further evidence continues to surface that capital markets do not always behave in accordance with the efficient market hypothesis, then should we reject the research that has embraced the EMH as a fundamental assumption? In this regard we can return to earlier chapters of this book in which we emphasised that theories are abstractions of reality. Capital markets are made of individuals and as such it would not (or perhaps, should not) be surprising to find that the …show more content…

Once a number of firms within an industry report their earnings then most of the industry-wide information would have been incorporated in competitors’ share prices. Accounting Headline 10.6 provides an example of the information transfer effect.

10.14 Some recent capital markets research investigates whether accounting information reflects the valuations that have already been made by the market (as reflected in share prices). In a sense, it assumes that the market has it ‘right’ and that a ‘good’ accounting approach is one that provides accounting numbers that relate to, or confirm, the market prices/returns. If we assume that the market has it ‘right’, what exactly is the role of financial accounting?

If we accept that the market is able to determine the appropriate price of a firm’s securities on the basis of information from a multitude of sources (the market has it ‘right’) then the role of accounting is to confirm these expectations. Of course, it is questionable whether markets can be expected to ‘get it right’ and as such it would typically be expected that there will be some unexpected information when financial statements are released. What must also be remembered is that the capital market is not the only user of accounting information and hence accounting has a role beyond informing or

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