A study of investor reaction to accounting changes required by FASB Statement no. 2 and Statement no. 8

Abstract

The present study was concerned with what criterion should be considered by accounting policy makers. The study focused on external reporting techniques. Financial statements, through accounting numbers, have generally been considered as the means of providing information to securities investors. Therefore, the reaction of the aggregate securities market to accounting numbers generated by alternative accounting treatments was investigated. More specifically, market reaction to recent policy standards required by FASB Statement No. 2 and Statement No. 8 was analyzed in an attempt to ascertain investor evaluation of the new standards. Three conflicting 'theories of market reaction to accounting treatment changes were considered. The economic value hypothesis (EVH) suggests that the securities V market adjusts prices only when accounting treatment changes modify the economic value of a firm. The naive investor hypothesis implies that investors are dependent upon external financial statements as a primary source of information, with reported earnings being the most important item on the statements. Any change in reported earnings, therefore, would cause a corresponding change in market prices. In contrast, the new information hypothesis assumes that if an accounting treatment change provides new information with which the securities market could better forecast future cash flows or risks associated with the flows, then the market would react by adjusting the security prices.