Question 1

An example of a bonding cost is:

Accepted Answer

A bonding cost refers to the expenses incurred to create a relationship of trust between two parties. In this case, income lost due to the manager's inability to disclose trade secrets to a competing firm creates trust between the manager and the managers' current company.

Question 2

A price-protected owner will remunerate their manager according to the owner's expectations of how much the manager's behaviour is likely to be contrary to the owner's interests.

Accepted Answer

A price-protected owner will remunerate their manager based on how much the manager's behavior is expected to deviate from the owner's interests. This is done to incentivize the manager to act in the owner's best interests even when faced with conflicting interests.

Question 3

Covenants that restrict production-investment opportunities aim to reduce claim dilution problem.

Accepted Answer

False

Question 4

Ball and Foster were among the researchers who supported the use of firm size as a measure of political costs.

Accepted Answer

Ball and Foster argued against the simplistic use of firm size as a proxy for political costs, suggesting that more nuanced measures are needed to accurately assess the political visibility and costs associated with a firm's activities.

Question 5

The more politically sensitive a firm,the more likely it is that the firm will understate its profits to prevent negative wealth transfers

Accepted Answer

Politically sensitive firms are those who operate in industries that are closely monitored by government agencies or are subject to intense public scrutiny. In such industries, negative publicity can result in significant financial losses for the firm. Therefore, these firms are more likely to understate their profits to avoid negative wealth transfers that could result from public backlash or regulatory actions.

Question 6

Managers and shareholders have differing incentives regarding the firm.The statement regarding incentives that is true is:

Accepted Answer

Managers may want to hold off paying dividends to shareholders in order to reinvest the profits into the firm and expand the business (i.e., "empire building"). This is because their compensation packages may be tied to the size or growth rate of the firm, rather than just the profitability of the firm. Shareholders, on the other hand, generally prefer to receive dividends and see a return on their investment. The other answer choices are not true or are unclear.

Question 7

Who were generally regarded as the pioneers in developing the agency theory?

Accepted Answer

Jensen and Meckling are generally regarded as the pioneers in developing the agency theory, with the publication of their 1976 article "Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure". While Alchian and Demsetz also contributed to the development of agency theory, their work focused more on the theory of property rights. Smith and Warner as well as Whittred and Zimmer do not have significant contributions to the development of agency theory.

Question 8

The situation where a manager protects against bearing agency costs by paying the agent according to the level of costs expected is called:

Accepted Answer

The answer of The situation where a manager protects against...

Question 9

Which of these management actions might be considered under the efficient contracting perspective?

Accepted Answer

The efficient contracting perspective suggests that management actions, such as choosing accounting methods that best reflect the economic reality or prevent negative financial outcomes, are made in the interest of fulfilling contracts efficiently and maintaining the company's financial health. All the actions listed (A, B, C) align with this perspective as they involve decisions aimed at either accurately representing the company's financial status or avoiding contractual breaches.

Question 10

Which of these is not an assumption of the efficient markets hypothesis (EMH)?

Accepted Answer

The efficient markets hypothesis (EMH) assumes that there are no transaction costs in the market, which contradicts choice C, stating there are costs of doing transactions.

Question 11

Initially monitoring costs are incurred by the principal,however,ultimately agents will bear the monitoring costs.

Accepted Answer

In principal-agent relationships, while principals initially incur monitoring costs to oversee agents' actions, these costs often get passed on to agents indirectly through lower compensation or other means, aligning with the principle of cost incidence.

Question 12

The bonus plan hypothesis and the debt hypothesis are predictions developed under the efficient contracting approach.

Accepted Answer

The answer of The bonus plan hypothesis and the debt...

Question 13

It may be appropriate to remunerate a manger using reported profits under which of these circumstances?

Accepted Answer

Both circumstances A and B provide valid reasons for using reported profits as a basis for remunerating a manager. In case A, when a firm's market value is non-observable due to thin trading, using reported profits can be a practical alternative for performance measurement. In case B, for management levels below the CEO, reported profits can serve as a more direct and controllable performance metric, making it appropriate for their remuneration.

Question 14

The size hypothesis predicts that the larger the firm,the more likely that managers will choose accounting methods that will move reported profits from future periods to current periods.

Accepted Answer

The size hypothesis suggests that larger firms are more likely to have diversified operations and access to capital markets, reducing their need to manage earnings aggressively to meet external expectations. Therefore, they might not necessarily choose accounting methods to shift profits from future to current periods more than smaller firms.

Question 15

The demand for auditing can be explained by agency theory as part of monitoring and bonding activities and costs.

Accepted Answer

According to agency theory, the principal hires the agent to act on their behalf, but the agent may have different incentives and goals. Auditing helps to monitor the agent's actions and ensure that they are acting in the best interest of the principal. Additionally, by providing an independent opinion on the accuracy of financial statements, auditing helps to bond the agent to the principal, reducing the risk of fraudulent behavior. As such, the demand for auditing can be explained as part of monitoring and bonding activities and costs.

Question 16

DeAngelo argues that larger auditors,such as those commonly referred to as the 'Big 4',are of lower quality than other auditors because larger auditors have 'more to lose' by failing to report a discovered breach in a particular client's record.

Accepted Answer

The statement is false. DeAngelo argues that larger auditors may feel more pressure to not report a breach in order to maintain the client relationship and avoid negative consequences, but this does not necessarily mean that they have lower quality than other auditors. Quality of audit work depends on many factors, including expertise, resources, and compliance with standards and regulations, which can vary across audit firms regardless of their size.

Question 17

Which of these is not an underlying assumption of positive accounting theory?

Accepted Answer

Non-financial aspects of individuals' utility functions are not considered to be important in the distribution of wealth according to positive accounting theory.

Question 18

Which statement is not true in relation to asset substitution as described in the shareholders-debtholders agency relationship?

Accepted Answer

Lenders are generally risk averse, not risk preferers. They prefer to invest in or lend to projects with lower risk to ensure the safety of their principal and interest payments.

Question 19

In the oil and gas industry the full costing method would be preferred under the size hypothesis.

Accepted Answer

The answer of In the oil and gas industry the...

Question 20

Under signalling theory it is predicted that firms will disclose less information than is demanded.

Accepted Answer

Under signaling theory, firms are expected to disclose more information than is demanded to signal their quality and differentiate themselves from competitors.

Quiz 11: Positive Theory of Accounting Policy and Disclosure