Relationship Between Accounting and Financial Market

The capital market as user

Financial accounting information is argued as not the only source of providing information for user in capital market (investors). In fact, investor is more reliant on more private information relevant to price adjustment to eliminate gains from new information. Portfolio managers normally benefit from market inefficiency during short-time scaled trading where the current market price does not reflect the true share value they have private information about to believe that future share price would gradually increase to adjust the true value. Therefore, agents have themselves incentives to gather not only accounting information but also non-financial information. Due to the aforementioned benefit of private information prior to release of accounting reports, insider information dealing is prevented so as insiders are not able to trade internal information for self-interest purposes.

Nevertheless, simple theory suggested that the accounting information still plays role in capital market contributing to time series of valuation model. Sunder (1997) argued that rational expectation hypothesis of which existing price is evaluated in valuation model as merely unbiased estimate based on available information and behavioural studies in labs suggest more complexity than assumptions used in econometric study. On the other hand, accounting policy changes or capital structure changes (debt covenants, remuneration) may influence stock price not directly but indirectly since they might enhance potential bias from managers. To prevent the bias choice of accounting methodologies from managers, institutionalised or standardised accounting is enforced. Creation of accounting standards hence is considered as part of market building (Sunder, 1997).

Standard setting and imaginary users

Due to pressure of capital market growth required comparability between investees, critique of standard setting process for an institutional change and rise of accounting education and science, financial accounting is continuously developed to provide users with more useful information. Back then, accountant gives more focus on accounting principles and fundamentals. There was a subsequent shift from accountant view (producer view) to user emphasis during recent decades. According to Young (2006), real users are imperfect to process information regardless the usefulness of the information and users are as normative abstraction featured in financial economics as assumptions of user needs. Young (2006) also stated that there has been a single purpose economic decision making gradually prioritized in financial accounting: financial accounting is there to help users to make economic decisions – to understand and shape future cash flows of a business. Users for accounting standard setter is economically rational individuals. Standard setters, therefore, use average uses instead of responding to the needs of all users.