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    Informativeness of financial statements in efficent markets

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    How do you think the efficient market hypothesis should impact the drafting of accounting standards, should it impact at all, and if so why or why not? and does accounting data really have predictive power, why or why not?

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    Solution Preview

    See the attached file. thanks

    As you know, we have three forms of market efficiency.
    Weak Form: One cannot earn abnormal returns just by doing technical analysis
    Semi-strong form: One cannot earn abnormal returns just by doing fundamental analysis
    Strong Form: One cannot earn abnormal returns just by insider information

    The stock price is determined in the market by the demand and supply of the stock. Buyers and sellers perform their own analysis about the stock performance and calculate the intrinsic value of the stock. At the market-clearing price, the demand for stock matches the supply of the stock.

    If the market is strongly efficient, then there is no information asymmetry between the investors and firm managers and hence whatever accounting information they provide does not have impact on the stock price (the market have better ways of ...

    Solution Summary

    The solution provided is in the form of long essay type answer. It first discusses the three forms of market efficiency. Then it discusses how the accounting standard can have an impact under these three forms of market efficiency. The answer refers to the work of Kwon and Wild (1994) to explain how informativeness of financial communication matters in stock market.