In the earlier sections of Accounting Theory, the course has focused on the investor’s need for information on future cash flows. The measurement and decision usefulness approach both support the notion that preparers and readers of financial statements should be indifferent to the accounting policies used to arrive at income, as long as it does not affect the cash flows. However, the previous section (chp.8) has shown us with the help of Positive Accounting Theory, that firms are not indifferent to the accounting policy chosen. Rather, at certain times certain types of accounting policies are preferred (ex. Earnings Management). Chapter nine looks at the economic consequences of choosing policies. It also shows how security markets can be efficient while at the same time allowing accounting policies to have economic consequences.
Game Theory models the interaction between two or more players. The theory attempts to create a model and to predict the outcome of a conflict between rational individuals, often with uncertainty and information asymmetry. We assume that the players are rational and that they all want to maximize their own expected utility. In game theory, each individual knows the strategies and payoffs available to everyone. However, they do not know the other players’ choices of strategy. The outcome of one player affects all the other players. Game Theory can be classified as either cooperative or non-cooperative. With a cooperative game, the players are in a situation where there is a binding agreement between the players. In a non-cooperative game, there is no binding agreement between the players.
Non-Cooperative Game Model
The Scott text uses the example of an investor and a manager to demonstrate the non-cooperative game theory of the conflict situation. A similar example of this model would be in the used car industry. The buyer desires all the relevant and reliable information about the car to aid...