3 accounting questions, to be done ASAP
total answer should not be longer than 2 pages
Describe what is meant by the naive investor hypothesis and the no-effects hypothesis
in relation to firms’ accounting policy changes.
Firms often borrow funds from lenders (i.e., debtholders) to finance their investments
and activities. However, this can create incentives for firms to take actions that are
opportunistic, such as claim dilution and asset substitution.
(a) What is meant by claim dilution and asset substitution?
(b) Who ultimately bears the (agency) costs if the firm engages in these opportunistic
actions and why?
(c) In relation to accounting, how can the interests of the firm and debtholders be
Explain why managers would have an incentive to choose income decreasing
accounting methods when there are (complex) bonus plan arrangements that pay
bonuses if reported earnings are between lower and upper bounds
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