Agenda

• Collect– reaction papers– multiple choice questions– class participation forms for day 3 (Tuesday)

• Discuss– Sunder– Lev– SEC readings

Spreads

• What’s a spread?– the difference between the bid (buying) and ask

(selling) prices set by the market maker.

• A spread is positive when ask > bid and negative when bid > ask

• Size of spreads reflects– extent of information asymmetry

– cost of holding inventory

– return to market makers’ human capital

• Accounting is an artifact of civilization: it exists to serve human needs

• Accounting activity is a social system– objectives are defined by social needs– carried out by specialized agents (professionals

in modern terminology)– education and training requirements keep

increasing as objectives become more complex and sophisticated

– rights and obligations of agents defined by society

• Business became more complex, more sophisticated concepts were needed: what attributes to measure? – What’s the goal? Decision making vs.

performance evaluation vs. stewardship

• With separation of ownership and control performance evaluation (profit earned) became crucial -- focus shifted to I/S.

• Stewardship still important -- B/S retained.

• Accrual accounting seen as incomplete, Cash flow statements acquire usefulness

Sunder: 1

• Accounting standards are political in nature, redistribute wealth and are costly to society.

• Standards are costly– need a bureaucracy

– bureaucrats’ incentives may be “wrong”

– standards stifle innovation, preserve status quo.

• Neither pure cost-benefit analysis nor Pareto-optimality is likely to be a useful crieterion on its own.

Sunder: 2

• Optimal level of standard setting trades off both the total costs and benefits as well as the distributional impact of standards.

• What standards would be best requires good information on costs and benefits -- can standard-setter learn these truthfully?

• Multiple mechanisms exist to set standards– common law, markets, referendum, legislation,

judiciary, bureaucracy

Sunder: 3

• APB was responsive to user needs– “lack of independence” seen as a virtue

• FASB is seen as an aggressive, overly active, costly, entrenched bureaucracy with a built-in “bias for action” and is losing support from key constituencies

• Slow down standard setting. Markets will deal with many issues without need for standards.

Lev: 1

• Equality of opportunity for all investors is key to a well-developed capital market

• Equality of opportunity comes from equitable distribution of information

• Inequity is costly: cost of capital goes up as investors seek to protect themselves. Lower volume of capital supplied and demanded. The economy as a whole is worse off.

Lev: 2

• Why mandate disclosure?– reduce costs of information asymmetry– voluntary disclosure incentives inadequate (?)

• How decide what to mandate?– information that investors value– management earnings forecasts or information that is

valuable for predicting future payoffs– information large investors or bankers get– protect the interests of the least informed

Lev: 3

• How to measure disclosure effectiveness?– reduction in spreads, – increase in price informativeness– reduced returns to insider information– equalization of returns across comparable

trading strategies

SEC: Chapter 1 (1)

• SEC charter: Securities acts of 1933/34

• 33 Act: distribution, 34 Act: trading

• Mandate: protect investors

• Why regulation to protect investors? – (Lev vs. Sunder?)

– Financial abuses preceding (and thought to have contributed to) 1929 crash.

– Increased direct access to investors by firms.

SEC: Chapter 1 (2)

• How? Regulate disclosure not merits• Why? Allow innovation, EMH.• Structure of the SEC?

– operational arms are called divisions• corporate finance, investment management, market

regulation, enforcement -- lawyers

– staff are organized in offices• office of chief accountant, economist, general counsel --

these are the lawyers’ accountant, economist and lawyers respectively.

SEC: Chapter 1 (3)

• How the SEC speaks:– FRRs (financial reporting releases) -- binding– AAERs (accounting and auditing enforcement

releases) -- who’s been naughty and what their punishment will be.

– ISRs (international series releases) -- all about them furrin’ firms and furrin’ markets.

– SABs (staff accounting bulletins) -- interpretations, not official positions of the SEC.

SEC: Chapter 2

• Understand the arguments for and against raising capital from the public (going public).

• Steps in the registration process and obligations of underwriters and management at every step. Especially note the restrictions relating to the quiet period.

• Who or what is exempt? Know this.