The Managerial Incentives Research Paper

The Managerial Incentives Research Paper

Instructions/Descriptions

The Managerial Incentives Research Paper

Discussion # 1

Although the equity method is a generally accepted accounting principle (GAAP), recognition of equity income has been criticized.

What theoretical problems can opponents of the equity method identify?

What managerial incentives exist that could influence a firm’s percentage ownership interest in another firm?

Comment these posts

The International Accounting Standards Board (IASB) requested feedback regards the equity method in the IASB’ Agenda consultation 2011 and this method was highly criticized since constituents have concerns about whether the information that it provides is useful to users.

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Other concerns include its complexity and that it has some inconsistencies with other IFRS requirements. IAS 28 defines the equity method as “a method of accounting whereby the investment is initially recognized at cost and adjusted thereafter for the post-acquisition change in the investor’s share of the investee’s net assets.” (Deloitte, 2011, par. 4) In other words, the equity method is used to account for company investment in another organization, which is the investee.

This method is used only when the investor has substantial influence over the investee. Substantial influence, according to the Norton & Trott (1981, p. 2),  means that “an investor owns 20 percent or more of an investee’s voting stock, he is presumed to have the ability to exercise significant influence”, therefore the investor recognizes its portion of the investee profits and losses in the periods when these are reflected in the accounts of the investee.

As mentioned before, the investor recognizes its portion of the investee profits when these are reflected in the investee’s accounts; this allows an investor to recognize income even when it may not have been received in the near future (Deloitte, 2011). Income is being accounted for based on the investee’s earning reported instead of on the dividends collected by the investor, being this the reason why this method is criticized.

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Accruing the income based on the investee’s reporting may cause the equity income to exceed the cash dividends received by the investor with no assurance that the difference will ever be forthcoming.

Most companies have contractual arrangements like debt covenants, managerial compensation agreements, etc. based on the percentages in the financial statements’ main body. A company that uses the equity method may report lower asset and liability values, therefore higher rates of return for its assets and sales, as well as lower debt to equity ratios, may result, giving a good presentation of the financial statements of the company to future investors.

According to Zack (2009, p. 71) “under the equity method of accounting, the holder maintains an asset account to reflect its investment in the other entity, which is measured based on the percentage of the equity it holds in the other entity” therefore, managers may feel tempted to maintain the eligibility to use the equity method rather than full consolidation.

Post #2 (SD)

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The investor can recognize income that may not be received in any usable form during the future with the equity method. According to (Brander & Poiteving, 1992) managerial contracts eliminates the agency cost of debt.  Based on earnings that are reported income is accrued. Sometimes equity income can exceed the investor’s share of investee cash dividends.

The ability of firms to use executive compensation contracts to address managerial incentive problems is hampered by risk-bearing concerns that stem from the risk aversion of top managers (Beatty & Zajac, 1994). Managerial compensation contracts are based on ratios in the financial statements.

Smaller values of assets and liabilities will be reported when using the method. We show that stock-price incentives are stronger and the firm’s overinvestment problem is more severe when the market is more optimistic (Bernardo, Cai, & Luo, 2016).

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Video

Please click on the link above to access the Video Discussion forum

Go to the Securities and Exchange Commission’s YouTube website

https://www.youtube.com/user/SECViews/playlists

Select any SEC recording from the playlists and post a substantive discussion describing the contents of the video and what you learned from watching the SEC at work. Please include the URL to the video in your discussion post.

Respond to any one of your classmates on the information they’ve posted about their video for a total of two (2) posts.

Comment these posts

Post#1 (DN)

The video I selected from the U.S. Securities and Exchange Commission (SEC) playlist is called “Brokers and Investment Advisers –Know the Difference”. The video talks about how important is to invest in today’s society but it becomes difficult when you are already trying to manage a budget and pay down student loans, why add another financial task to your to-do list?

However, investing might be the most important of all. Investing is essential for good management of money because it ensures financial security both in the present and in the future. Not only you could earn more money from what you invested, you get another income source as well. Investing not always could turn out favorable, this is why a financial professional who can help with investing is extremely important.

According to the U.S SEC (2019a, min 1:20), there are two crucial questions about financial professionals, “first is the financial professional registered with the SEC or a state regulator and second is the financial professional a broker or is the financial professional and investment adviser?”

Knowing if the financial professional is registered with the SEC is important since they have to follow rules that are designed to protect the individuals, if the financial professional is not registered, you are at risk of being scammed giving your personal financial information to a fake financial professional, the U.S SEC (2012, par. 2), states that  “before you invest or pay for any investment advice, make sure your brokers, investment advisers have not had disciplinary problems or been in trouble with regulators or other investors” if the financial professional had disciplinary problems before, I believe it would be best to reconsider taking advise from that financial professional. Additionally, understanding what are the main differences between a broker and a financial adviser is key to select the type of services you will receive.

According to the U.S SEC (2019b, min: 0:25) “brokers and investment advisor can both give advice on whether to buy specific investments like stocks in a company or an index fund” however, brokers make recommendations about whether to buy, sell or hold those specific investments and they can complete the transaction for the customer, but the customer is responsible for the decision of what to do.

An investment advisor generally manages the customer’s account, also advises whether to buy, sell or hold securities but the investment advisor can agree to make some or all of those decisions for the customer.

Post#2 (SD)

I chose SEC video on The Strength of America’s Capital Markets. According to (U.S. Securities and Exchange Commission, 2020) the U.S. has one of the strongest capital markets in the world is because there are one of the ones that are effectively regulated. For example, The U.S. Financial Regulatory System is responsible for how much money is printed and where it is distributed to.

If the country constantly prints money its value will deflate over time. The private equity and venture capital industry in the US continues to expand its important role as a major driver of technology commercialization, job creation, and productivity enhancement (Taylor, 2001).

Having a great regulatory system will ensure economic growth for the United States. Despite very uncertain public markets, with conditions changing almost daily, venture-backed companies raised a record level of capital through initial public offering (IPO) (Taylor, 2001).

Power Point

Find a current accounting (no older than 2015) article related to The Equity Method of Accounting for Investments from a scholarly reference source and make a 10 slide PowerPoint presentation explaining the article

The Managerial Incentives Research Paper

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