BUS103: Introduction to Financial Accounting

After a company reports its information, the next stop along the road involves the market digesting that information. Analysts on both the buy- and sell-side play an important role in interpreting and disseminating information, and acting in effect as translators. 

In considering ways to enhance financial reporting, we need to take into account the ability of investors and analysts to digest complicated information. It appears that investors as a group are not confused, at least over the long-term, by accounting choices that affect reported GAAP earnings, but not the real health of the company. For example, they are able to work their way through such issues as straight-line versus accelerated depreciation; purchase versus pooling accounting; expensing versus capitalizing R&D costs; and recognition versus deferral of unrealized gains on marketable securities. 

However, even if analysts and investors ultimately can parse through to the important information, there is an increased cost as more decryption and interpretation becomes necessary. Less transparency often leads to a greater divergence of opinions regarding the valuation of a company's securities, which itself raises the uncertainty and costs surrounding a decision to commit capital. 

Here, too, conflicts raise the potential for bad choices by analysts as they interpret corporate disclosures, and make investment decisions or recommendations. Biased research analysts or other intermediaries can distort the impact of information in the marketplace, and encourage a misallocation of capital. To avoid this distortion and protect investors, we must recognize and deal with conflicts of interest that can pressure analysts to make bad choices.