CONSERVATIVE FINANCIAL REPORTING

Conservative Financial Reporting

Conservative Financial Reporting

Introduction

The traditional literature on the functioning of financial markets states that primarily the problems are associated with lack of information of agents who do not take financial decisions at optimal levels. Specifically, this literature argues that information problems asymmetrically generated by the low awareness in general have caused the lender and the borrower to make improper decisions. Financial agents are not optimal, which makes it difficult to disseminate the information. (Dietrich, Muller & Riedl, 2004, pp 120)

This is related to the optimality of financing decisions, which are associated with the production and acquisition of information. The aim is reducing problems of asymmetric information by individuals at a greater financial knowledge. (Gove, 1961, pp 231-233

A course underlying all these works is the rationality of individuals in the acquisition and use of information when making their financial decisions. This ultimately must be reflected in the assumption of rational expectations. The “homo economicus”, or rational individual uses all available information efficiently to obtain the maximum benefit and welfare with an unlimited capacity for processing and updating the beliefs based on new information received. This not only allows to make optimal plans in a long planning horizons, but also minimizes the probabilities of risk and uncertainty. (Buijink, Coppens & Peek, 2004, pp 67)

One of the fundamental assumptions of the neoclassical paradigm of markets is the perfect competition and the existence of complete and perfect market. The market transparency requires that all participants have full knowledge of general market conditions. Individuals accept prices as exogenous and make their decisions by comparing prices, because they all have the same information about prices and quantities supplied and demand of goods. All these factors play an important role in the way the financial reporting is being done. This is because the procedures and policies related to accounts have been made possible because there are many issues regarding the various factors that in one way or the other affect financial reporting. (Herbert, 1994, pp 212)

However, especially a market where information is far from complete and perfect is the financial market. The literature on functioning of financial markets states that, for the most part, are problems associated with lack of information leading to the financial decisions taken by agents being not optimal. Within this literature we find mainly two groups of works. In first, with a long tradition in economic theory, there are studies consider that the production of information by the financial institutions solve the problems related to information asymmetric between lenders and borrowers. (Thorndike, 2004, pp 98-101)

Second, recently and less numerous, there arises a literature-most empirically that considers the lack of information and financial knowledge forms the basis of the problems related to the agents to make financial decisions that seem to be non-optimal or "Abnormal." (Zelizer, 1999, pp 332)

Discussion

Information asymmetry in financial markets may take different forms, but among them include adverse selection,

moral hazard and monitoring costs. (Jeff, 2004, pp 32-34)

Adverse selection occurs when an investor is unable to distinguish between ...