Measurement information avoid perverse effects

Measurement information avoid perverse effects is a dilemma, focus on fair value but how accurate and ‘manageable’. Pressure to achieve certain results. In assessing the probable and actual effects of measurement information: Measurement information avoid perverse effects

  • it is its impact on behaviour that counts; and Measurement information avoid perverse effects
  • how people use information and respond to it are therefore critical issues. Measurement information avoid perverse effects

It cannot be assumed that those who use financial reporting information are perfectly rational in how they respond to it. Certain biases in the way that people typically process information are well attested; some of these are intellectual short-cuts that people use to make it easier to handle information, others are emotional biases. These biases may well affect how people deal with financial reporting information. For example, there is some evidence that investors tend to disregard the effects of changes in the value of money. As much financial reporting information includes data that covers long periods of time, this could have a distorting effect on how people interpret it. Measurement information avoid perverse effects

How, if at all, financial reporting should respond to such biases is far from clear. The point being made here is simply that they are relevant to how information is used, Measurement information avoid perverse effectsand are therefore at least potentially relevant to deciding measurement questions in financial reporting.

Much information is relevant because it measures performance on which organisations and individuals are judged. But if people are judged on the basis of a particular measure, this can have perverse effects: ‘when a measure becomes a target, it ceases to be a good measure.’ There are three key problems here:

  • Desirable activities whose results are not reflected in the measurement will tend to be neglected. For example, some argue that concentration on annual profit measurement leads to the long-term and non-financial effects of actions being disregarded by managers.
  • There will be a tendency to redefine what is or is not included in the measurement, so as to achieve a favourable result. Measurement information avoid perverse effects
  • Those whose performance is being judged in the light of the measurement have a motive to bias it.
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All of these are behavioural issues with which financial reporting (and business reporting in general) constantly has to grapple. Other things being equal, information that does not have perverse effects is obviously preferable to information that does. Measurement information avoid perverse effects

The implications of such behavioural issues for financial reporting are profound, as they suggest a need for it to be constantly evolving to keep ahead of the behavioural techniques that will inevitably develop to ensure that reported measures are as favourable as possible, regardless of whether they
reflect underlying reality. Measurement information avoid perverse effects

There are also behavioural issues affecting the links between management reporting and financial reporting, and whether particular measurement practices lend themselves to fraud.

What is still no solid base for financial reporting

In a perfect world, investors, board members, and executives would have full confidence in companies’ financial statements. They could rely on the numbers to make intelligent estimates of the magnitude, timing, and uncertainty of future cash flows and to judge whether the resulting estimate of value was fairly represented in the current stock price. And they could make wise decisions about whether to invest in or acquire a company, thus promoting the efficient allocation of capital. Measurement information avoid perverse effects

Unfortunately, that’s not what happens in the real world, for several reasons. First, corporate financial statements necessarily depend on estimates and judgment calls that can be widely off the mark, even when made in good faith. Second, standard financial metrics intended to enable comparisons between companies may not be the most accurate way to judge the value of any particular company—this is especially the case for innovative firms in fast-moving economies—giving rise to unofficial measures that come with their own problems. Finally, managers and executives routinely encounter strong incentives to deliberately inject error into financial statements. Measurement information avoid perverse effects

Measurement information avoid perverse effects

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