Question

Distinguish between the "information perspective" and the "contracting approach."

Answer 1

Information perspective is that perspective that views different pieces and sets of accounting data as providing information with regards to inputs to valuation models. Accounting data for valuation models usually are data pertaining to earnings, dividends, and cash flows. This perspective then tests for any association that exists between accounting disclosures and the prices of a stock and returns generated by a stock. The basic tenet of information perspective is the presence of information asymmetry between the management and the shareholders. Superior information vests with the management.

In contracting approach, on the other hand, the accounting methods are determined by making use of accounting numbers that are present in contracts between different parties to the organization or the company. The accounting disclosures, under the contracting approach, directly affect the contractual claims of the parties. This in turn affects the value of those claims (this includes stock prices as well).