Definition information asymmetry and relationship to accounting?

Answer 1

So here's what's up - two issues combine to create one big problem for business owners (and thus for investors): First - there are Agency problems which basically say that Managers and Business Owners have different priorities - for instance, even though owners hire managers to run their business, managers often want to both make as much money as they can and do as little work as possible...two things which reduce the profits of the business owner. Second - there's a problem of Information Asymmetry. This is just a verbose way of saying that the manager actually knows MORE about the business and about his/her own work than the business owner does. The more that the manager knows but the owner does not - the more opportunity the manager has to be dishonest. This relates to accounting in a few ways, but I'll just go into the most basic reason. Business owners and investors rely on financial reporting - a product of accounting - to make all sorts of decisions - one of those decisions is how much to pay the CEO (if anything). However, these financial reports have an inherent credibility issue because managers have a pretty good idea how truthful and accurate they are, but investors do not. In response, investors hire a bunch of auditors to come in check things out, to make sure that the financial reports are pretty much what they seem to be.