The efficient market hypothesis is an investment theory which suggests that financial markets reflect all available information making it impossible for the investors to sell stocks at high inflated prices or buy the undervalued ones. Murdoch and Klause (1989), explain that this hypothesis is relevant to accounting because the annual accounts are an influential source of information available to the market. EMH is highly disputed but forms a back bone of modern financial theory. The purpose of accounting standards is to regulate the way companies account for their profits and therefore minimize the chances of creative accounting and tax evasion as well as fooling prospective creditors and investors. Information acquired from company accounts does influence the markets. However this should not influence the drafting of accounting standards is usually developed to prevent unethical malpractices.
The primary objective of accounting information is to assist the users of financial statements forecast the amount, timing and uncertainty of the prospective cash inflows to the business. Traditionally, earnings and current cash flows have been used to predict the future cash flows of an enterprise (Riahi-Belkaoui, 2004). The Financial accounting standards board asserts that earnings do provide better forecasts on the future cash flows. Random walk cash flow prediction models are also used and perform just as well as those models which use accrual data. Prediction of future organizations cash flow is important for business enterprises. In this regard, Riahi-Belkaoui (2004) explains that accounting data may have a predictive power in two ways;
a) The ability of the accounting data to predict and explain future economic events;
b) The ability of accounting data to predict and explain the market’s reaction to disclosure (Riahi-Belkaoui, 2004).
Information gained after gathering the accounting data facilitates the decision making process.