Economic consequences and positive accounting theory try to explain why managers care about accounting policy choices and to predict how managers will respond to changes in accounting standards.

Required:

a) Explain the relation between economic consequences and contracting, and between contracting and the moral hazard problem.

b) A current debate in accounting practice is whether rules-based or principles-based GAAP (generally accepted accounting principles) is preferable. Which do you think is preferable from the perspective of economic consequences and efficient contracting between investors and managers? Why?