Understanding Efficient Market Hypothesis And Business Organization Forms

Part A

Efficient Market Hypothesis is an investment theory which suggests that the stock price of a company incorporates all the information which has the potential to influence the price of the stock and hence earning continuous alpha is not possible in such markets. There is no way for a trader to exploit the market and generate super normal earnings as buyer and sellers are the only factor determining the movement in stock prices (?i?an 2015).

Because an efficient market has consequences for various tactics and might effect the profitability aspect of a particular investment, it is critical for an investor to understand the present state of the market. Another essential feature of market efficiency is that if the market is sufficiently efficient, both equities research and valuation would be inefficient and time-consuming. The chances of finding a stock that is cheap are little to none, and the benefits gained by research and other methods are almost non-existent. (Fakhry 2016).

There are three basic forms of market efficiency which includes weak form, strong form and semi-strong efficient market. Each form of market efficiency has certain characteristics which are explained below:

Weak-form efficiency – The weak version of market efficiency states that a company’s stock price includes all past knowledge about stock price movement, and so no technical analysis can be useful in generating alpha (Rossi 2015). In this type of market efficiency, fundamental analysis may be used to continue making money.

Semi-strong efficiency – The semi-strong form efficiency advocates that the information required to find out the intrinsic value of a stock are all incorporated and hence no fundamental or technical analysis can be beneficial in earning super normal profits for prolonged periods of time (Ying et.al 2019). Proponents of this theory suggests that information that are still not available to the public can be used to earn super normal profits.

Strong form efficiency – This version of market efficiency suggests that all the information is incorporated in the stock price of a company and no fundamental or technical analysis would prove to be beneficial in earning super normal profits consistently. The proponents of this theory suggest that no investment made can earn profits that exceeds the market returns and hence, information retrieved of any nature cannot assist traders to earn super normal profits.

The weak and semi-strong form of market efficiency tends to exists in developing countries due to information asymmetry between market participants. On the other hand, strong form of market efficiency is difficult to find in real world as there is lack of transparency in even the developed markets (Marwala and Hurwitz 2017).

Question 1

A business organization can take several forms like Limited Liability, Joint Stock Company, General Partnership, Limited partnership and Joint venture (Kalowski 2015). Following sections defines each of the business forms in detail:

• Limited Liability – It is a form of business in which all the partners involved have some sort of liabilities. It can display characteristics of both partnerships and corporations combined within itself. The primary difference between a limited liability partnership and traditional partnership is that in an LLP every member is not responsible for the actions and conducts of other members which include negligence and fraud. A limited liability partnership requires a minimum of 2 partners and a maximum of 30 partners.
• Joint stock company -It is a type of organization where the company is divided into shares and are bought and sold to shareholders. Each and every shareholder of the company is a proportionate owner of the company according to the money invested. The shares hold by each company can be purchased or sold by the shareholders anytime to another potential investor; individual or institutional. A joint stock company is also called as a corporation or a limited company.
• General partnership – A general partnership is an agreement between two or more people to split a company’s earnings and losses. The business partners hold the assets, liabilities, and other financial instruments collectively. In a general partnership, the partners commit to unlimited responsibility as a condition of the agreement, which effectively implies that in the event of bankruptcy or inability to pay debts, the individual’s assets can be confiscated to fulfil the demand.
• Joint venture – Joint venture is a type of informal business arrangement between two or more people which does not require any legally binding agreement for the process of formation. When a venturer transacts on behalf of the partnership, he or she assumes limitless obligation to third parties. A non-transacting venturer’s obligation is restricted to his part of the partnership.

The auditor report in the annual report of the company for the year 2020 suggests that the Leonardo company is a closed joint stock company.

There are two methods for accounting of tangible noncurrent assets under IAS 16 property, plant, and equipment: a) Cost model and b) Revaluation model (Kirli 2018).

• Cost model – The carrying amount of PPE is computed using the cost model by subtracting accrued depreciation from the asset’s cost. Depreciation is the methodical allocation of an item’s cost over the course of its useful life. The gap between an asset’s recoverable value and its carrying value is known as impairment loss. Because it is based on the historical cost principle, this approach is quite basic and straightforward. Under the cost model of accounting, the carrying amount of plant property and equipment is measured at its cost, followed by cumulative depreciation, if any (Molociniuc 2021).
• Revaluation model – Under the revaluation model of accounting, PPE is carried in the books at cost or revalued amount less recorded impairment losses and cumulative depreciation. This method necessitates revaluation of PPE on a regular or periodic basis to ensure that the carrying amount does not deviate from its fair value. When one piece of PPE is reprioritized, the entire asset class should also be reprioritized.

The property, plant, and equipment portion of Leonardo Company’s annual report reflects the company’s systematic allocation process.

There are four measuring bases according to IASB framework which are discussed below:

• Historical cost: It is a method of accounting for the assets or liabilities at the historical cost. For instance, when a goodwill is recorded by a company, the historical cost method of accounting is followed.
• Fair value/realizable value: The value at which assets are sold in the market is called the realizable value or fair value assets. When a company buys a stock, it is recorded at the fair value which is the current trading price of the stock.
• Present value – Present value technique is a method of accounting assets and liabilities at the current value of the benefits derived by discounting them with an appropriate discount rate. The present value method of accounting can be used in recognizing revenues.
• Current cost – Current cost t is also known as book value, and it is similar to how you would amortise the cost of a bond each year to record its current cost, or how you would depreciate the cost of a building each year to record its current cost (Marshal and Lennard 2016).

The non-current assets of the company are valued at the lowest of carrying value and fair value less expenses to sell. At the acquisition date, the company recognised the acquired firm’s assets, liabilities, and identified contingent liabilities at their respective fair values.

The many forms of share capital are listed below.

• Equity Share Capital – Equity share capital is the amount of money raised in return for a share of the company’s ownership and equity shareholders are the company’s owners.
• Preference Share Capital – Preference share capital has a preferred right to dividend payments at a predetermined rate for the duration of the company’s existence and s shareholders with a preference do not have ownership rights.
• Registered/ Authorized Share Capital – Every company’s Memorandum of Association must state the amount of capital it wishes to be registered with. This type of capital is referred to as “registered” or “authorised” capital.
• Share capital issued – Issued capital is the portion of Authorised/Registered that is available for subscription in the form of shares to the general public.
• Paid-up Share capital – The amount obtained by the firm via the issuing of shares to shareholders is referred to as paid-up share capital.

The capital structure of Leonardo company consists of share capital valued at EUR 2498 million in the year 2020.

Going concern is a concept which depicts that a company has enough financial assets and is perfectly able to meet its obligations and continue to operate its business in the future periods to come (Zéman and Lentner 2018). The company’s running costs have been decreased, and as a result, the company’s operational income has increased. In addition, the company’s earnings have improved with each passing year, demonstrating that it is a going concern. The fact that no firm branches have closed in recent years is also mentioned in the independent auditor’s report, indicating that the company is a continuing concern. Despite the fact that the company’s cash flow statement indicates a growth in cash flows, the company’s equity and liabilities reduced by a lesser margin. This shows that the company’s running expenditures, which must be paid, may be readily fulfilled without jeopardising the going concern concept.

All financial assets from personal accounts are reported on the balance sheet at the conclusion of each accounting cycle and then totalled together, with like items grouped together (Pattipeilohy 2016). The following section explains the horizontal and vertical method of preparing financial statements:

Horizontal – In a horizontal arrangement, all assets are shown on the left, while all liabilities are listed on the right. The amount of assets and liabilities always matches the total of liabilities due to the way transactions are recorded using double-entry bookkeeping.

Question 2

Vertical – The bottom half of a vertical format usually represents capital, while the upper half represents the asset and liabilities of the company. The resulting structure is known as net asset approach.

Leonardo company follows a vertical format approach with assets and liabilities showing at the top half of the statement.

The company has booked around EUR 13,410 million in revenues in the year 2020 which is 2.71% less than the revenue generated in the year 2019. EBITDA of the company was around EUR 494 million which is 50% less than compared with EBITDA earned in 2019. The operating profit of the company fell by around 70% in the year 2020 to the levels of EUR 253 million compared to EUR 869 generated in the previous year. The company earned EUR 2 million as profit from discontinued operations in the year 2020 compared to EUR 100 million earned in the year 2019. The net profit for the company in the year 2020 was around EUR 243 million and the EPS of the company was around EUR 0.419.

References

Fakhry, B., 2016. A literature review of the efficient market hypothesis. Turkish Economic Review, 3(3), pp.431-442.

Kalowski, A., 2015. Structure determining factors of business organization. International Journal of Innovation, Management and Technology, 6(3), p.206.

Kirli, M., 2018. Comparison of Depreciation Methods in” International Accounting Standard 16 Property, Plant and Equipment” and an Application. Annals of the University Dunarea de Jos of Galati: Fascicle: I, Economics & Applied Informatics, 24(3).

Marshall, R. and Lennard, A., 2016. The reporting of income and expense and the choice of measurement bases. Accounting Horizons, 30(4), pp.499-510.

Marwala, T. and Hurwitz, E., 2017. Efficient market hypothesis. In Artificial Intelligence and Economic Theory: Skynet in the Market (pp. 101-110). Springer, Cham.

Molociniuc, M., 2021. Comparative Analysis of Measurement after Recognition of Property, Plant and Equipment–IAS 16 vs. OMPF No. 1802/2014. CECCAR Business Review, 2(3), pp.59-72.

Pattipeilohy, C., 2016. A comparative analysis of developments in central bank balance sheet composition.

Rossi, M., 2015. The efficient market hypothesis and calendar anomalies: a literature review. International Journal of Managerial and Financial Accounting, 7(3-4), pp.285-296.

?i?an, A.G., 2015. The efficient market hypothesis: Review of specialized literature and empirical research. Procedia Economics and Finance, 32, pp.442-449.

Ying, Q., Yousaf, T., Akhtar, Y. and Rasheed, M.S., 2019. Stock investment and excess returns: a critical review in the light of the efficient market hypothesis. Journal of Risk and Financial Management, 12(2), p.97.

Zéman, Z. and Lentner, C., 2018. The changing role of going concern assumption supporting management decisions after financial crisis. Polish Journal of Management Studies, 18.