Chapter 3 - Accounting Regulation and politics

A. Free Market Perspective

It often provides a perspective that accounting information should be treated like other goods, and demand and supply forces should be allowed to operate so as to generate an optimal supply of information about an entity.

Jensen and Meckling, Watts and Zimmerman, Smith and Watts are supporters.

Rationale: The argument by some advocates of the ‘free-market” perspective is that in the absence of regulation there will be private incentives to produce accounting information. Organizations that do not produce information will be penalised by higher cost of capital.

B. The ‘Pro-regulation’ Perspective

Accounting information is a “Public Goods” – once available, people can use it without paying and can pass it on to others. Parties that use goods or service without incurring some of the assoicated production costs are referred to as ‘free-riders’. Few people will hava an incentive to pay for te goods or services and so does the producers of the particular goods or services, which in turn leads to an underproduction of information.

To alleviate this underproduction, regulation is argued to be necessary to reduce the impacts of market failure.

C. The rationale for regulating financial accounting practice

In most developed countries there is a multitude of accounting standards covering a broad cross-section of issues – but do we really need all this regulation? There are two broad schools of thought.

For regulation – they don’t agree the free-market approach and support the view that regulation could lead to uniform methods and so enhancing comparability and protect from misleading information.

Against regulation – the free-market arguments concerns regulation will lead to over-supply of information and would lead to an optimal supply of information by entities. They support the Markets view as it is efficient and the markets will provide incentives and penalties to ensure that managers do as the market expect.

Chapter 3 -The Regulation of financial accounting

D.Regulation – The Theory for and against

Public Interest theory of regulation

The theory proposes that regulation be introduced to protect the public.

This theory assumes that the regulatory body is a neutral arbiter of the ‘public interest’ and does not let its own self-interest impact on its rule-making processes.

Rationale: The protection may be required as a result of inefficient market.

Capture theory of regulation

A contrary perspective of regulations is provided by captured theory which argues that although regulation is often introduced to protect the public, the regulatory mechanisms are often subsequently controlled (captured) so as to protect the interests of particular self-interested groups within society.

Rationale: The ‘regulated” tend to capture the “regulator”. Posner argues that “the original purposes of the regulatory program are later thwarted through the efforts of the interest group.

Economic interest theories of regulation

The theory assumes that everybody acts in their own self-interest, including regulators and those people that are regulated.

Rational: ‘Regulators will only propose and support regulation which leads to favorable outcomes for themselves, perhaps in terms of their re-election.

Chapte 3 – The Regulation of financial accounting

Accounting regulation as an output of a political process

1.If we accept that the accounting standard-setting process is a political process, then the view that financial accounting should be

Objective,

Neutral and

Apolitical

is something that can be easily challenge .

Rational: Because financial accounting affects the distribution of wealth within society, it consequently will be political.

Standard-Setter

Standard-setting bodies typically encourage various affected parties to make submissions on draft version of proposed accounting standards. This is deemed to be part of the normal ‘due process’.

2.If we accept that the standard-setters give due consideration to the views expressed in the various submissions they receive, then we must accept that accounting standards, and therefore financial accounting reports, are the result of various social and economic considerations.

Hence they are very much standards are developed. Therefore it is arguably very questionable whether financial accounting should claim to be “neutral” or “objective”.

3.While it is accepted that accounting standards are developed having regard to social and economic consequences, it is also a requirement in many jurisdictions that corporate financial statement be “True and Fair”.

Rational: Perhaps it is easier to say they are “fair”. It is doubtful to say the financial statements are “true “when the standards are determined depending on various economic and social consequences.

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