3. The Regulation of Financial Accounting

Question 1

What is the ‘free market’ approach?

Answer 1

Proponents (advocates) of the view that the provision of accounting information should be based on the laws of supply and demand rather than on regulation

Question 2

Did Adam Smith still propose regulation?

Answer 2

Yes, to protect the interests of those who are disadvantaged

Question 3

Why do some people think free market in accounting would work?

Answer 3

Executives usually receive a share of the profits > executives would want cheaper cost of capital > they would give any information necessary to lenders for this > they would be audited to increase trust > as everyone acts in self-interest, therefore will work

Question 4

Why does the idea of free market not work?

Answer 4

If the firm manager wanted to negoiate with various firms all wanting different information the cost would go up and therefore be too costal before even receiving the capital

Question 5

What are other arguments related to ‘free markets’?

Answer 5

Market for managers

Market for coportae takeovers

Question 6

What is a ‘market for managers’?

Answer 6

A market in which managers negotiate their salaries on the basis of their ability and performance. Information about past performance is assumed to be known by participants in this market

Question 7

What is a ‘market for corporate takeovers’?

Answer 7

A market in which corporations are bought and sold. Managers will try to maximise firm value to minimise the likelihood that outsiders could seize control of the organisation at low cost

Question 8

What is the ‘market for lemons’?

Answer 8

The view being that in the absence of disclosure the capital market will assume that the organisation is a ‘lemon’

Question 9

What is ‘enlightened self-interest’?

Answer 9

This would be in operation when managers of an organisation respond to community concerns (as if to appear to be caring) in those situations where doing so also fulfills the goal of maximising the value of the organisation, and therefore the wealth of owners and managers.

Question 10

fun fact: Darwin noticed how bulls have large horns to fight with other bulls, not against predators, it actually made them worse off because natural selection had made them so big, (peacocks etc)

Answer 10

why do some species do this to each other? (economics).

Its like an arms race between countries

Question 11

What is the capital market made up of?

Answer 11

Mostly the share market, but also bonds and other forms of capital lending for companies

Question 12

What is Regulation?

Answer 12

A rule of order, as for conduct, prescribed by authority; a governing direction or law. It is designed to control or govern conduct.

Question 13

What is the Expectations gap?

Answer 13

Liggio (1974) and Deegan and Rankin (1999) provide definitions of the expectations gap. From an accounting perspective, an expectations gap is considered to exist when there is a difference between the expectations users have with regard to particular attributes of information and the expectations preparers believe users have in regard to that information.

Question 14

What is Due process?

Answer 14

A process wherein the regulator involves those parties likely to be affected by the proposed regulation in the discussions leading to the regulation; it provides an opportunity to ‘be heard’.

Question 15

What is Apolitical?

Answer 15

Politically neutral; without political attitudes, content or bias.

Question 16

What is Regulatory capture?

Answer 16

Occurs when a regulatory agency which was established to act in the public interest instead advances the interests of particular groups that dominate the industry or sector that the regulatory agency was charged with regulating.

Question 17

What is Public interest theory?

Answer 17

A theory of regulation which suggests that regulation is developed in the ‘public interest’. Regulators are assumed to be motivated by the ‘public interest’ and will select regulation on the basis that the social benefits of the regulation exceed the social costs.

Question 18

What is the Invisible hand?

Answer 18

A view, typically attributed to Adam Smith, that without regulatory involvement, productive resources will, as a result of individuals pursuing their own self-interest, somehow, as if by an invisible hand, find their way to the most productive uses.

Question 19

What is Market failure?

Answer 19

A situation where market forces of supply and demand do not lead to economically or socially optimal levels of production.

Question 20

What are Free riders?

Answer 20

Parties that use goods or services without contributing to costs that are borne by other people.

Question 21

What is a Public good?

Answer 21

Something that can be used by people without having to pay for it. Generally, use by one party does not affect the ability of others to use the particular item.

Question 22

What is a Stakeholder?

Answer 22

A person, group, organisation, member or system that affects or can be affected by an organisation’s actions.