L6 Regulation of financial accounting - history and current issues Flashcards
What are the 2 competing views about whether regulation is necessary?
- Anti-regulation (free market) advocates
- Pro-regulation advocates
What is the Anti-regulation (Free-market)’ perspective (in reference to whether regulation is necessary)?
- Regulation is unnecessary—people will pay for useful info.
- Markets punish firms that don’t disclose (e.g., “no news = bad news”).
- Firms will disclose out of self-interest.
- Regulation may cause info oversupply, as users overstate needs without bearing costs.
- It limits flexibility—firms can’t use accounting methods that best reflect their situation.
What are the criticisms of the free market perspective?
- Markets are rarely efficient, they do not always work in the way economic theory predicts
- Investors cannot always demand information (especially if disperse)
What is the Pro-regulation perspective (in reference to whether regulation is necessary)?
- Accounting info is a public good—can’t rely on supply/demand alone.
- Free riders understate true demand → underproduction of info.
- Pricing system fails for public goods.
- Market efficiency overlooks individual rights.
- Regulation is needed to correct market failures and ensure sufficient, fair info disclosure.
What are the 3 theories that explain the introduction of regulation?
- public interest theory
- capture theory
- economic interest group theory (private interest theory)
What is the public interest theory (in reference to introduction of regulations)?
Regulation aims to benefit society as a whole, not private interests.
Regulators and politicians are seen as acting in the public’s best interest.
Regulation is a balancing act—weighing social benefits vs social costs.
Assumes the government acts as a neutral, fair decision-maker.
Provide an example of the public interest theory.
Sarbanes-Oxley Act (SOX) - increases responsibility, independence and disclosure standards and increased penalties for non-compliance and fraud.
Social benefits:
- Improved busines ethics
- Improved internal control effectiveness
- Improved corporate governance
Social costs:
- Costs of maintaining compliance
What is the capture theory (in reference to introduction of regulations)?
Regulation may start with public interest in mind, but can be taken over by the industry being regulated.
The industry tries to influence or “capture” the regulator.
Once captured, regulations are shaped to benefit the industry, not the public.
It’s hard for regulators to stay independent from the parties they oversee.
Provide an example of the capture theory.
Walker (1987): Capture of the Australian ASRB by the accounting profession.
They lobbied to block independent research and appoint an admin officer (not a research director).
Priorities were set with the AARF, and AARF submissions were fast-tracked, others weren’t.
Most board members were from the accounting profession = lack of independence.
What are the criticisms of the capture theory?
Other interest groups, not just the regulated industry, can influence regulators.
Regulated industries can create new regulatory agencies, not just capture existing ones.
Regulated industries could prevent the creation of a regulatory agency altogether.
What is the economic interest group theory (in reference to introduction of regulations)?
- Groups form to protect their economic interests.
- These groups lobby for legislation to benefit themselves, often at others’ expense.
- No public interest in the theory.
- Regulators and politicians act out of self-interest, not neutrality.
- Regulators seek to maintain power or re-election.
- Regulation serves the interests of politically powerful groups.
- Weak groups struggle to influence regulation.
What are the two lobbying by companies hypotheses?
Political Cost Hypothesis:
- Large firms facing regulatory/political pressures lobby for accounting rules that reduce income.
Bonus Plan Hypothesis:
- Firms not facing such pressures lobby for accounting rules that increase reported income (to boost bonuses).
What did Watts and Zimmerman (1982) find about audit firms lobbying?
- Audit firms didn’t always align with clients’ preferences.
- Sometimes they took positions opposite to most clients.
- Auditors lobby in their own self-interest as well as for clients.
