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