CHAPTER 12
Standard Setting: Economic Issues
Cory Bettel ∙ Jeff Chang ∙ Danielle Dodd
Ryan Gruenspan ∙ Victoria Kavanagh ∙ Sally Regenstreif
AGENDA
12.1
• Overview
12.2
• Regulation of Economic Activity
12.3
• Characterizing Information Production
12.4
• First-best Information Production
12.5
• Market Failures in Info. Production
12.6
• Contractual Incentives for Information Production
12.7 & 12.8
12.9
• Market-based Incentives for Information Production
• Disclosure
12.10
• Decentralized Regulation
12.11
• How much information is enough?
Article 1
• Improved Standards in the Future
OVERVIEW
OVERVIEW
REGULATION
INFORMATION
PRODUCTION
MARKET
FAILURES
CONTRACTUAL
INCENTIVES
MARKET-BASED
INCENTIVES
DISCLOSURE
DECENTRALIZED
REGULATION
HOW MUCH IS
ENOUGH ?
FUTURE OF
STANDARDS
Standard Setting: The regulation
of firm’s external information
production decisions by a
regulator.
OVERVIEW
REGULATION
INFORMATION
PRODUCTION
MARKET
FAILURES
CONTRACTUAL
INCENTIVES
MARKET-BASED
INCENTIVES
DISCLOSURE
DECENTRALIZED
REGULATION
HOW MUCH IS
ENOUGH ?
FUTURE OF
STANDARDS
OVERVIEW
•Standard setting is ultimately the
government’s responsibility
•Regulators are agencies delegated to
set accounting standards (E.g. IASB and
FASB)
•Act as a mediator between conflicting
interests of investors and managers
•Ensure the right amount of information
is in the financial statements
OVERVIEW
REGULATION
INFORMATION
PRODUCTION
STANDARD SETTING
•Fundamental problem is discerning the
socially “right” amount of information
MARKET
FAILURES
CONTRACTUAL
INCENTIVES
MARKET-BASED
INCENTIVES
DISCLOSURE
DECENTRALIZED
REGULATION
HOW MUCH IS
ENOUGH ?
FUTURE OF
STANDARDS
•First-Best: Amount that equates
marginal benefits to marginal costs
•Impossible due to market complexities
OVERVIEW
REGULATION
INFORMATION
PRODUCTION
MARKET
FAILURES
CONTRACTUAL
INCENTIVES
MARKET-BASED
INCENTIVES
DISCLOSURE
DECENTRALIZED
REGULATION
HOW MUCH IS
ENOUGH ?
FUTURE OF
STANDARDS
REGULATION OF ECONOMIC ACTIVITY
•Regulation protects individuals who are at
an information disadvantage
•Occurs due to information asymmetry
•Improves markets by enhancing public
confidence
•Common Examples:
GAAP, IFRS, MD&A,
profession laws, full
disclosure laws, etc.
OVERVIEW
REGULATION
REGULATION OF ECONOMIC ACTIVITY
•2 Types of Information:
INFORMATION
PRODUCTION
MARKET
FAILURES
CONTRACTUAL
INCENTIVES
MARKET-BASED
INCENTIVES
DISCLOSURE
DECENTRALIZED
REGULATION
HOW MUCH IS
ENOUGH ?
FUTURE OF
STANDARDS
Proprietary
Information
Nonproprietary
Information
OVERVIEW
REGULATION
INFORMATION
PRODUCTION
MARKET
FAILURES
CONTRACTUAL
INCENTIVES
MARKET-BASED
INCENTIVES
DISCLOSURE
DECENTRALIZED
REGULATION
HOW MUCH IS
ENOUGH ?
FUTURE OF
STANDARDS
CHARACTERIZE INFORMATION PRODUCTION
•“Production” of information used for 2
reasons:
1. Information is a commodity
2. Consistent way of thinking about its
production
•Quantity of information:
•Finer information
•Additional information
•Credibility
OVERVIEW
REGULATION
INFORMATION
PRODUCTION
MARKET
FAILURES
CONTRACTUAL
INCENTIVES
MARKET-BASED
INCENTIVES
DISCLOSURE
DECENTRALIZED
REGULATION
HOW MUCH IS
ENOUGH ?
FUTURE OF
STANDARDS
PROS & CONS OF INFORMATION PRODUCTION
•Benefits include:
•Better-informed investment decision
•Lower costs of capital
•Better-working markets
•Reduction of monopoly power
•Timely recognition of firm failure
•Potential information release about other
firms
•Costs include:
•Direct costs of preparation and release
•Possible release of proprietary information
•Increased contracting costs
OVERVIEW
MARKET FAILURES IN INFO. PRODUCTION
REGULATION
INFORMATION
PRODUCTION
MARKET
FAILURES
CONTRACTUAL
INCENTIVES
MARKET-BASED
INCENTIVES
Externality: An action taken by a firm or
individual that imposes costs or benefits on
others for which the creating entity is not
charged or does not receive revenue.
•The perception of these costs and benefits
differs between the firm and society
DISCLOSURE
DECENTRALIZED
REGULATION
HOW MUCH IS
ENOUGH ?
FUTURE OF
STANDARDS
Free-riding: The receipt of a firm or
individual of a benefit from an externality
.
OVERVIEW
REGULATION
INFORMATION
PRODUCTION
MARKET
FAILURES
CONTRACTUAL
INCENTIVES
MARKET-BASED
INCENTIVES
DISCLOSURE
DECENTRALIZED
REGULATION
HOW MUCH IS
ENOUGH ?
FUTURE OF
STANDARDS
EXTERNALITY EXAMPLES
•Darrough and Stoughton: monopolies keeps
certain information private to deter entry
•Reduces proprietary costs, but decreases
benefit to society
•Lambert, Leuz, and Verrecchia: earnings
information released affects other firm’s stock
prices
•Decreases Beta which decreases cost of
capital- but decreases for all firms
•Anilosky, Feng and Skinner: firm’s reporting
good earnings does not provide an externality
about future economic performance
•If firms’ reporting became more timely, this
could increase
OVERVIEW
REGULATION
INFORMATION
PRODUCTION
MARKET
FAILURES
CONTRACTUAL
INCENTIVES
MARKET-BASED
INCENTIVES
DISCLOSURE
DECENTRALIZED
REGULATION
HOW MUCH IS
ENOUGH ?
FUTURE OF
STANDARDS
FREE-RIDING EXAMPLES
•Information has a public-good nature,
more than one investor can use it
•Investors are able to free-ride
•Information must be free
•Firms produce less
information than society
would like
OVERVIEW
REGULATION
INFORMATION
PRODUCTION
MARKET
FAILURES
CONTRACTUAL
INCENTIVES
MARKET-BASED
INCENTIVES
DISCLOSURE
DECENTRALIZED
REGULATION
HOW MUCH IS
ENOUGH ?
FUTURE OF
STANDARDS
ADVERSE SELECTION PROBLEM
1. Insider trading
• Managers trade on inside information
• No longer a fair game
2. Bad news is not released
OVERVIEW
MORAL HAZARD PROBLEM
REGULATION
•Net income is not fully informative of effort
INFORMATION
PRODUCTION
MARKET
FAILURES
CONTRACTUAL
INCENTIVES
MARKET-BASED
INCENTIVES
DISCLOSURE
DECENTRALIZED
REGULATION
HOW MUCH IS
ENOUGH ?
FUTURE OF
STANDARDS
•Mangers disguise shirking and low
profits by earnings management or
reducing disclosure
OVERVIEW
REGULATION
INFORMATION
PRODUCTION
MARKET
FAILURES
CONTRACTUAL
INCENTIVES
MARKET-BASED
INCENTIVES
DISCLOSURE
DECENTRALIZED
REGULATION
HOW MUCH IS
ENOUGH ?
FUTURE OF
STANDARDS
UNANIMITY
•If markets work well, shareholders will
unanimously be in favour of the manager
maximizing the market value of the firm
•If markets do not work well, no longer will
be unanimous
OVERVIEW
REGULATION
INFORMATION
PRODUCTION
MARKET
FAILURES
EXAMPLES OF CONTRACTUAL INCENTIVES
•Information is required to observe
compliance with contracts
•Unobservable managerial effort
CONTRACTUAL
INCENTIVES
•Financial covenants for firms issuing debt
MARKET-BASED
INCENTIVES
•When a private firm goes public, increased
possibility of shirking
DISCLOSURE
DECENTRALIZED
REGULATION
HOW MUCH IS
ENOUGH ?
FUTURE OF
STANDARDS
OVERVIEW
REGULATION
INFORMATION
PRODUCTION
MARKET
FAILURES
CONTRACTUAL
INCENTIVES
MARKET-BASED
INCENTIVES
JENSEN & MECKLING MODEL
•Investors will become aware of shirking
•As a result, share prices decline
•Management incentive to reduce
shirking
•Contracts include forecasts
DISCLOSURE
DECENTRALIZED
REGULATION
HOW MUCH IS
ENOUGH ?
FUTURE OF
STANDARDS
•Increase financial reporting
•Overall increase in information
production
OVERVIEW
THE COASE THEOREM
REGULATION
•Created by Ronald Coase
INFORMATION
PRODUCTION
•Problem of externalities can be internalized
MARKET
FAILURES
CONTRACTUAL
INCENTIVES
MARKET-BASED
INCENTIVES
DISCLOSURE
DECENTRALIZED
REGULATION
HOW MUCH IS
ENOUGH ?
FUTURE OF
STANDARDS
•Reduce need for regulation
•Illustrated by two farms located side by side
OVERVIEW
REGULATION
INFORMATION
PRODUCTION
MARKET
FAILURES
COASE THEOREM ILLUSTRATION
•Two farms:
1. One raises cattle
2. One grows crops
CONTRACTUAL
INCENTIVES
•Cattle roam into crops, damaging value
MARKET-BASED
INCENTIVES
•Two solutions:
1. Regulate the two farms – fencing
2. Farmers bargain
DISCLOSURE
DECENTRALIZED
REGULATION
HOW MUCH IS
ENOUGH ?
FUTURE OF
STANDARDS
OVERVIEW
COASE THEOREM ILLUSTRATION
REGULATION
•Fence costs $100, damage costs $150
•Assume property rights belong to the cattle
farmer
•Cattle can stray
•Crop farmer will put up fence
•Assume property rights belong to the crop
farmer
•Damages repaid by cattle farmer
•Cattle farmer will put up fence
•The fence replaces the need for regulation
INFORMATION
PRODUCTION
MARKET
FAILURES
CONTRACTUAL
INCENTIVES
MARKET-BASED
INCENTIVES
DISCLOSURE
DECENTRALIZED
REGULATION
HOW MUCH IS
ENOUGH ?
FUTURE OF
STANDARDS
OVERVIEW
REGULATION
INFORMATION
PRODUCTION
COASE THEOREM ILLUSTRATION
•Firm information costs $100 to release
•Benefit to investor is $150
MARKET
FAILURES
CONTRACTUAL
INCENTIVES
MARKET-BASED
INCENTIVES
DISCLOSURE
Cost to
Firm
<
Benefit
to
Investors
DECENTRALIZED
REGULATION
HOW MUCH IS
ENOUGH ?
FUTURE OF
STANDARDS
.: Firm will release information without
regulation
OVERVIEW
MANAGERIAL LABOUR MARKET
REGULATION
•Evaluates manager performance on an
ongoing basis
•Reputation suffers if information is false, biased
or incomplete
•Need for contracts not completely removed
•Number of incentives reduced
INFORMATION
PRODUCTION
MARKET
FAILURES
CONTRACTUAL
INCENTIVES
MARKET-BASED
INCENTIVES
DISCLOSURE
DECENTRALIZED
REGULATION
HOW MUCH IS
ENOUGH ?
FUTURE OF
STANDARDS
•Example: Manager‘s profit share
•Reduced from 35% to 20%
•Lower amount of compensation in jeopardy
•Risk averse manager more likely to provide
information
OVERVIEW
REGULATION
INFORMATION
PRODUCTION
MARKET
FAILURES
CONTRACTUAL
INCENTIVES
MARKET-BASED
INCENTIVES
DISCLOSURE
DECENTRALIZED
REGULATION
HOW MUCH IS
ENOUGH ?
FUTURE OF
STANDARDS
CAPITAL MARKETS
•Managers motivated by reputation and wanting
to increase firm value
•Assume investors cannot diversify against
adverse selection & estimation risk
•Managers release information due to
motivation to strengthen reputation and
increase firm value
•Market prices of the firms’ shares increase,
or equivalently, cost of capital will fall
•Higher firm profitability and value
•Increased compensation
OVERVIEW
TAKEOVER MARKET
REGULATION
•Market for corporate control
INFORMATION
PRODUCTION
•If manager does not increase value, subject
to takeover bid
MARKET
FAILURES
CONTRACTUAL
INCENTIVES
MARKET-BASED
INCENTIVES
DISCLOSURE
DECENTRALIZED
REGULATION
HOW MUCH IS
ENOUGH ?
FUTURE OF
STANDARDS
•Replacement of management
•The more aggravated investors are, more
likely takeover will happen
•Market motivates managers to increase firm
value
•Information is produced and released
OVERVIEW
THE DISCLOSURE PRINCIPLE
REGULATION
•Disclosure Principle – managers will
release all info, good or bad
•Rational investors
 Assume the manager will only release
favourable info
 If managers do not release info, will
assume the worst
 Therefore, managers should release
all info, or risk decreasing firm value
 Incentive to keep share price from
falling
INFORMATION
PRODUCTION
MARKET
FAILURES
CONTRACTUAL
INCENTIVES
MARKET-BASED
INCENTIVES
DISCLOSURE
DECENTRALIZED
REGULATION
HOW MUCH IS
ENOUGH ?
FUTURE OF
STANDARDS
OVERVIEW
REGULATION
INFORMATION
PRODUCTION
MARKET
FAILURES
CONTRACTUAL
INCENTIVES
MARKET-BASED
INCENTIVES
DISCLOSURE
DECENTRALIZED
REGULATION
HOW MUCH IS
ENOUGH ?
FUTURE OF
STANDARDS
THE DISCLOSURE PRINCIPLE
•“Does it always work?”
•Verrecchia (1983): managers may not fully
disclose at all times
•Assumptions:
i. Disclosures made are truthful
ii. Disclosures have a cost
iii. Investors know managers have info
& the cost of disclosure
iv. Investors do not know what the info
is
OVERVIEW
REGULATION
INFORMATION
PRODUCTION
MARKET
FAILURES
CONTRACTUAL
INCENTIVES
MARKET-BASED
INCENTIVES
DISCLOSURE
DECENTRALIZED
REGULATION
HOW MUCH IS
ENOUGH ?
FUTURE OF
STANDARDS
THE DISCLOSURE PRINCIPLE
•Threshold levels of disclosure exist
•News will be disclosed if info exceeds
threshold
•Unknown to investors why managers
are withholding info
•Disclosure principle fails
•Reinstated if cost
of disclosure = 0
OVERVIEW
REGULATION
INFORMATION
PRODUCTION
MARKET
FAILURES
CONTRACTUAL
INCENTIVES
MARKET-BASED
INCENTIVES
DISCLOSURE
DECENTRALIZED
REGULATION
HOW MUCH IS
ENOUGH ?
FUTURE OF
STANDARDS
PAE (2005)
•Relaxed the assumption that the market
knows the manager has info
Still an incentive for voluntary
disclosure?
More than one piece of news?
What happens with non-proprietary
info?
OVERVIEW
REGULATION
INFORMATION
PRODUCTION
MARKET
FAILURES
CONTRACTUAL
INCENTIVES
MARKET-BASED
INCENTIVES
DISCLOSURE
DECENTRALIZED
REGULATION
HOW MUCH IS
ENOUGH ?
FUTURE OF
STANDARDS
PAE (2005)
•Forecast of earnings & cash flows
•Costly for firms to develop internally
& no cost of release
•Investors do not know whether firms
have developed them or not
•Investors will asses probabilities
•Iffirm develops both forecasts, only
disclose > threshold
•Iffirm has not developed either, disclose
nothing
OVERVIEW
REGULATION
INFORMATION
PRODUCTION
MARKET
FAILURES
CONTRACTUAL
INCENTIVES
MARKET-BASED
INCENTIVES
DISCLOSURE
DECENTRALIZED
REGULATION
HOW MUCH IS
ENOUGH ?
FUTURE OF
STANDARDS
DISCLOSURE PRINCIPLE
•Though it is a basic & strong argument
that firms will release news, it easily
breaks down in a number of situations
•Therefore, cannot be relied upon that all
info will always be released by firms
OVERVIEW
SIGNALING
REGULATION
INFORMATION
PRODUCTION
MARKET
FAILURES
CONTRACTUAL
INCENTIVES
MARKET-BASED
INCENTIVES
DISCLOSURE
DECENTRALIZED
REGULATION
HOW MUCH IS
ENOUGH ?
FUTURE OF
STANDARDS
Signaling: An action taken by a hightype manager that would not be
rational if that manager was low-type.
•Signal must be less costly for a
high-type manager to be credible
•Irrational for low-type to mimic hightype
•Some signals include…
SIGNALS
OVERVIEW
REGULATION
INFORMATION
PRODUCTION
MARKET
FAILURES
CONTRACTUAL
INCENTIVES
MARKET-BASED
INCENTIVES
DISCLOSURE
DECENTRALIZED
REGULATION
HOW MUCH IS
ENOUGH ?
FUTURE OF
STANDARDS
1. Proportion of retained equity
•Entrepreneur/manager making an IPO
•Too costly for low-type to do
2. Audit quality
•Signals value of new securities issue
•High quality auditors are costly for low-type
3. Forecasts
•E.g. Canadian Tire’s MD&A
•Info disclosure beyond minimum
requirements
•Signals confidence in firm’s future, which
adds credibility
OVERVIEW
REGULATION
INFORMATION
PRODUCTION
MARKET
FAILURES
CONTRACTUAL
INCENTIVES
MARKET-BASED
INCENTIVES
DISCLOSURE
DECENTRALIZED
REGULATION
HOW MUCH IS
ENOUGH ?
FUTURE OF
STANDARDS
SIGNALS
4. Capital Structure
• Issuance of new shares causes
existing shares to drop in value
• High-type firm would likely find other
sources of financing
• E.g. Bonds, internal financing
5. Dividend Policy
• High payout ratio = confidence in
future performance
6. Accounting Policy
• Increased conservation = greater
confidence
SIGNALING
OVERVIEW
REGULATION
INFORMATION
PRODUCTION
MARKET
FAILURES
CONTRACTUAL
INCENTIVES
MARKET-BASED
INCENTIVES
NOTE: Managers must have choice.
•E.g. if equal audit quality imposed
on all firms, then not available as a
DISCLOSURE
DECENTRALIZED
REGULATION
HOW MUCH IS
ENOUGH ?
FUTURE OF
STANDARDS
signal
OVERVIEW
REGULATION
INFORMATION
PRODUCTION
MARKET
FAILURES
CONTRACTUAL
INCENTIVES
MARKET-BASED
INCENTIVES
DISCLOSURE
DECENTRALIZED
REGULATION
HOW MUCH IS
ENOUGH ?
FUTURE OF
STANDARDS
PRIVATE INFORMATION SEARCH
•Management onus to release info
•Implies investors are passive
•Investors may conduct private info searches
•If successful, inside info can quickly go public
•High cost to society
OVERVIEW
REGULATION
INFORMATION
PRODUCTION
MARKET
FAILURES
CONTRACTUAL
INCENTIVES
MARKET-BASED
INCENTIVES
THEORY OF SUPERIOR DISCLOSURE
•Theory: If market forces motivate
superior disclosure levels from firms
•Firms should benefit from a lower
cost of capital
•Decrease exists as increased
disclosure reduces investors risk
DISCLOSURE
DECENTRALIZED
REGULATION
HOW MUCH IS
ENOUGH ?
FUTURE OF
STANDARDS
•May also positively affect the firms’
future investment and production
decisions
OVERVIEW
REGULATION
INFORMATION
PRODUCTION
MARKET
FAILURES
CONTRACTUAL
INCENTIVES
MARKET-BASED
INCENTIVES
DISCLOSURE
DECENTRALIZED
REGULATION
HOW MUCH IS
ENOUGH ?
FUTURE OF
STANDARDS
THEORY OF SUPERIOR DISCLOSURE
•The theory is relatively unproven and many
researchers still disagree today
•Supporters include:
1. Lehavy & Sloan (2008): When
number of wealthy (Assumed informed)
investors holding stock increased, future
returns on the stock fell
•Less risk as investor estimation risk
is minimized
OVERVIEW
REGULATION
INFORMATION
PRODUCTION
MARKET
FAILURES
CONTRACTUAL
INCENTIVES
MARKET-BASED
INCENTIVES
DISCLOSURE
DECENTRALIZED
REGULATION
HOW MUCH IS
ENOUGH ?
FUTURE OF
STANDARDS
THEORY OF SUPERIOR DISCLOSURE
•Supporters also include:
2. Dechow, Sloan & Sweeney (1996): An
average drop of 9% in share price on the
day that the SEC decides to investigate a
firm that has violated GAAP/IFRS
•Bad Reporting = Higher Investor Risk
•Higher Risk
= More volatile earnings
(High Cost of Capital)
.: Good Reporting = Stable earnings
(Low Cost of Capital)
OVERVIEW
REGULATION
INFORMATION
PRODUCTION
MARKET
FAILURES
CONTRACTUAL
INCENTIVES
MARKET-BASED
INCENTIVES
DISCLOSURE
DECENTRALIZED
REGULATION
HOW MUCH IS
ENOUGH ?
FUTURE OF
STANDARDS
THEORY OF SUPERIOR DISCLOSURE
•Those opposing the theory include:
1. Core, Guay & Verdi (2008): Higher
accrual quality does not imply a lower
cost of capital
• It’s believed that higher accrual
quality will signal to users about the
organization’s next year of business
• This would in tern decrease investor
estimation risk and decrease WACC
• Core, Guay & Verdi determined that
such a connection does not exist.
OVERVIEW
REGULATION
INFORMATION
PRODUCTION
MARKET
FAILURES
CONTRACTUAL
INCENTIVES
MARKET-BASED
INCENTIVES
DISCLOSURE
DECENTRALIZED
REGULATION
HOW MUCH IS
ENOUGH ?
FUTURE OF
STANDARDS
THEORY OF SUPERIOR DISCLOSURE
•In conclusion…
•Difficult to say that firms and investors do not
benefit from higher disclosure from an
accounting perspective
•Difficult to prove conclusively though, due to:
1. Variety of measures of investor risk
2. Difficult to measure cost of capital
effectively
OVERVIEW
REGULATION
INFORMATION
PRODUCTION
MARKET
FAILURES
CONTRACTUAL
INCENTIVES
MARKET-BASED
INCENTIVES
DISCLOSURE
DECENTRALIZED
REGULATION
HOW MUCH IS
ENOUGH ?
FUTURE OF
STANDARDS
DECENTRALIZED REGULATION
•Gives management some flexibility in
reporting
•Reduces comparability across firms
•Improves the relevance of reporting
•Reliability may be controlled
•Since management would have to
change a firms internal organization to
exploit flexibility
OVERVIEW
REGULATION
INFORMATION
PRODUCTION
MARKET
FAILURES
CONTRACTUAL
INCENTIVES
MARKET-BASED
INCENTIVES
DISCLOSURE
DECENTRALIZED
REGULATION
HOW MUCH IS
ENOUGH ?
FUTURE OF
STANDARDS
DECENTRALIZED REGULATION
1. Segment Reporting
•Useful since relevant information may be
buried in consolidated totals
•It is harder to disguise poor performance
•Regulated by IFRS 8
•Requires reporting externally on
same basis as internally
•Flexibility results in useful information
to investors
•The cost of opportunism in segment
reporting will be high
OVERVIEW
REGULATION
INFORMATION
PRODUCTION
MARKET
FAILURES
CONTRACTUAL
INCENTIVES
MARKET-BASED
INCENTIVES
DISCLOSURE
DECENTRALIZED
REGULATION
HOW MUCH IS
ENOUGH ?
FUTURE OF
STANDARDS
DECENTRALIZED REGULATION
2. Standards allowing Fair Value
•Decentralized since management is
given a choice
•Gives management the ability to
signal through its choice of reporting
methods
OVERVIEW
REGULATION
INFORMATION
PRODUCTION
MARKET
FAILURES
CONTRACTUAL
INCENTIVES
MARKET-BASED
INCENTIVES
DISCLOSURE
DECENTRALIZED
REGULATION
HOW MUCH IS
ENOUGH ?
FUTURE OF
STANDARDS
HOW MUCH INFO IS ENOUGH?
• Complete Regulation is too costly
• Direct costs such as
• Bureaucracy to establish and
administer regulations
• Compliance costs to firms
• Indirect costs such as
• Reduction in mgmt opportunity to
signal
• Costs of “wrong” amounts of
information
OVERVIEW
HOW MUCH INFO IS ENOUGH?
REGULATION
• Complete Deregulation
• Not socially desirable
• Uncontrolled impacts of externalities,
adverse selection, and moral hazard
would be extremely serious
•Markets would probably
cease to function
INFORMATION
PRODUCTION
MARKET
FAILURES
CONTRACTUAL
INCENTIVES
MARKET-BASED
INCENTIVES
DISCLOSURE
DECENTRALIZED
REGULATION
HOW MUCH IS
ENOUGH ?
FUTURE OF
STANDARDS
OVERVIEW
HOW MUCH INFO IS ENOUGH?
REGULATION
•Range of regulation is up for debate
•Theorem of the second best
•We many never know the socially correct
extent of regulation
INFORMATION
PRODUCTION
MARKET
FAILURES
CONTRACTUAL
INCENTIVES
MARKET-BASED
INCENTIVES
DISCLOSURE
DECENTRALIZED
REGULATION
HOW MUCH IS
ENOUGH ?
FUTURE OF
STANDARDS
•Consider the effects of the Sarbanes-Oxley Act
•Showed net positive effect to investors
•But reduced utilities of insiders, and
lowered the number of firms offering
securities
•Can’t infer the “social” benefits are
positive
OVERVIEW
HOW MUCH INFO IS ENOUGH?
REGULATION
•In conclusion…
•The extent of standards is a complex and
important question for a market economy
•Standard setting boils down to a costbenefit trade-off.
•However this trade-off may never be
fully known
•A method for dealing with this
uncertainty is to give firms flexibility in
meeting reporting standards
INFORMATION
PRODUCTION
MARKET
FAILURES
CONTRACTUAL
INCENTIVES
MARKET-BASED
INCENTIVES
DISCLOSURE
DECENTRALIZED
REGULATION
HOW MUCH IS
ENOUGH ?
FUTURE OF
STANDARDS
OVERVIEW
REGULATION
INFORMATION
PRODUCTION
MARKET
FAILURES
CONTRACTUAL
INCENTIVES
MARKET-BASED
INCENTIVES
DISCLOSURE
DECENTRALIZED
REGULATION
HOW MUCH IS
ENOUGH ?
FUTURE OF
STANDARDS
THE FUTURE: IMPROVED STANDARDS
•AcSB has started the Accounting
Standards Improvement project
•Focused on ensuring statements
prepared with best practices
•Increased discussion of convergence
between IASB and FASB
•Would create a “gold standard” for major
capital markets
•Maintaining converged standards =
converged interpretation processes