Accounting theory & Accountability essay on stock exchange
Accounting Theory and Accountability
Standard Setting (Godfrey Chapter 3)
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The Learning Objectives for this lecture:
Applying theory to Accounting regulation
The Regulatory framework for financial reporting
The Institutional structure for setting accounting standards.
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Defining Regulation
“[R]egulation is the policing, according to a rule, of a subject’s choice of activity, by an entity not directly party to or involved in the activity.”
Elements of regulation
Intention to intervene
Restriction on choice to achieve certain goals
Exercise of control by a party independent of those directly involved in the activity.
Theories Of Regulation
Accounting information is a ‘public good’
Managers have incentives to voluntarily provide accounting information, so why do observe the regulation of financial reporting?
Explanations are provided by:
- theory of efficient markets
- agency theory
- theories of regulation
The forces of supply and demand influence market behaviour and help keep markets efficient
This applies to the market for accounting information and should determine what accounting data should be supplied and what accounting practices should be used to prepare it
Theory of efficient markets
Theory of efficient markets Cont
The market for accounting data is not efficient
The ‘free-rider’ problem distorts the market
Users cannot agree on what they want
Accountants cannot agree on procedures
Firms must produce comparable data
The government must therefore intervene
Agency theory
The demand for accounting information:
for stewardship purposes (motivate the agent and distribute the risk efficiently)
for decision-making purposes (role of information – improve the allocation of resources and risks in the economy reducing uncertainty.)
A framework in which to study the relationship between those who provide accounting information - e.g. a manager - and those who use it – e.g. a shareholder or creditor
Theories Of Regulation
There are three theories of regulation:
- Public Interest Theory
- Regulatory Capture Theory
- Private Interest Theory
Public Interest Theory
Public Interest theory assumes:
Economic markets are generally not perfect
-lack of competition
- barriers to entry
-information asymmetry ( One party has more information)
Public Interest Theory Cont
Regulation is virtually costless
- public-good products (financial information to a single individual makes it costless to other individuals)
Concludes that regulation is supplied in response to the demands of the public for the correction of these inefficient or inequitable market practices.
Public Interest Theory Cont
Governments intervene:
- to get votes
- Because public interest groups demand intervention
- Because they are neutral arbiters
Regulatory Capture Theory
Regulatory Capture theory holds that regulation is supplied in response to demands of self interested groups trying to maximise the incomes or interests of their members.
- people are rational utility maximisers.
- The coercive power of government can be used to give valuable benefits to particular groups.
- Regulation can be viewed as a product that is governed by the laws of supply and demand
Regulatory capture theory Cont
The public interest is not protected because those being regulated come to control or dominate the regulator
The regulated protect or increase their wealth
Assumes the regulator has no independent role to play but is simply an arbiter between battling interest groups
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Regulatory capture theory Cont
Professional accounting bodies or the corporate sector seek to control the setting of accounting standards
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The End