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Chapter 13_Notes

Chapter 13_Notes - Chapter 13 Notes 13.1 Overview From an...

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Chapter 13 Notes 13.1 Overview From an economic perspective, the question of the extent of regulation of accounting and reporting standards is unsettled. We do not know whether increased market failures that would follow from deregulation of firms’ information production would be more or less costly to society than the various costs of the standard-setting process. Information asymmetry leads to the problem of unanimity. Thus, investors may push for regulation to remedy the problem. This suggests that standard setting is fundamentally as much a political process as an economic one. It seems natural to expect that the various accounting groups would appeal to the political process when their conflicting interests cannot be resolved by contractual or market forces. The Public Interest Theory Regulation is the result of public demand for correction of market failures. Under the public interest theory, the regulatory body attempts to produce an amount of regulation that maximizes social welfare, by trading off social benefits and social costs of information production. This view represents an ideal of how regulation should be carried out. Problems with its implementation (e.g., Stigler 1971; Posner 1974): Because of the difficulties of determining the socially optimal amount of regulation, the regulatory body under the public interest theory may produce more or less than this amount. It is difficult for a legislature (political authority) to monitor the operations of the regulator because: o The nature of regulation is complex. Page  1  of  10
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o Costly and lengthy hearings would be needed for the legislature to know whether the regulator is doing a good job. This creates a moral hazard problem. o There is a possibility that the regulatory agency will operate on its own behalf rather than on behalf of the public. The public interest theory represents a sort of first-best approach to regulation. In practice, the first-best approach may not be attainable, because of problems of implementation. This leads directly to another theory. The Interest Group Theory Under the interest group theory, the regulatory body is assumed to maximize its own interests, not necessarily those of the public, while at the same time balancing demands of the various groups. To do this, it supplies regulation to those constituencies that are most effective in lobbying for it. To maximize its own interests, the regulatory body may produce as much regulation as it can. If so, regulation will probably be produced beyond the socially optimal amount. 13.2.3 Which theory of regulation applies to standard-setting? Standard setters emphasize due process as a way of moderating the inherent constituency conflict in standard-setting.
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