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  • Public good - once info is released it is available to everyone - not just those who pay for it (ie. the shareholders) -those who get free access are known as ‘free riders’ - under a regulatory regime they do not moderate their demand for info because they do not pay the price - AASB can respond to this ‘demand’ and cause an oversupply
  • The public interest issue pursued by politicians can coincide with the politicians private interests but this cannot always be the case
  • The ministerial council consisted of each State Attorney General (relates to the Companies Code which operated before the Corporations law now in place)

Lecture03 Lecture03 Presentation Transcript

  • Lecture 3Regulation of FinancialReporting in Australia (cont.) AASB
  • Lecture OverviewReview The fundamental problem of financial accounting theory Current Australian accounting regulationsIs regulation the answer? (section 2.4) ‘free market’ perspective ‘pro-regulation’ perspectiveThree theories of regulation (2.5)Standard setting as a political process (2.6)
  • The Fundamental Problem ofFinancial Accounting TheoryProvision of relevantinfo. to aid investorDecision making Provision of reliable info. to control management behaviour
  • Possible solutions1. Let market forces determine whatinformation is supplied2. Regulate the provision of financialinformation
  • Current Sources of Accounting Regulations in AustraliaFRC - Financial Reporting Council oversight of the standard setting processAASB - Aust. Accounting Standards Board Technical deliberations about new and changed accounting standards Approximately 40 standards on issue Currently undertaking harmonisation with International Accounting Standards
  • Is Regulation the Answer? (section 2.4)
  • Free market approachAccounting information is like any otherproduct, subject to: demand (from users/investors) and supply (by companies/managers)Rely on market forces (including contractualdemands) to determine what information to supply the quality of information suppliedMarket-based penalties discourage non-supply and misleading information
  • Incentives for managers to supply informationContractual Information for monitoring of managers (to overcome problems of moral hazard) Contractual terms are often tied to accounting numbers – creates demand for accounting and auditing (stewardship role of financial reporting) Threat of price-protection transfers incentive from other parties to managers – managers have an incentive to supply information
  • Incentives for managers to supply information (cont.)Capital markets Demand for information about potential investments (to overcome problems of adverse selection) Need to raise capital creates incentives for managers to supply the information (information role of financial reporting) Penalties for non-supply and/or misleading information include higher costs of capital
  • Incentives for managers to supply information (cont.)Markets for managers and corporatetakeovers Impose further penalties for non-supply and/or misleading information (manager remuneration, threat of takeover)Market for ‘lemons’ Provides further incentives to disclose information, including ‘bad news’Potential litigation costs impose furtherpenalties in relation to misleadinginformation
  • Free market approachEquilibrium is where costs of providing info = benefitsManagers have incentives to supplyinformation, eg. to raise debt and equitycapital, but must also consider the costassociated with disclosing the informationInvestors demand information. However,once the information is available, they bear nocosts, only benefitsSome parties demanding the info. are morepowerful than others
  • The ‘pro-regulation’ perspectiveAccounting information is a public good once the information is released it can be made available to everyoneFree-riders (eg potential investors) do not pay aprice for the production of the informationCauses underproduction of information due to adecreased incentive to supply the informationfor free (market failure => need regulation)Counter-argument (against regulation) Free-riders have greater incentives to demand increased disclosure (there is a risk that the AASB responds to this exaggerated demand)
  • The ‘pro-regulation’ perspectiveAnother problem with the ‘free market’approach is thatFirms are monopolist suppliers ofinformation about themselves tendency to under-produce and sell at a high priceThese problems prevent optimal operationof competitive market - market failure
  • The ‘pro-regulation’ perspectiveRegulation creates a ‘level playing field’ Everyone has access to the same information Increases confidence in capital marketsRegulation is in the ‘public interest’ To protect the ‘more vulnerable’
  • Why is financial reporting so regulated?Free-market approach and self-regulation by profession had problemsGovernment intervention to protect thepublic interest (investors and otherusers of financial information)This is what the public interest theoryproposes
  • Three Theories of Regulation (Section 2.5) 1 1 2 3
  • Three Theories of Regulation1. Public Interest Theory2. (Regulatory) Capture Theory3. Private Interest Theory (EconomicInterest Group Theory of Regulation)Important - these theories help is tounderstand ‘what is’ rather thanprescribing ‘what should be’
  • Public Interest TheoryGovernment intervention in markets is in the‘public interest’ due to inefficient orinequitable market practicesGovernment intervened in accountingregulation in 1984 (ASRB) due to marketfailure failed companies with clean audit bills lack of info stemming from information asymmetriesTheory based on some unrealistic (?)assumptions
  • Public Interest Theory: AssumptionsMarkets are subject to failurePoliticians help investors by regulating thesupply of financial informationThere are agents (politicians / public interestgroups) who genuinely seek regulation in thepublic interestGovernment has no independent role to playin the development of regulation - it is aneutral arbiter. ie theory ignores self-interestof politicians and government officials
  • Review - Self InterestAn important concept that helps usunderstand the way the world worksFinancial reporting and its regulationare affected by the self interest of theindividuals involvedIndividuals form into groups to helpachieve their objectives
  • Interests of the Accounting ProfessionThe accounting profession has an interest incontrolling and overseeing the regulation offinancial reportingSelf-regulation by profession failed due tonon-compliance and lack of legitimacyAlternative solution - ‘capture’ governmentregulation of financial reporting
  • The Capture ProcessRegulators set out to protect publicinterest, but are subsequently capturedby regulated partiesDue to the interaction during theprocess of regulatingRegulatory agencies empathise withthose who are regulatedSubsequent regulations areadvantageous to regulated parties
  • Capture Theory: Application to AccountingWalker (1987) argues that Government initially created the ASRB (now AASB) to protect the public interest Professional bodies (the regulated industry) subsequently managed to capture the ASRB Outcome – Standards set by accounting profession and legitimised by Government (Perfect for profession!)
  • Impact of Self InterestCapture theory builds on public interesttheory by considering the self-interest ofregulated partiesHowever, capture theory ignores the selfinterest of other groups and individualsPrivate interest theory (economic interestgroup theory) does not have this limitation
  • Private Interest TheoryAcknowledges that individuals form intogroups to pursue their self interestProposes that private interests rather thanpublic interests dominate the regulatoryprocessRegulatory outcomes reflect the interests ofthe most powerful groupPoliticians are not neutral arbiters – theyseek re-election and are able to be ‘bought’
  • Who seeks the power in financial reporting?Accounting profession was not the onlygroup to focus on the AASBThe producer group (companies) are likely toseek control of accounting regulationMajor interest groups are: Members of accounting professional bodies Managers of companies (producer group) Government officials and politicians
  • Who is the highest Bidder?The industry group(companies) often has thegreatest ability to supplythe desired payoffs to thepolitical power brokers
  • Summary of theories of regulationPublic interest theory ignores self interestcompletely - niaveRegulatory capture acknowledges some selfinterest - part of the story but not all of itPrivate interest theory acknowledges selfinterest of all parties involvedTheories build on each other.
  • Standard Setting as a Political Process (Section 2.6)
  • The Politics of Accounting RegulationStandard setting is a political processStandard setting is political because it affectsthe well-being of a wide variety of interestgroupsExpect these groups to pursue their interestsand attempt to influence the processAccounting standards are developed havingregard to social and economic consequences
  • The Process of Developing AASBs (Due Process)1. Selection of topics2. Appointment of advisory panel3. Discussion paper / theory monograph4. Key issues5. Exposure draft6. Accounting standard7. Legislation
  • Objective, neutral & apoliticalFinancial Reporting and the Regulation ofFinancial Reporting are not: Objective Neutral ApoliticalFinancial reporting is a function of (a)accounting regulations, and (b) financialreporting decisionsIf neither of these are objective, neutral orapolitical, how can financial reporting be?
  • For Tutorials Required reading Text chapter 3 Self assessment questions Questions 8 - 17 from module 2 Answers in tutorials