Chapter 13
Standard Setting: Political Issues
13 - 1
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Chapter 13 Standard Setting: Political Issues
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Copyright © 2009 by Pearson Education Canada
13.2 Two Theories of Regulator Behaviour
• Public Interest Theory
– Objective of regulator is to maximize social welfare
• Interest Group Theory
– Regulator takes own interests into account, while
balancing demands of investors and managers
– Implies conflict between constituencies
• Standard setters’ emphasis on due process
suggests that interest group theory best applies
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13.3 Conflict and Compromise
• 13.3.1 Another example of economic consequences
– Difficulties faced by IASB in developing IAS 39 illustrate
extent of constituency conflict in standard setting
• Concerns of several constituencies
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–
–
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European Central Bank
European Union carveout
Danish regulators
Association of Corporate Treasurers
• IASB compromises
– Macro hedging
– Restrict fair value option
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13.3.2 Other Comprehensive Income
• Items included
– Unrealized gains and losses on available-for-sale
securities
– Unrealized gains and losses on cash flow hedges
• Rationale
– To secure management constituency’s acceptance of
fair value accounting
» Continued
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13.3.2 Other Comprehensive Income
(continued)
• 2 alternative presentations
– Presented with Income Statement
•
•
•
•
•
Net income from operations
Extraordinary items
Net income
Other comprehensive income
Comprehensive income
xxx
xxx
xxx
xxx
xxx
– Alternative Presentation
• As part of statement of changes in shareholders’ equity
» Continued
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13.3.2 Other Comprehensive Income
(continued)
• Firms’ choice of alternative has information
content for investors
– Theory in Practice 13.1
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13.4 Rules-Based v. Principles-Based
Accounting Standards
• Rules-Based Standards
– Lay down detailed rules
– Possible to lay down rules for everything?
• Recall Hobbes, text Section 1.3
• Principles-Based Standards
– Lay down general principles
– Auditor professional judgement relied on to prevent
opportunistic manager behaviour when applying the
principles
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13.5 Criteria for Standard Setting
• Decision usefulness
• Reduction of information asymmetry
• Economic consequences
– Benefits > social costs
• Acceptable to constituencies
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13.6 International Integration of Capital
Markets
• Increasing adoption of IASB standards
– Some examples
•
•
•
•
•
European Union, 2005
China, Japan (partially)
Australia, 2005
Canada, from 2011
United States?
– Allows foreign companies under SEC jurisdiction to report using
IASB standards without reconciliation, 2007
– Norwalk Agreement to work towards standards convergence
» Continued
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13.6 International Integration of Capital
Markets (continued)
• 13.6.2 effect of customs and institutions
– Code law countries
• Greater influence of families and banks in corporate governance
than in common law countries
• Lower moral hazard problem
• Shows up as less timely and less conservative reporting, even if
country has adopted IASB standards
– Implication that investors should be aware of local
practices and customs when interpreting financial
statements, even if country uses IASB standards
» Continued
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13.6 International Integration of Capital
Markets (continued)
• 13.6.3 role of auditor
– Even high quality standards must be enforced
– Protection of small investors
• Moral hazard problem switches to one between an entrenched
controlling interest and small investors
– Auditor may be under great pressure from controlling
interests
• Some evidence that auditors succumb to this pressure
– Guedhami & Pittman (2006)
» Continued
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13.6 International Integration of Capital
Markets (continued)
• 13.6.4 benefits of high quality accounting
standards
– Better working securities markets
– Higher earnings quality
– More foreign investment
» Continued
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13.6 International Integration of Capital
Markets (continued)
• Should standard setters compete?
– e.g., if firms could choose between IASB & FASB
standards
• Race to the bottom?
• Race to the top? (Problem 13.7)
– Firms could signal commitment to high quality reporting by
choosing the higher quality standards
• Do benefits of competition outweigh increased costs of
allowing 2 sets of standards?
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13.7 Summing Up
• Information asymmetry is basic reason for financial
reporting
– Adverse selection
– Moral hazard
• Fundamental problem of financial accounting
theory
– Best information system to control adverse selection not
necessarily the same as best system to control moral
hazard
– Leads to constituency conflict
– Standard setters must mediate this conflict
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The End
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