What is the foundation for the claim that accounting regulation can stifle reporting companies’ ability to
disclose information about their financial performance and position in an efficient manner?
Ans.
This is an argument made by those who are opposed to regulation and who believe that businesses should
be free to choose the accounting techniques that best reflect their underlying operations. It’s a regulatory
skeptic’s argument.
The idea is that organizations have numerous market-based motivations to give information that
accurately reflects the reporting entity’s financial performance and financial situation. According to one
school of thought, the more effectively an organization can offer accounting information, the lower the
perceived risk of investing in it. That is, managers inside organizations will be rewarded for using
accounting procedures that best reflect the entity’s underlying financial performance and position
(commonly referred to as the ‘efficiency perspective’).
Regulators may decide to limit the accounting methods that an organization can use. (Perhaps the
regulators will issue an accounting standard prohibiting certain accounting procedures; for example, they
may issue an accounting standard requiring all firms to expense research spending as it is incurred, even
if the research would result in considerable economic advantages.) If this is the case, the reporting entity
will no longer be able to choose the most appropriate (or ‘efficient’) accounting procedures, and hence
the accounting information will not accurately reflect the entity’s financial performance or situation. Users
will not be able to monitor the business as well as they might otherwise be able to if the information does
not accurately reflect the underlying transactions, which will increase the perceived risk of investing in
the entity.
As a result, the firm will have to pay more to attract capital.
While the preceding arguments (which are focused on efficiency) argue against limiting the accounting
procedures that reporting organizations can use, it is important to recognize that there is a ‘opportunistic
perspective’. If we feel that managers are opportunistic, it might be desirable to limit the accounting