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CHAPTER 12 Standard Setting: Economic Issues
Cory Bettel ∙ Jeff Chang ∙ Danielle Dodd Ryan Gruenspan ∙ Victoria Kavanagh ∙ Sally Regenstreif
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AGENDA 12.1 Overview 12.2 Regulation of Economic Activity 12.3
Characterizing Information Production 12.4 First-best Information Production 12.5 Market Failures in Info. Production 12.6 Contractual Incentives for Information Production 12.7 & 12.8 Market-based Incentives for Information Production 12.9 Disclosure 12.10 Decentralized Regulation 12.11 How much information is enough? Article 1 Improved Standards in the Future
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OVERVIEW OVERVIEW REGULATION INFORMATION PRODUCTION MARKET FAILURES CONTRACTUAL INCENTIVES MARKET-BASED INCENTIVES DISCLOSURE DECENTRALIZED REGULATION HOW MUCH IS ENOUGH ? FUTURE OF STANDARDS Standard Setting: The regulation of firm’s external information production decisions by a regulator.
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OVERVIEW OVERVIEW REGULATION INFORMATION PRODUCTION MARKET FAILURES CONTRACTUAL INCENTIVES MARKET-BASED INCENTIVES DISCLOSURE DECENTRALIZED REGULATION HOW MUCH IS ENOUGH ? FUTURE OF STANDARDS Standard setting is ultimately the government’s responsibility Regulators are agencies delegated to set accounting standards (E.g. IASB and FASB) Act as a mediator between conflicting interests of investors and managers Ensure the right amount of information is in the financial statements
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First-Best: Amount that equates marginal benefits to marginal costs
STANDARD SETTING OVERVIEW REGULATION INFORMATION PRODUCTION MARKET FAILURES CONTRACTUAL INCENTIVES MARKET-BASED INCENTIVES DISCLOSURE DECENTRALIZED REGULATION HOW MUCH IS ENOUGH ? FUTURE OF STANDARDS Fundamental problem is discerning the socially “right” amount of information First-Best: Amount that equates marginal benefits to marginal costs Impossible due to market complexities
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REGULATION OF ECONOMIC ACTIVITY
OVERVIEW REGULATION INFORMATION PRODUCTION MARKET FAILURES CONTRACTUAL INCENTIVES MARKET-BASED INCENTIVES DISCLOSURE DECENTRALIZED REGULATION HOW MUCH IS ENOUGH ? FUTURE OF STANDARDS Regulation protects individuals who are at an information disadvantage Occurs due to information asymmetry Improves markets by enhancing public confidence Common Examples: GAAP, IFRS, MD&A, profession laws, full disclosure laws, etc.
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REGULATION OF ECONOMIC ACTIVITY
OVERVIEW REGULATION INFORMATION PRODUCTION MARKET FAILURES CONTRACTUAL INCENTIVES MARKET-BASED INCENTIVES DISCLOSURE DECENTRALIZED REGULATION HOW MUCH IS ENOUGH ? FUTURE OF STANDARDS 2 Types of Information: Proprietary Information Non-proprietary Information
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CHARACTERIZE INFORMATION PRODUCTION
OVERVIEW REGULATION INFORMATION PRODUCTION MARKET FAILURES CONTRACTUAL INCENTIVES MARKET-BASED INCENTIVES DISCLOSURE DECENTRALIZED REGULATION HOW MUCH IS ENOUGH ? FUTURE OF STANDARDS “Production” of information used for 2 reasons: Information is a commodity Consistent way of thinking about its production Quantity of information: Finer information Additional information Credibility
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PROS & CONS OF INFORMATION PRODUCTION
OVERVIEW REGULATION INFORMATION PRODUCTION MARKET FAILURES CONTRACTUAL INCENTIVES MARKET-BASED INCENTIVES DISCLOSURE DECENTRALIZED REGULATION HOW MUCH IS ENOUGH ? FUTURE OF STANDARDS Benefits include: Better-informed investment decision Lower costs of capital Better-working markets Reduction of monopoly power Timely recognition of firm failure Potential information release about other firms Costs include: Direct costs of preparation and release Possible release of proprietary information Increased contracting costs
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MARKET FAILURES IN INFO. PRODUCTION
OVERVIEW REGULATION INFORMATION PRODUCTION MARKET FAILURES CONTRACTUAL INCENTIVES MARKET-BASED INCENTIVES DISCLOSURE DECENTRALIZED REGULATION HOW MUCH IS ENOUGH ? FUTURE OF STANDARDS Externality: An action taken by a firm or individual that imposes costs or benefits on others for which the creating entity is not charged or does not receive revenue. The perception of these costs and benefits differs between the firm and society Free-riding: The receipt of a firm or individual of a benefit from an externality .
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EXTERNALITY EXAMPLES OVERVIEW REGULATION INFORMATION PRODUCTION MARKET FAILURES CONTRACTUAL INCENTIVES MARKET-BASED INCENTIVES DISCLOSURE DECENTRALIZED REGULATION HOW MUCH IS ENOUGH ? FUTURE OF STANDARDS Darrough and Stoughton: monopolies keeps certain information private to deter entry Reduces proprietary costs, but decreases benefit to society Lambert, Leuz, and Verrecchia: earnings information released affects other firm’s stock prices Decreases Beta which decreases cost of capital- but decreases for all firms Anilosky, Feng and Skinner: firm’s reporting good earnings does not provide an externality about future economic performance If firms’ reporting became more timely, this could increase
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FREE-RIDING EXAMPLES OVERVIEW REGULATION INFORMATION PRODUCTION MARKET FAILURES CONTRACTUAL INCENTIVES MARKET-BASED INCENTIVES DISCLOSURE DECENTRALIZED REGULATION HOW MUCH IS ENOUGH ? FUTURE OF STANDARDS Information has a public-good nature, more than one investor can use it Investors are able to free-ride Information must be free Firms produce less information than society would like
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ADVERSE SELECTION PROBLEM
OVERVIEW REGULATION INFORMATION PRODUCTION MARKET FAILURES CONTRACTUAL INCENTIVES MARKET-BASED INCENTIVES DISCLOSURE DECENTRALIZED REGULATION HOW MUCH IS ENOUGH ? FUTURE OF STANDARDS Insider trading Managers trade on inside information No longer a fair game Bad news is not released
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MORAL HAZARD PROBLEM Net income is not fully informative of effort
OVERVIEW REGULATION INFORMATION PRODUCTION MARKET FAILURES CONTRACTUAL INCENTIVES MARKET-BASED INCENTIVES DISCLOSURE DECENTRALIZED REGULATION HOW MUCH IS ENOUGH ? FUTURE OF STANDARDS Net income is not fully informative of effort Mangers disguise shirking and low profits by earnings management or reducing disclosure
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UNANIMITY OVERVIEW REGULATION INFORMATION PRODUCTION MARKET FAILURES CONTRACTUAL INCENTIVES MARKET-BASED INCENTIVES DISCLOSURE DECENTRALIZED REGULATION HOW MUCH IS ENOUGH ? FUTURE OF STANDARDS If markets work well, shareholders will unanimously be in favour of the manager maximizing the market value of the firm If markets do not work well, no longer will be unanimous
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EXAMPLES OF CONTRACTUAL INCENTIVES
OVERVIEW REGULATION INFORMATION PRODUCTION MARKET FAILURES CONTRACTUAL INCENTIVES MARKET-BASED INCENTIVES DISCLOSURE DECENTRALIZED REGULATION HOW MUCH IS ENOUGH ? FUTURE OF STANDARDS Information is required to observe compliance with contracts Unobservable managerial effort Financial covenants for firms issuing debt When a private firm goes public, increased possibility of shirking
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JENSEN & MECKLING MODEL
OVERVIEW REGULATION INFORMATION PRODUCTION MARKET FAILURES CONTRACTUAL INCENTIVES MARKET-BASED INCENTIVES DISCLOSURE DECENTRALIZED REGULATION HOW MUCH IS ENOUGH ? FUTURE OF STANDARDS Investors will become aware of shirking As a result, share prices decline Management incentive to reduce shirking Contracts include forecasts Increase financial reporting Overall increase in information production
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CONTRACTUAL INCENTIVES
THE COASE THEOREM OVERVIEW REGULATION INFORMATION PRODUCTION MARKET FAILURES CONTRACTUAL INCENTIVES MARKET-BASED INCENTIVES DISCLOSURE DECENTRALIZED REGULATION HOW MUCH IS ENOUGH ? FUTURE OF STANDARDS Created by Ronald Coase Problem of externalities can be internalized Reduce need for regulation Illustrated by two farms located side by side
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COASE THEOREM ILLUSTRATION
OVERVIEW REGULATION INFORMATION PRODUCTION MARKET FAILURES CONTRACTUAL INCENTIVES MARKET-BASED INCENTIVES DISCLOSURE DECENTRALIZED REGULATION HOW MUCH IS ENOUGH ? FUTURE OF STANDARDS Two farms: One raises cattle One grows crops Cattle roam into crops, damaging value Two solutions: Regulate the two farms – fencing Farmers bargain
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COASE THEOREM ILLUSTRATION
OVERVIEW REGULATION INFORMATION PRODUCTION MARKET FAILURES CONTRACTUAL INCENTIVES MARKET-BASED INCENTIVES DISCLOSURE DECENTRALIZED REGULATION HOW MUCH IS ENOUGH ? FUTURE OF STANDARDS Fence costs $100, damage costs $150 Assume property rights belong to the cattle farmer Cattle can stray Crop farmer will put up fence Assume property rights belong to the crop farmer Damages repaid by cattle farmer Cattle farmer will put up fence The fence replaces the need for regulation
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COASE THEOREM ILLUSTRATION
OVERVIEW REGULATION INFORMATION PRODUCTION MARKET FAILURES CONTRACTUAL INCENTIVES MARKET-BASED INCENTIVES DISCLOSURE DECENTRALIZED REGULATION HOW MUCH IS ENOUGH ? FUTURE OF STANDARDS Firm information costs $100 to release Benefit to investor is $150 .: Firm will release information without regulation Benefit to Investors Cost to Firm <
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MANAGERIAL LABOUR MARKET
OVERVIEW REGULATION INFORMATION PRODUCTION MARKET FAILURES CONTRACTUAL INCENTIVES MARKET-BASED INCENTIVES DISCLOSURE DECENTRALIZED REGULATION HOW MUCH IS ENOUGH ? FUTURE OF STANDARDS Evaluates manager performance on an ongoing basis Reputation suffers if information is false, biased or incomplete Need for contracts not completely removed Number of incentives reduced Example: Manager‘s profit share Reduced from 35% to 20% Lower amount of compensation in jeopardy Risk averse manager more likely to provide information
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MARKET-BASED INCENTIVES
CAPITAL MARKETS OVERVIEW REGULATION INFORMATION PRODUCTION MARKET FAILURES CONTRACTUAL INCENTIVES MARKET-BASED INCENTIVES DISCLOSURE DECENTRALIZED REGULATION HOW MUCH IS ENOUGH ? FUTURE OF STANDARDS Managers motivated by reputation and wanting to increase firm value Assume investors cannot diversify against adverse selection & estimation risk Managers release information due to motivation to strengthen reputation and increase firm value Market prices of the firms’ shares increase, or equivalently, cost of capital will fall Higher firm profitability and value Increased compensation
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MARKET-BASED INCENTIVES
TAKEOVER MARKET OVERVIEW REGULATION INFORMATION PRODUCTION MARKET FAILURES CONTRACTUAL INCENTIVES MARKET-BASED INCENTIVES DISCLOSURE DECENTRALIZED REGULATION HOW MUCH IS ENOUGH ? FUTURE OF STANDARDS Market for corporate control If manager does not increase value, subject to takeover bid Replacement of management The more aggravated investors are, more likely takeover will happen Market motivates managers to increase firm value Information is produced and released
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THE DISCLOSURE PRINCIPLE
OVERVIEW REGULATION INFORMATION PRODUCTION MARKET FAILURES CONTRACTUAL INCENTIVES MARKET-BASED INCENTIVES DISCLOSURE DECENTRALIZED REGULATION HOW MUCH IS ENOUGH ? FUTURE OF STANDARDS Disclosure Principle – managers will release all info, good or bad Rational investors Assume the manager will only release favourable info If managers do not release info, will assume the worst Therefore, managers should release all info, or risk decreasing firm value Incentive to keep share price from falling
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THE DISCLOSURE PRINCIPLE
OVERVIEW REGULATION INFORMATION PRODUCTION MARKET FAILURES CONTRACTUAL INCENTIVES MARKET-BASED INCENTIVES DISCLOSURE DECENTRALIZED REGULATION HOW MUCH IS ENOUGH ? FUTURE OF STANDARDS “Does it always work?” Verrecchia (1983): managers may not fully disclose at all times Assumptions: Disclosures made are truthful Disclosures have a cost Investors know managers have info & the cost of disclosure Investors do not know what the info is
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THE DISCLOSURE PRINCIPLE
OVERVIEW REGULATION INFORMATION PRODUCTION MARKET FAILURES CONTRACTUAL INCENTIVES MARKET-BASED INCENTIVES DISCLOSURE DECENTRALIZED REGULATION HOW MUCH IS ENOUGH ? FUTURE OF STANDARDS Threshold levels of disclosure exist News will be disclosed if info exceeds threshold Unknown to investors why managers are withholding info Disclosure principle fails Reinstated if cost of disclosure = 0
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MARKET-BASED INCENTIVES
PAE (2005) OVERVIEW REGULATION INFORMATION PRODUCTION MARKET FAILURES CONTRACTUAL INCENTIVES MARKET-BASED INCENTIVES DISCLOSURE DECENTRALIZED REGULATION HOW MUCH IS ENOUGH ? FUTURE OF STANDARDS Relaxed the assumption that the market knows the manager has info Still an incentive for voluntary disclosure? More than one piece of news? What happens with non-proprietary info?
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MARKET-BASED INCENTIVES
PAE (2005) OVERVIEW REGULATION INFORMATION PRODUCTION MARKET FAILURES CONTRACTUAL INCENTIVES MARKET-BASED INCENTIVES DISCLOSURE DECENTRALIZED REGULATION HOW MUCH IS ENOUGH ? FUTURE OF STANDARDS Forecast of earnings & cash flows Costly for firms to develop internally & no cost of release Investors do not know whether firms have developed them or not Investors will asses probabilities Iffirm develops both forecasts, only disclose > threshold Iffirm has not developed either, disclose nothing
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MARKET-BASED INCENTIVES
DISCLOSURE PRINCIPLE OVERVIEW REGULATION INFORMATION PRODUCTION MARKET FAILURES CONTRACTUAL INCENTIVES MARKET-BASED INCENTIVES DISCLOSURE DECENTRALIZED REGULATION HOW MUCH IS ENOUGH ? FUTURE OF STANDARDS Though it is a basic & strong argument that firms will release news, it easily breaks down in a number of situations Therefore, cannot be relied upon that all info will always be released by firms
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MARKET-BASED INCENTIVES
SIGNALING OVERVIEW REGULATION INFORMATION PRODUCTION MARKET FAILURES CONTRACTUAL INCENTIVES MARKET-BASED INCENTIVES DISCLOSURE DECENTRALIZED REGULATION HOW MUCH IS ENOUGH ? FUTURE OF STANDARDS Signaling: An action taken by a high-type manager that would not be rational if that manager was low-type. Signal must be less costly for a high-type manager to be credible Irrational for low-type to mimic high- type Some signals include…
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MARKET-BASED INCENTIVES
SIGNALS OVERVIEW REGULATION INFORMATION PRODUCTION MARKET FAILURES CONTRACTUAL INCENTIVES MARKET-BASED INCENTIVES DISCLOSURE DECENTRALIZED REGULATION HOW MUCH IS ENOUGH ? FUTURE OF STANDARDS Proportion of retained equity Entrepreneur/manager making an IPO Too costly for low-type to do Audit quality Signals value of new securities issue High quality auditors are costly for low-type Forecasts E.g. Canadian Tire’s MD&A Info disclosure beyond minimum requirements Signals confidence in firm’s future, which adds credibility
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MARKET-BASED INCENTIVES
SIGNALS OVERVIEW REGULATION INFORMATION PRODUCTION MARKET FAILURES CONTRACTUAL INCENTIVES MARKET-BASED INCENTIVES DISCLOSURE DECENTRALIZED REGULATION HOW MUCH IS ENOUGH ? FUTURE OF STANDARDS Capital Structure Issuance of new shares causes existing shares to drop in value High-type firm would likely find other sources of financing E.g. Bonds, internal financing Dividend Policy High payout ratio = confidence in future performance Accounting Policy Increased conservation = greater confidence
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MARKET-BASED INCENTIVES
SIGNALING OVERVIEW REGULATION INFORMATION PRODUCTION MARKET FAILURES CONTRACTUAL INCENTIVES MARKET-BASED INCENTIVES DISCLOSURE DECENTRALIZED REGULATION HOW MUCH IS ENOUGH ? FUTURE OF STANDARDS NOTE: Managers must have choice. E.g. if equal audit quality imposed on all firms, then not available as a signal
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PRIVATE INFORMATION SEARCH
OVERVIEW REGULATION INFORMATION PRODUCTION MARKET FAILURES CONTRACTUAL INCENTIVES MARKET-BASED INCENTIVES DISCLOSURE DECENTRALIZED REGULATION HOW MUCH IS ENOUGH ? FUTURE OF STANDARDS Management onus to release info Implies investors are passive Investors may conduct private info searches If successful, inside info can quickly go public High cost to society
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THEORY OF SUPERIOR DISCLOSURE
OVERVIEW REGULATION INFORMATION PRODUCTION MARKET FAILURES CONTRACTUAL INCENTIVES MARKET-BASED INCENTIVES DISCLOSURE DECENTRALIZED REGULATION HOW MUCH IS ENOUGH ? FUTURE OF STANDARDS Theory: If market forces motivate superior disclosure levels from firms Firms should benefit from a lower cost of capital Decrease exists as increased disclosure reduces investors risk May also positively affect the firms’ future investment and production decisions
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THEORY OF SUPERIOR DISCLOSURE
OVERVIEW REGULATION INFORMATION PRODUCTION MARKET FAILURES CONTRACTUAL INCENTIVES MARKET-BASED INCENTIVES DISCLOSURE DECENTRALIZED REGULATION HOW MUCH IS ENOUGH ? FUTURE OF STANDARDS The theory is relatively unproven and many researchers still disagree today Supporters include: 1. Lehavy & Sloan (2008): When number of wealthy (Assumed informed) investors holding stock increased, future returns on the stock fell Less risk as investor estimation risk is minimized
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THEORY OF SUPERIOR DISCLOSURE
OVERVIEW REGULATION INFORMATION PRODUCTION MARKET FAILURES CONTRACTUAL INCENTIVES MARKET-BASED INCENTIVES DISCLOSURE DECENTRALIZED REGULATION HOW MUCH IS ENOUGH ? FUTURE OF STANDARDS Supporters also include: 2. Dechow, Sloan & Sweeney (1996): An average drop of 9% in share price on the day that the SEC decides to investigate a firm that has violated GAAP/IFRS Bad Reporting = Higher Investor Risk Higher Risk = More volatile earnings (High Cost of Capital) .: Good Reporting = Stable earnings (Low Cost of Capital)
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THEORY OF SUPERIOR DISCLOSURE
OVERVIEW REGULATION INFORMATION PRODUCTION MARKET FAILURES CONTRACTUAL INCENTIVES MARKET-BASED INCENTIVES DISCLOSURE DECENTRALIZED REGULATION HOW MUCH IS ENOUGH ? FUTURE OF STANDARDS Those opposing the theory include: Core, Guay & Verdi (2008): Higher accrual quality does not imply a lower cost of capital It’s believed that higher accrual quality will signal to users about the organization’s next year of business This would in tern decrease investor estimation risk and decrease WACC Core, Guay & Verdi determined that such a connection does not exist.
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THEORY OF SUPERIOR DISCLOSURE
OVERVIEW REGULATION INFORMATION PRODUCTION MARKET FAILURES CONTRACTUAL INCENTIVES MARKET-BASED INCENTIVES DISCLOSURE DECENTRALIZED REGULATION HOW MUCH IS ENOUGH ? FUTURE OF STANDARDS In conclusion… Difficult to say that firms and investors do not benefit from higher disclosure from an accounting perspective Difficult to prove conclusively though, due to: Variety of measures of investor risk Difficult to measure cost of capital effectively
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DECENTRALIZED REGULATION
OVERVIEW REGULATION INFORMATION PRODUCTION MARKET FAILURES CONTRACTUAL INCENTIVES MARKET-BASED INCENTIVES DISCLOSURE DECENTRALIZED REGULATION HOW MUCH IS ENOUGH ? FUTURE OF STANDARDS Gives management some flexibility in reporting Reduces comparability across firms Improves the relevance of reporting Reliability may be controlled Since management would have to change a firms internal organization to exploit flexibility Decentralized regulation gives management some flexibility in reporting. Even though this approach reduces comparability across firms, it allows the potential to increase decision useful information by improving relevance. In addition, reliability mat be controled since management would have to change a firms internal organization to exploit the flexibility.
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DECENTRALIZED REGULATION
OVERVIEW REGULATION INFORMATION PRODUCTION MARKET FAILURES CONTRACTUAL INCENTIVES MARKET-BASED INCENTIVES DISCLOSURE DECENTRALIZED REGULATION HOW MUCH IS ENOUGH ? FUTURE OF STANDARDS Segment Reporting Useful since relevant information may be buried in consolidated totals It is harder to disguise poor performance Regulated by IFRS 8 Requires reporting externally on same basis as internally Flexibility results in useful information to investors The cost of opportunism in segment reporting will be high One example of decentralized regulation is segment reporting. Information about firms segments is potentially useful to investors since relevant information such as risks, rates of return, and opportunities for growth, may be buried in consolidated totals. Segment reporting also makes it harder to discuise poor performance in one segment by burying it in good performance of another. Decentralized reporting is regulated by IFRS 8, which requires that firms normally report segment information on the same basis as it organizes its segments internally for top management decision making and performance evaluation. IFRS 8 leads to greater usefulness as it will give investors the best insights into the firm’s operations. Also results in the cost of opportunism to be high leading to greater reliability.
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DECENTRALIZED REGULATION
OVERVIEW REGULATION INFORMATION PRODUCTION MARKET FAILURES CONTRACTUAL INCENTIVES MARKET-BASED INCENTIVES DISCLOSURE DECENTRALIZED REGULATION HOW MUCH IS ENOUGH ? FUTURE OF STANDARDS Standards allowing Fair Value Decentralized since management is given a choice Gives management the ability to signal through its choice of reporting methods Another example of decentralized regulation is the standards allowing Fair Value, which gives management a choice. This ultimately gives management the opportunity to signal to investors by their choice of reporting methods.
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Complete Regulation is too costly Direct costs such as
HOW MUCH INFO IS ENOUGH? OVERVIEW REGULATION INFORMATION PRODUCTION MARKET FAILURES CONTRACTUAL INCENTIVES MARKET-BASED INCENTIVES DISCLOSURE DECENTRALIZED REGULATION HOW MUCH IS ENOUGH ? FUTURE OF STANDARDS Complete Regulation is too costly Direct costs such as Bureaucracy to establish and administer regulations Compliance costs to firms Indirect costs such as Reduction in mgmt opportunity to signal Costs of “wrong” amounts of information A very important question in Accounting theory now becomes how much info is enough? On one end of the spectum we have complete regulation, which poses too costly. Direct costs include the bureaucracy to establish and administer all the regulations, and the compliance costs to firms. The indirect costs of complete regulation include the reduction in managments opportunity to signal, and the costs of any wrong amounts of informatino production, which can be huge given the complexity information.
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Complete Deregulation Not socially desirable
HOW MUCH INFO IS ENOUGH? OVERVIEW REGULATION INFORMATION PRODUCTION MARKET FAILURES CONTRACTUAL INCENTIVES MARKET-BASED INCENTIVES DISCLOSURE DECENTRALIZED REGULATION HOW MUCH IS ENOUGH ? FUTURE OF STANDARDS Complete Deregulation Not socially desirable Uncontrolled impacts of externalities, adverse selection, and moral hazard would be extremely serious Markets would probably cease to function On the other end of the spectrum with have complete deregulation, which is not socially desirable. The uncontrolled impacts of externalities, adverse selection, and moral hazard would be sufficiently serious that markets would probability cease to function.
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HOW MUCH INFO IS ENOUGH? Range of regulation is up for debate
OVERVIEW REGULATION INFORMATION PRODUCTION MARKET FAILURES CONTRACTUAL INCENTIVES MARKET-BASED INCENTIVES DISCLOSURE DECENTRALIZED REGULATION HOW MUCH IS ENOUGH ? FUTURE OF STANDARDS Range of regulation is up for debate Theorem of the second best We many never know the socially correct extent of regulation Consider the effects of the Sarbanes-Oxley Act Showed net positive effect to investors But reduced utilities of insiders, and lowered the number of firms offering securities Can’t infer the “social” benefits are positive Thus ultimately the range of regulation is up for debate. And the theorem of the second bests suggests that we many never know the socially correct extent of regulation. The effects of the Sarbanes-Oxley Act provides an illistration of the complexity of regulation. The act was intended to incrase social welfare by reducing the ability of managers to act opportunistically. Results shows positive net effects to investors, but it also led to reductions in the utilities of insiders, and reductions in the number of firms offering securities to the public. Thus, because of the complexitiy of regulation we are unable to infer that the social benefits of this act are positive.
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HOW MUCH INFO IS ENOUGH? In conclusion…
OVERVIEW REGULATION INFORMATION PRODUCTION MARKET FAILURES CONTRACTUAL INCENTIVES MARKET-BASED INCENTIVES DISCLOSURE DECENTRALIZED REGULATION HOW MUCH IS ENOUGH ? FUTURE OF STANDARDS In conclusion… The extent of standards is a complex and important question for a market economy Standard setting boils down to a cost- benefit trade-off. However this trade-off may never be fully known A method for dealing with this uncertainty is to give firms flexibility in meeting reporting standards In conclusion the extent to which standards for information production should be imposed is a complex and important question for a market economy. There are many private forces of voluntary information production discussed earlier, however these alone do not produce enough information to meet demand. Thus, regulation introduced by standard setters, however many costs are associated. As a result, standard setting boils down to a costs benefit trade-off. As discussed we may never know the most beneficial tradeoff. However, to deal with this uncertainty standard setters gives firms some flexibilty in meeting reporting standards.
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THE FUTURE: IMPROVED STANDARDS
OVERVIEW REGULATION INFORMATION PRODUCTION MARKET FAILURES CONTRACTUAL INCENTIVES MARKET-BASED INCENTIVES DISCLOSURE DECENTRALIZED REGULATION HOW MUCH IS ENOUGH ? FUTURE OF STANDARDS AcSB has started the Accounting Standards Improvement project Focused on ensuring statements prepared with best practices Increased discussion of convergence between IASB and FASB Would create a “gold standard” for major capital markets Maintaining converged standards = converged interpretation processes
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