QUESTION
A) Let us assume that the government has become concerned that existing disclosure regulation tends to fixate on the financial performance of organisations but fails to address other aspects of corporate performance, including a failure to provide information about corporate social and environmental impacts as well as about various initiative and investments an organisation has undertaken to improve its social and environmental performance. As such, the government has decided to introduce legislation that will require business corporations to provide information about the social and environmental impacts of their operations, as well as the social and environmental initiatives undertaken by the corporations. You are required to do followings:
1) Explain from public interest theory perspective that rationale for the government introducing the legislation and how the government will ultimately assess whether any proposed legislation should actually e introduced.
2) Predict from a capture theory perspective the types of constituents that will benefit in long run from any social and environmental disclosure legislation.
3) Predict from an economic interest group theory perspective of regulation whether any potential legislation to be introduce will lead to an increase in the accountability of corporations in relation to their social and environmental performance despite any implications that this increased corporate accountability might have for the financial success of large but heavily polluting organisations.
B) The website of the FASB (as at early 2009) states that FASB intends:
To promulgate standards only when the expected benefits exceed the perceived costs. While reliable, quantitative cost-benefit calculations are seldom possible, the Board strives to determine that proposed standards will meet a significant need and that the costs it imposes, compared with possible alternatives, are justified in relation to the overall benefits.
Do you think that cost-benefit considerations will be different in different countries? If so, how would cost-benefit considerations will be determined by a global accounting standard setter such as the IASB?s
Required:
Critically analyse and evaluate the arguments for, and against, for each of the case studies. Which arguments do you consider to be more compelling? (In other words, what is your opinion?) (1000 words each).
SOLUTION
A) Let us assume that the government has become concerned that existing disclosure regulation tends to fixate on the financial performance of organisations but fails to address other aspects of corporate performance, including a failure to provide information about corporate social and environmental impacts as well as about various initiative and investments an organisation has undertaken to improve its social and environmental performance. As such, the government has decided to introduce legislation that will require business corporations to provide information about the social and environmental impacts of their operations, as well as the social and environmental initiatives undertaken by the corporations. You are required to do followings:
1) Explain from public interest theory perspective that rationale for the government introducing the legislation and how the government will ultimately assess whether any proposed legislation should actually be introduced.
What we understand from public interest theory is that it is a theory of economic regulation that is created due to public demand to achieve desired results. The markets cannot regulate themselves, thus the government must take certain steps to regulate markets and to correct the inefficiencies of the market and inequitable practices which can be seen as the accounting inconsistencies between two firms.[1] Government intervention is in the best interest of the public. Some of the activities of the government in the matter of public interest are national defense, legal institutions, roads & canals, education and other city services on one side as against economic regulations and social & environmental regulations on the other. Economic regulations include ensuring a fair market conditions and at the same time, seeing to it that information about the financial position of the company is known to the public.[2] Social & environmental regulations include regulations on child labour, human & animal rights, etc. Environmental regulation should also include disclosures from companies and other entities, the effect that they are having on the environment. Many of the companies have started an internal cell of their own, for corporate social responsibility; which the company highlights as the steps taken by them for the betterment of the environment. But they do not disclose the harm they have done to the environment, in the first place. They over emphasise their initiatives taken to improve the environmental condition but fail to comment on the adverse effects they are having on the environment. Disclosing such information may prove to instil a sense of responsibility towards the environment. The purpose of environmental regulations should not be to enable a stable & liveable society but to sustain an environment. Any entity must be held accountable for the footprint it has had on the environment. Although such legislation will come under a lot of protest from the business corridor, the effect of this legislation can easily be assessed from the good effects on the environment.
2) Predict from a capture theory perspective the types of constituents that will benefit in long run from any social and environmental disclosure legislation.
The system of the public interest theory began to get challenged when research suggested that the regulatory agencies were not working for the interest of the public at all. Some even criticised the system saying that the agencies worked for private interests of the leading organizations in the industry governed by that agency. The regulated seek to take charge of the regulator.[3] It is great surprise that citizens do not play any part in the process of economic regulations which may be due to the complexity of the regulations or the extremely small effect they have on each individual. The capture theory suggests that the regulations are sometimes in response to demands from various interest groups so as to maximizing their incomes. The main motive is to protect public interest but the regulated companies eventually manage to capture the regulating agencies. Summarising this theory, it will serve the interests of industry branch involved, in due course of time. The agency’s dependency on the company for information, gives rise to the tendency to avoid conflicts with the company. Also there may be career opportunities in the companies for the regulators. Thus in the longer term, the regulators represent the interests of the company and work for the detriment of the public. The entities involved in the legislation are the government, which is the policy maker, regulator agency, regulated company and the general public. The government benefits through political coalitions where company business friendly policies are made in exchange for campaign contributions and having large industries on their side.[4] When the company captures the regulated agency, they are effectively working for their own interests and the public are set to lose. While this increases the efficiency of the company, it also has adverse effects on the environment as the companies are interested in profitability and the environment is of any concern. In the short run, there will be considerable improvements in the environmental conditions but once the capture theory sets in, once the regulator and the regulated collude, in the long run, it will not be a pretty picture from the environment point of view.
3) Predict from an economic interest group theory perspective of regulation whether any potential legislation to be introduce will lead to an increase in the accountability of corporations in relation to their social and environmental performance despite any implications that this increased corporate accountability might have for the financial success of large but heavily polluting organisations.
An economic interest group theory perspective of regulation originated as a response to the capture theory. In contrast to the capture theory which suggests that monopoly over a regulator agency is by a narrow powerful interest group, the economic interest group theory proposes that multiple groups compete for the monopoly. Just like in capture theory, the regulated companies want regulations but the economic interest theory has competition among the interest groups. The economic regulation serves the private interests of politically effective groups. The assumption is that groups are formed for the protection of particular economic interests. There is no notion of public interest and the groups formed are in conflict with each other. Just like the capture theory, the regulator is not neutral. The private interests of politically effective groups are served whereas the groups with insufficient power are ineffective. Keeping the economic interest group theory perspective of regulation in mind, as in the case of capture theory, the social & environmental performance will begin to deteriorate in the long run. The social and environmental accountability will take the back seat as the corporations continue to focus on their financial success.[5] The legislation will no doubt be for in the best interests of the public and the environment but once the companies and the regulators collude, the downfall of the environmental performance will begin. The large and heavily polluting industries will bend the regulations to favour them and thus we can safely conclude that their accountability will not increase.
B) The website of the FASB (as at early 2009) states that FASB intends:
To promulgate standards only when the expected benefits exceed the perceived costs. While reliable, quantitative cost-benefit calculations are seldom possible, the Board strives to determine that proposed standards will meet a significant need and that the costs it imposes, compared with possible alternatives, are justified in relation to the overall benefits.
Do you think that cost-benefit considerations will be different in different countries? If so, how would cost-benefit considerations will be determined by a global accounting standard setter such as the IASB?s
If the cost of a project exceeds the benefits then there is no need to take up the project as the activity will not be worth the economic cost. In the same way, if the adverse effects of standards outweigh the benefits of that standard then such a standard should not be adopted. This is what a cost benefit analysis is all about. It is an analytical procedure which estimates the net economic value of a project or policy.[6] If the lifetime expected benefits exceed the overall costs then the project should be undertaken. Cost benefit analysis has two ways of measuring the benefits of a change in policy – willingness to pay and willingness to be paid, which are how much an individual would pay for a change as against how much the individual will have to paid for a change. When the difference between the two is considerable, it can be evaluated easily.[7] When costs and benefits are accrued in the future, they, typically, have to be discounted for time which introduces some ambiguities like what the discount rate should be. Cost benefit analysis helps to decide whether or not to invest in a particular project. It tries to monetize the benefits as well as the costs involved in every decision. There are many who believe that economic efficiency i.e. the difference between the benefits and the costs, should be the key criteria to evaluate any proposed regulation because the society has only limited resources which can be used for greater social good. A cost benefit analysis is characterized by a number of things like the desirability of a policy change, relevant costs & benefits and trying to monetize them and come up with a final figure. If cost benefit analysis is considered then it is simple to know how much of a regulation is enough, i.e. as long as the incremental benefit is greater than the incremental cost. But the problem lies in measuring the incremental benefits & costs. Cost benefit analysis is an important part of regulatory decision taking but it should not be the only consideration.
Different countries have different laws relating to environment and any other things. So the same policy may not be applicable in all countries. There are certain questions which have to be answered before approving or rejecting a policy or regulation. The quality of regulations should be evaluated in a feasible manner by the cost benefit analysis. It should provide a morally accepted means of evaluation. The most important question is whether there is a more feasible procedure of evaluating a regulation. There are various other considerations in regulatory decision making. Firstly, cost benefit analysis should be used to compare the favourable & unfavourable effects of a regulation Also the economic costs & benefits of different policies should be considered in the development of a regulation. The scale of the analysis should depend on the stakes involved and to the extent to which the resulting analysis will affect the decision making. It should be remembered that aggregate benefits & aggregate costs are not the only important factors. However all benefits & costs cannot be quantified and in such cases care should be taken that the quantitative factors do not dominate the qualitative factors. The regulations require a lot of external reviews and retrospective assessment is essential. At the same time, the economic assumptions made should be consistent. Although a cost benefit analysis should not be the only consideration for formulating, it can provide an excellent framework and can improve the process of policy analysis. The results of the analysis are subject to conflicting interpretations. If the analysis is done properly, it can serve as a great consideration for the agencies evaluating the regulations and can provide trade-offs involved in the policy formulation. Saying this even if a regulation does not pass the cost benefit analysis, it should not be rejected outright and should be brought under scrutiny before any decision is taken because economic efficiency should not be the only consideration. Sometimes, however, it helps in rejecting ridiculously costly policies.
Cost benefit analysis should not take the primary seat in process of regulatory reform. There are a few negatives as well of cost benefit analysis i.e. it is theoretically suspect and practically indeterminate and susceptible to manipulation due to which it is unlikely to serve as an independent and objective check. Interestingly cost benefit analysis has never undergone a cost benefit test.[8] The valuation of a life in cost benefit theory is the most difficult issue and safety & health regulations affect lives.[9] If we consider all the consequences of a policy, almost every policy has life & death implications. Then there are issues of political implementability, moral foundations and practical & conceptual limitations. But it continues to command respect and influence. Inspite of so many drawbacks the reason why the cost benefit analysis is still used is the fact that it gives the right answer majority of the times. Thus the role of such an analysis is retained irrespective of the limitations. A cost benefit analysis provides a summary statistic of the efficiency of a regulation but efficiency is only one of the many considerations. It is an analysis which should yield a result as an unambiguous no rather than an unambiguous yes. Summarising, a cost benefit analysis should be given a higher weightage in policy regulations but should not serve as the only method for regulatory reform.
Required:
Critically analyse and evaluate the arguments for, and against, for each of the case studies. Which arguments do you consider to be more compelling? (In other words, what is your opinion?) (1000 words each).
[1] Stigler, George J. (1971), “Theory of Economic Regulation”, Bell Journal of Economics and Management Science.
[2] Peltzman, S. (1976), “Toward a More General Theory of Regulation”, Journal of Law and Economics.
[3] Capture Theory Of Regulation, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2012. [Accessed: May 22, 2012].
[4] McGraw Hill Australia Pty Ltd (2006), Financial Accounting Theory
[5] Unruh G. (2010), Environmental Regulations: The New Frontier, Forbes
[6] SafetyNet (2009) Cost-Benefit Analysis, retrieved 21 May 2012.
[7] Deat (2004) Cost Benefit Analysis, Integrated Environmental Management, Information Series 8, Department of Environmental Affairs and Tourism (DEAT), Pretoria.
[8] Stavins R. (2009), Is Benefit-Cost Analysis Helpful for Environmental regulation?, Harvard Kennedy School
[9] Cowen T. (1998), Cost Benefit, Department of Economics, George Mason University
LE17
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