QUESTION
ssume that the government has become concerned that existing disclousure regulation tends to fixate on the finiancial performance of organisations but fails to address other aspects of corporate performance, including a failure to provide information about corporate social and enviromental impacts as well as about various initiatives and investments an organisation has undertaken to improve its social and enviromental performnace. As such, the government has decided to introduce legislation that will require business corporations to provide information about the social and enviromental impacts of their operations, as well as the social and enviromental initiatives undertaken by the corporations. you are required to do the following:
a) Explain from a public interest theory perspective the rationale for the government introducing the legislation and how the government will ultimately assess whether any proposed legislation should actually be introduced.
b) Predict from the capture theory perspective the types of constituents that will beifit in the long run form any social and enviromental disclosure legislation.
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The website of FASB (as at early 2009) states that FASB intends:
To promulgate standards only when the expected benifits exceed the preceived costs. while reliable, quantitative cost-benifit calculations as seldom possible. The board strives to determine that a propsed standard will meeet a significant need and that the costs it imposes, compared with possible alternations, are justified in relation to the overall benifits.
Do you think that cost-benifit consideration will be different in different contries? if so, how would cost-benifit consideration be determined by a global accounting standard. setter such as the IASB?
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 openion?) 1000 words each.
SOLUTION
let us assume that the government has become concerned that existing disclousure 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 enviromental impacts as well as about various initiatives 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 the following:
a) Explain from a public interest theory perspective the rationale for the government introducing the legislation and how the government will ultimately assess whether any proposed legislation should actually be introduced.
Answer: Public interest theory perspective : Public interest theory was developed by A.C. Pigou (1932). The author said that the regulations are made in the public interest when they are demanded by the public for correcting inefficient practices. Regulations are assumed to benefit the whole society rather than any individual’s interest. The regulatory body is to serve the interest of the society as a whole rather than making laws in favor of the regulators.
The Public Interest theory assumes that the economic markets are very weak and they tend to operate inefficiently and in favor if individual’s interest while ignoring the interest of the society as a whole. Therefore to govern and monitor the economic markets government’s intervention is required. The author said that the government regulates the banks to make them work in the social interest. The banks are able to serve the social interest when resources are allocated efficiently and in social interest.
Stigler (1972)’s public choice theory is contrasted with Pigou (1932)’ public interest theory. Stigler said regulations are made when the public demands the efficient allocation of the resources. He said regulations are not socially efficient and used by private players to prohibit the entry of competitors in the market.
Now when corporate are disclosing only financial performance of organizations but they are disclosing other non financial but relevant information such as environmental and social impact of the organizations activities, initiatives of the organizations to improve the adverse impact of their activities on the society and environment.
With reference to the public interest theory it is a rationale decision to introduce the legislation which mandates for the corporate to disclose the impact of their activities on the society and environment and also disclose the initiatives taken by them to protect the society and the environment from the adverse impact of their activities.
Now after clarifying the rationale of introducing the legislation the questions comes whether the proposed legislation should be introduced? For assessing the legislation the government can conduct a survey before introducing it and also put the survey results on the website. The proposed legislation should also completely make available online for the common public. For appropriate time duration the legislation should be available online for public comments. The public comments should be reviewed by an experts’ panel and these comments should be assessed on the basis of rationale of the legislation driven from public interest theory. The public comments in the website should also be compared with the survey from the corporate and other professional. If the difference between the survey results and the public comments are very wide then the public interest should be kept above all other views.
Thus on the basis of above discussion we can say that the public interest would be served if the government makes the legislation which mandates the disclosure of impact of corporate activities on the society and the environment. Not only the impact of their activities but also they need to disclose their initiative of improving the adverse impact of their activities on the society and environment.
b) Predict from the capture theory perspective the types of constituents that will benefit in the long run form any social and environmental disclosure legislation.
Answer: The tenet that the government agencies established in the country to regulate the industry in the best interest of the society but in practice they work in the interest of the industry in which they regulate. The capture theory states the government agencies are formulated by former and future industry employees, hence these employees of the industry work in the best interest of the industry. These agencies create an inefficient allocation of resources of the society rather than creating an allocation as per the society’s needs.
The capture theory recognizes the close relationship between the government agencies and the industries in which they operate. The regulating agencies are formed by the government at central, state and local level to ensure the protection of society’s interest from industrial decisions and the activities. For instance, a government agency is established at state level to regulate the cotton die industry and protect the society from its adverse impact. But if the members of the agency are the past or future employees of the industry then this agency instead of working for society’s welfare, the members of the agency starts working in the favor of the industry because they get attracted by high paycheck as an industry employee either in the past or in future. If these members of the agency work in favor of the industry they get highly paid in future from the industry when they join it or rejoin it.
The government is the rule maker and these rules can be very simple and can be very complicated depending on numerous factors.
The highly regulated industries are energy, banking, transportation, education, communications, insurance etc. The regulations imposed by the government agencies formed for these industries are price control, quality control, quantity control, minimum standard of operating activities and employees’ protection standards.
The regulatory agencies need an expertise and deep knowledge of the industry which is being regulated. For instance, regulation of the insurance industry requires the expertise of working of banking industry and agencies working for education industry need expertise in how this industry works. But unfortunately, the people who have most knowledge about a particular industry, they belong to that industry either they already worked there or would be going in future or will rejoin after a sabbatical or break from the industry. These agencies are generally formed by such people and eventually they start working in favor of the industries they belong. If the regulators or agency members are highly attached with the industry in which they are working that means the agency is captured by the industry and no more they look for society’s benefit.
The regulatory agencies are established for protecting interest of the society by increasing the resource allocation efficiency but if the agencies are captured by the industry they start working for the industry’s interest. When government agencies are created to regulate the oligopoly industries where few firms work with identical products , then if these agencies are captured by the industry ,they are transformed into monopoly. Then these agency work as effective head of the industry and get very high power and esteem in the industry.
Thus according to captured theory ,the regulators, industry will manipulate the things for their benefits and these are the benefiters of any regulation. But the disclosure regulation can be benefited to several constituents such as employees, banks, common public, government, investors etc.
The website of FASB (as at early 2009) states that FASB intends:
To promulgate standards only when the expected benifits exceed the preceived costs. while reliable, quantitative cost-benifit calculations as seldom possible. The board strives to determine that a propsed standard will meeet a significant need and that the costs it imposes, compared with possible alternations, are justified in relation to the overall benifits.
Do you think that cost-benifit consideration will be different in different contries? if so, how would cost benifit consideration be determined by a global accounting standard. setter such as the IASB?
Answer: Cowen(1998) said cost benefit analysis is applied to regulatory reforms finds net economic value of a new regulation. It measures are costs and benefits of the regulation into monetary terms.
The cost-benefit analysis for a new regulation is done in the following manner :
-Consider all other things constant in the system/economy/world and analyze whether the proposed regulation is good or desirable.
-Identify all the costs and benefits of the proposed regulation.
-measure the costs and benefits in money term.
-then discount the future value of benefits and costs to arrive at the present value, by using appropriate formulae.
-arrive at the nest benefits or costs by subtracting the all the costs from all the benefits.
The regulations which do not get the positive net benefits from cost-benefit analysis should be considered for review before implementing and then again cost-benefit analysis should be done and this process gets repeated until the proposed regulation gets positive net benefits.
There are many questions which arise while doing cost-benefit analysis are:
1) Is cost benefit analysis a feasible method of evaluating the new proposed regulations?
2) Is the result of cost-benefit analysis justifiable on moral ground?
3) Who makes implementation of cost-benefit analysis mandatory while implementing a new regulation?
There are several practical limits to cost-benefit analysis. These limits are as follows:
The cost-benefit analysis provides an economic value of the proposed legislation. When the net benefits are positive or net benefits are highest among all the options then the regulation is accepted otherwise not. Many views suggest that cost-benefit analysis provides efficiency analysis of the proposed regulation that is how efficient is this regulation? It is clear that there are many objectives preferred over efficiency or the economic value, therefore the policy makers face a trade-off among different objectives. In doing trade-off if we apply the capture theory , the trade-off will be done in regulators favor according to their own wish.
The benefits of proposed regulations can be measured in two ways by cost-benefit analysis. These two ways are: one is willingness to pay and second, is willingness to be paid. These two concepts measures how much an individual is willing to pay for that proposed change and how much benefit the individual will receive from the proposed change by the regulation.
The proposed regulation is unfeasible when the amount of willingness to pay differ widely from the amount of willingness to be paid.
The cost-benefit analysis would differ country to country if standard economic theory is applied. According to standard economic theory willingness to pay and willingness to be paid differs due to income effect. The income effect varies country to country therefore it can be stated that cost-benefit analysis will give different results in different countries. If the income effect is absent then the amount of willingness to pay and the willingness to be paid will be equal.
Boardman,et.al(1996) reported a range of 4-15 times difference between willingness to pay and the willingness to be paid for a regulation. In a clean air survey the willingness to be paid for clean air exceeded the willingness to pay the clean air (Rowe et al., 1980).
Knetsch and Sinden (1984) reported a very wide difference between willingness to pay and willingness to be paid .They reported average willingness to pay for a lottery ticket is four times less than the willingness to be paid for the same ticket. Kahneman and Tversky (1979) documented an endowment effect ,in which individual gives higher value for the things he owns at present than the things he will achieve in future by paying something.
In cost-benefit analysis the costs and benefits are discounted for present time . Then the value of future benefits and costs are compared with the present value of the same. The determination of the discount rate is ambiguous and the policies with long run effect need an appropriate discount rate.
There are many methods of finding a discount rate but two methods which are most used are : one is the real rate method, that is the rate of return on private capital is used for discounting. This rate varies over time and across countries. Therefore cost-benefit analysis may give different results in different countries. Another method is calculating the interest rate of time preference that is the interest rate paid on government securities. The government bonds are riskless(no default risk) and the interest provided on them is for time for which the investors are deprived from their money invested in the bonds, hence interest is paid for that time period. The interest paid on these bonds is much less than the rate of return on private capital, though the interest rate on bonds also varies over time and across countries.
Many researchers claim that zero rate of discount should be used if intergenerational policies are being formulated because the current generations do no value future benefits and the future generations cannot enjoy the current benefits.
The cost benefit analysis becomes very complicated when human life valuation is required for policy formulation. Most of the policies change human life value in some or other way. For instance, safety policy, health regulations etc brings a great change in the human health and therefore requires valuation of human life. The cost-benefit analysis measures the value of life by value of increased or decreased risk and increased or decreased chance of safety.
The option value is also a complication in cost-benefit analysis. The Public Parks are examples of option, where people have option to take advantage of it. If they do not visit the park they will not take the benefit. Therefore according to these people value of park will be very less.
Thus on the basis of above discussion it can be concluded that the cost-benefit analysis may vary across countries over time. Its discount rate may vary in different countries. Similarly income effect also changes as per the demographic features of the country. There are several limitations with cost –benefit analysis while evaluating the new regulation but still this method is widely used across countries due to its objectivity in measurement.
REFERNCES
Boardman, Anthony E., Greenberg, David H., Vining, Aidan R., Weimer, David L. Cost-Benefit Analysis: Concepts and Practice. Upper Saddle River, New Jersey: Prentice Hall, 1996.
Chapter prepared by Tyler Cowen, Department of Economics, George Mason University, Fairfax, VA 22030, Draft January 15, 1998.
Kahneman, Daniel and Tversky, Amos, 1979. “Prospect Theory: An Analysis of Decision Under Risk.” Econometrica, 47, 263-291.
Knetsch, Jack L and Sinden, J.A., 1984. “Willingness to Pay and Compensation Demanded: Experimental Evidence of an Unexpected Disparity in Measures of Value.” Quarterly Journal of Economics, 99, 507-521.
Pigou, A. C. (1932) The Economics of Welfare. London: Macmillan and Co.
Rowen, R.D., R.C. D’Arge and D.S. Brookshire, 1980. “An Experiment on the Economic Value of Visibility.” Journal of Environmental Economics and Management, 8, 1-19.
Stigler, G.J. 1972. “The Theory of Economic Regulation”. Bell Journal of Economics and Management Science 11: 3-21.
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