QUESTION

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?

case studies sent in next email

Qn 3.33 –  cases a , b and c

Qn 4.28 — only one case study
words – 1800 words

deadline  2nd 11pm

CRAIG DEEGAN TEXT book edition 3

SOLUTION

3.33 a)

Considered as the first amongst the group of regulatory theories, public interest theory was established by keeping in the interest of public in mind during allocation of scare resource to a collective group in the best possible manner. It is an established fact that the allocation of resources is majorly coordinated by the existing mechanism of a market, however, in practice this approach fails to allocate the resources in an optimal manner which in turn raises the demand for enhancing the methods adopted for allocation. It is therefore to bring in efficiency to the process, government regulations were introduced (Arrow, 1970). Government intervention in highlighting the social and environmental initiatives of the organization can do the trick of strengthening their competitive market share. This theory is considered instrumental for the government in trouncing over the demerits of imperfect condition of the market and its undesirable results. The theory forms the base of introduction of regulation into the financial accounting system. Regulation in turn has the ability of facilitating and maintaining a consistent condition for market operation which improves the process of allocation of even scarce resources and symmetric distribution of information. At the same time it seems like an apt tool in gauging the performance of the firm in other areas as well. The theory was considered desirable by the government in preventing certain disturbances which occurs temporarily but leaves a permanent impact. It is therefore on the basis of various attributes of market operations and inherent inefficiencies that motivated the government for introduction of legislation.

Despite such positive attributes the theory has been criticized on the base that it considers regulations by the government as an effective approach which doesn’t incur additional costs. Also most of the efficiencies as it exists in the market are solved by marketers themselves and doesn’t require intervention of a regulatory body. It has also been argued on the basis of theoretical research that an economy as a whole cannot be made efficient with mere allocation of resources when unavoidable inefficiencies continue to persist in the system. Such kind of distortion of the market has an increasing tendency of leading to suboptimal allocation of resources which in turn fails to attain the primary objective of the theory. Furthermore, the public interest theory fails to explain why objective like redistribution are done at the expense of economic efficiency (Joskow and Noll, 1981). All such attributes makes this theory incomplete as it is unable to explain how interest of the public can be translated into legislative action and lead to maximization of economic welfare. Henceforth before actual introduction of legislation it is indispensable that the government makes a rational assessment of prospects as well as consequences of a specific theory, which in turn can deliver desired results.

3.33 b)

Social and environmental disclosure legislation can bring in sea of changes in the manner in which the company operates in the current market. As per the capture theory the regulatory mechanism is well captured by the regulated party and tend to take the charge or capture the regulator with the objective to ensure that rules are implemented which can benefit the required party. Through implementation of capture theory it is expected that in the long run the utility of social and environmental attributes of a company will be maximized. It is through the assimilation of political behaviour with the economic body which would secure and maintain a political power in the field of social and environmental branch. However, one of the major downside of this theoretical approach is that the utilities are not specified. In the context of socio-environmental legislation, the capture theory is likely to yield results as it has the capability of influencing the outcome. Also it provides financial and other support to the regulators helps in accomplishing the objective. However, this theory fails in focusing upon public interest as it assumes that interest of the public is underlying to any regulation. Due to this downside, the long run benefit in the social and environmental front becomes dicey. Also the theory is incapable of explaining that after subjecting any agency towards interest the branch is not able to prevent its coming into existence. Further this theory serves the interest of the consumer more than that of the organization, as the regulatory bodies are often obliged to extend their voluntarily chosen level of services to a next level which in turn increases the skepticism towards them in terms of delivering long term benefit. At the same time there is an increasing chance that the regulations related to environment and society can negatively impact the profitability of the company, hence is more likely to be opposed by the companies themselves. So much so as capture theory is more of a hypothesis than an actual theory, it is unlikely to yield benefits when actually implemented.

3.33 c)

When the economic interest group theory is implemented for introduction of a legislation related to social and environmental performance of an organization it is likely that regulators would be more easily influenced by corporate interest, which rates profitability over responsibility towards society and environment. This is argued on the basis that the economic interest theory is based upon the assumption that groups are formed in order to protect a specific economic interest of the company. Further on the basis of the central proposition of this theory, the regulation which is acquired by a specific industry is designed in such a manner that it works solely for their benefit. It is thereby more likely that the organizations would mould the regulation in increasing their profitability rather than focus upon certain socio-economic activities which is assumed to impact the organizational profitability in a negative manner (Stigler, 1971). More so the regulator is not seen as a neutral intermediary but more of an interest group which focused upon maintenance of power, position and privilege within a community. Contrasting this view it has been argued that involvement of regulatory bodies has the innate ability of prohibiting the entry of competitors while suppressing the use of substitutes, which has the potential of increasing the demand for regulation. Once this demand for regulation rises, it can exert a social pressure upon the regulatory bodies in emphasizing the accountability of corporate houses towards the environment and the society. Despite the demerits in the current state of business affairs it is seemingly one of the useful theory in evaluation of adequacy of the auditors independence as it is expected that the member of the accounting body, organizational managers along with the regulatory official can influence the process of financial control while overseeing the overall process of regulatory reporting

Though it has been difficult to explain the actual manner of intervention of the government in a market which can ensure the benefit to the society, one cannot withstand the fact that regulatory interest theory is strongly based upon the fact that coercive power as yielded by a government is capable of yielding benefits to the society, which in turn is more likely to increase the accountability of the corporate houses towards their surroundings. Again, it helps in drawing in another insight which emphasizes that it helps in locating the curves of demand and supply in the market which when understood in the right manner can strengthen the bottom-line of the company.

As the theory incorporates the cartel attribute it helps in enlightening a marketer about both the benefit and the cost side of market in a specific industry, which are considered effective in designing the company strategies that can enhance their role and visibility in the social and environmental arena. So much so even in case of a heavily polluting industry, if the forces of the market and the regulation are capable of driving them towards acting in a socially responsive manner, it can in the long run enhance the firm’s profitability; for the demand curve and consumer awareness is shifting more towards environmental protection. This change is significantly impacting the consumer preference for a company as well as the sustainability of the company in the competitive market.

4.28

The attribute of equating cost with benefits is considered as one of the basic steps which can influence an organization towards adoption of certain regulation. If the ultimate objective of a business firm is to maximize the shareholders value for money while increasing the profitability of the firm, it is essential to keep in mind that it is possible only when a proposed change in the standards of accounting shows the advantages of change with reference to its cost of adoption and implementation. Like every other individual, the organization strives to understand the justified relation of benefit with respect to certain changes. Therefore global accounting standard setter IASB tends to conduct a cost benefit analysis prior to proposition of a new standard and ensure that benefits drawn from the improved manner of financial reporting process exceeds the cost of implementing the same. Though FASB intends to follow suit with IASB while ethically setting the accounting standards, it has been challenged with the constraint that what exist in theory differs from what is put into practice. At a theoretical level, the concept of benefit derived from implementation of a new accounting standard seems alluring, however when put into practice there is evidently a conflict with respect to the commitment of cost-benefit consideration of FASB. As a matter of fact there exists no concrete evidence in favor of FASB making a fair judgment of cost and benefits in the context of any proposed standards of accounting (Martens and Stevens, 1994).

In general there exists six traits of qualitative nature which are equally considered by both FASB and IASB in determining the standards of accounting. Both the committee agrees on the fact that guidance and regulatory standards of accounting should stand same for any organization irrespective of their size, nature or geographic location. The six attributes consists of relevance of the proposed reporting standard in business, degree of faithful representation of organizational health, understandability, comparability, materiality as well as cost-benefit consideration, which as expected demands greater attention. One of the instances wherein board members of both FASB and IASB jointly agree is the case of cost benefit aspect for both small and large companies across the globe. So much so the need and importance of a flexible and a transparent financial accounting framework has been heightened, which can prove to be more advantageous in terms of innovation especially in case of an uncertain economy (Yoon, 2005). Apart from being one of the basic elements for a successful business enterprise and economy, this attribute is considered critical from the perspective of protecting both the consumer and the investor. Hence the basic standards for cost and benefit consideration are kept same across countries.

References:

1. Arrow, K. J. (1970), ‘The Organization of Economic Activity: Issues Pertinent to the Choice of Market Versus Nonmarket Allocation’, in Haveman, Robert H. and Margolis, Julius (eds), Public Expenditure and Policy Analysis, Chicago, Rand MacNally College Publishing Company
2. Bullen, H.G. and Crook, K. (2005), ‘Revisiting the Concepts: FASB, IASB’, A New Conceptual Framework Project
3. Deegan, C., Morris, R. and Stokes, D. (1990), ‘Audit Firm Lobbying on Proposed Disclosure Requirements’, 15, No. 2 Australian Journal of Management 261
4. Deegan, C. (2005). ‘Australian financial accounting’ (4th ed.). Sydney, Australia: McGraw-Hill Australia.
5. Joskow, P. L. and Noll, R. C. (1981), ‘Regulation in Theory and Practice: An Overview’, in Fromm, Gary (ed.), Studies in Public Regulation, Cambridge, MA, The MIT Press
6. Kahn, A. E. (1988), ‘The Economics of Regulation: Principles and Institutions’, Cambridge, MA, MIT Press
7. Martens, S. and Stevens, K. (1994), ‘The FASB Cost Benefit Constraint in Theory and Practice’, Journal of Business Ethics, Vol. 13, No.3
8. Posner, R. A. (1974), ‘Theories of Economic Regulation’, The Bell Journal of Economic and Management Science, Vol. 5, Issue 2
9. Stigler, G. (1971). ‘The economic theory of regulation’, Bell Journal of Economics

10. Yoon, L. (2005), ‘Reporting: One Standard Fits All?’, CFO

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