copyright © 2009 by pearson education canada 13 - 1 chapter 13 standard setting: political issues

Copyright © 2009 by Pearson Education Canada13 - 1

Chapter 13 Standard Setting: Political Issues

Copyright © 2009 by Pearson Education Canada13 - 2

Chapter 13 Standard Setting: Political Issues

Copyright © 2009 by Pearson Education Canada 13 - 3

13.2 Two Theories of Regulator Behaviour• Public Interest Theory

– Objective of regulator is to maximize social welfare

• Interest Group Theory– Regulator takes own interests into account, while

balancing demands of investors and managers– Implies conflict between constituencies

• Standard setters’ emphasis on due process suggests that interest group theory best applies


13.3 Conflict and Compromise• 13.3.1 Another example of economic

consequences– Difficulties faced by IASB in developing IAS 39 illustrate

extent of constituency conflict in standard setting• Concerns of several constituencies

– European Central Bank– European Union carveout– Danish regulators– Association of Corporate Treasurers

• IASB compromises– Macro hedging– Restrict fair value option


13.3.2 Other Comprehensive Income• Items included

– Unrealized gains and losses on available-for-sale securities

– Unrealized gains and losses on cash flow hedges

• Rationale– To secure management constituency’s

acceptance of fair value accounting

» Continued


13.3.2 Other Comprehensive Income (continued)• 2 alternative presentations

– Presented with Income Statement• Net income from operations xxx• Extraordinary items xxx• Net income xxx• Other comprehensive income xxx• Comprehensive income xxx

– Alternative Presentation• As part of statement of changes in shareholders’ equity

» Continued


13.3.2 Other Comprehensive Income (continued)

• Firms’ choice of alternative has information content for investors– Theory in Practice 13.1


13.4 Rules-Based v. Principles-Based Accounting Standards• Rules-Based Standards

– Lay down detailed rules– Possible to lay down rules for everything?

• Recall Hobbes, text Section 1.3

• Principles-Based Standards– Lay down general principles– Auditor professional judgement relied on to

prevent opportunistic manager behaviour when applying the principles


13.5 Criteria for Standard Setting• Decision usefulness• Reduction of information asymmetry• Economic consequences

– Benefits > social costs

• Acceptable to constituencies


13.6 International Integration of Capital Markets

• Increasing adoption of IASB standards– Some examples

• European Union, 2005• China, Japan (partially)• Australia, 2005• Canada, from 2011• United States?

– Allows foreign companies under SEC jurisdiction to report using IASB standards without reconciliation, 2007

– Norwalk Agreement to work towards standards convergence

» Continued


13.6 International Integration of Capital Markets (continued)

• 13.6.2 effect of customs and institutions– Code law countries

• Greater influence of families and banks in corporate governance than in common law countries

• Lower moral hazard problem• Shows up as less timely and less conservative reporting,

even if country has adopted IASB standards

– Implication that investors should be aware of local practices and customs when interpreting financial statements, even if country uses IASB standards

» Continued


13.6 International Integration of Capital Markets (continued)• 13.6.3 role of auditor

– Even high quality standards must be enforced– Protection of small investors

• Moral hazard problem switches to one between an entrenched controlling interest and small investors

– Auditor may be under great pressure from controlling interests

• Some evidence that auditors succumb to this pressure– Guedhami & Pittman (2006)

» Continued



• 13.6.4 benefits of high quality accounting standards– Better working securities markets– Higher earnings quality– More foreign investment

» Continued



• Should standard setters compete?– e.g., if firms could choose between IASB &

FASB standards• Race to the bottom?• Race to the top? (Problem 13.7)

– Firms could signal commitment to high quality reporting by choosing the higher quality standards

• Do benefits of competition outweigh increased costs of allowing 2 sets of standards?


13.7 Summing Up• Information asymmetry is basic reason for

financial reporting– Adverse selection– Moral hazard

• Fundamental problem of financial accounting theory– Best information system to control adverse selection not

necessarily the same as best system to control moral hazard

– Leads to constituency conflict– Standard setters must mediate this conflict

The End

Thank you

copyright © 2009 by pearson education canada 13 - 1 chapter 13 standard setting: political issues

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