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"Throughout the world in recent years a number of industries have been deregulated, for example, the banking industry, the telecommunications industry, and the airline industry. There have been numerous similar calls for a reduction in accounting regulations (using such terminology as accounting standard overload) - but what would be some of the implications if financial accounting were to be deregulated" (Craig Deegan-2000).

Major questions that may arise here are:

Why those firms have been deregulated? And even if there was a need of deregulation, why then, were they even regulated previously?

What are the arguments that are used in support of their decision?

If the accounting regulation is reduced, what is the mechanism that will force the firms to produce an optimal amount of information? (Deegan, C. 2000)

What is actually called an optimal amount of information?

Why after so many years the guru's of accounting have not been able to develop generally acceptable principals for Financial Accounting?

What are the reasons, why businesses find it difficult to accept standardised rules for the publication of their financial statements?

Whilst being opposed on different grounds by different professionals, there are numerous accounting regulations throughout the world that are highly imposed in many countries requiring different rules and principles in respect of their (country's) laws and legislations. Therefore, the question that comes in mind is; why financial accounting is so heavily regulated? The straightforward answer to this question is to force the managers to produce an "optimal amount of information" about the operations of the organisation. An optimal amount of information is the level of information that reflects true view of the value of an organisation.

More questions that arise here are why, and under what circumstances firms do not want to produce true and fair accounting information about their operations? What are the arguments that opponents of this accounting regulation provide in support of their view? And how they assure the production of the optimal amount of information about the firms in the absence of regulation?

To study both (pro-regulation and anti-regulation) views we need to have a look into different approaches for and against the regulations that are used for setting standards in accounting, and also the arguments provided by their advocates, as well as the criticism to those arguments.

Free Market Perspective:

According to the free market perspective to accounting regulation the accounting information should be treated like other goods. And the forces of demand and supply will assure the generation of best possible amount of information (Deegan, 2000).

According to many authors, it is in the best interest of the organisation to provide information about its operations to the parties outside the organisation. If any organisation fails to produce this information then it will faced with increased cost of operations (Agency Theory). Furthermore there is a thought based on economic principal of "rationality", which implies that each individual operates for their self interest, unless they are forced to do so. Each party (shareholders and debtors) will expect that the others will operate for the own self interest, so this lack of trust will require managers to get into contract with shareholders and debtors to protect their interests and increase their confidence.

There were many examples of contracting managers and shareholders referred to as "monitoring and bonding agreements" to reduce agency costs even before the 19th century when the financial statements were required by law to be published. One of the most important examples is the covenant that restricts the payment of dividends.

In the 1620 a corporate charter (New River Company) included a limitation that dividends would only be paid from the profits. Some company charters after that date did not include dividend covenant (Kehal, 1941).

This infers that even before the legislative requirements firms were concerned about their stakeholders.

In addition managers should also be given rewards in order to work for increasing the value of the organisation. An example would be sharing the profit.

In 1887 the Leeds Estate Building and Investment Company's articles had a provision whereby the managers and directors were entitled to a bonus based on the amount of profit available for dividends. (Edwards, 1968)

The shareholders and the debt holders will need to be provided with the essential information about the organisation which then will increase their confidence. For this purpose managers are required to be audited by an external auditor, regarding their financial accounts.

From 1844 to 1900 the UK company laws did not require the companies to publish audited financial statements, yet they presented these to their shareholders at the annual general meetings.

In 1890 British auditors came to the US to audit US firms, raising capital in London, because their firm's reputations were important to the success of those issues (Watts and Zimmerman, 1983, DeMond, 1951). Even there were requirements by the stock exchanges of the US for the presentation of audited financial statements, not because of government regulation, but because of self interest (Benston, 1969).

When there are a small number of parties the argument of getting into contracts to decrease the cost seems to be valid but when there are a large number of stakeholders present, the cost of contracts itself will be very high and here this argument does not work.

Another argument is that highly ranked best performing organisations will take over the organisations that are performing low. The acquiring firm may replace all the existing staff. This threat will force the managers to work to increase the value of the organisation.

Another argument in the favour of free market view is reflected in the "Market for Lemons" perspective given by Akerlof, G.A. in August 1970. An organisation is referred to be a lemon if it is firstly assumed of a good quality, but after sometime it turns into a substandard one (Craig Deegan). Akerlof claims that even without imposing accounting regulation the firm will be disclosing true information about its operations whether good or bad. If the organisation is not open about its performance, the market will perceive this as negative and assume that the firm has something bad to conceal.

Stated above are some claims given by the supporters of the free market view of accounting regulation. All these arguments focus on the point that the firms can efficiently produce information about their operations even in the absence of regulation. Now we will consider some arguments in the favour of regulation.


The advocates of free market theory of accounting regulation based their arguments on the two basic perspectives. First of these perspective says that if anybody really needs to get information about the organisation he will be willing to pay for it (For example if an organisation is working really well, the risk of loss on the investment will be decreased and hence if there is low risk the return demanded will also get to a lower level). The demand and supply forces will ensure the production of best possible amount of information. The second perspective states that if the organisation fails to produce reasonable information, then there will be great doubt about the operational efficiency of the organisation. This situation will result in an increased operational cost.

The supporters of pro-regulation approach claim that this argument is not valid for the goods that are free or public goods. Accounting information is known as public goods (Deegan, C. 2000), this is a good that can be available to the public for use without even paying for it. The people who use this information without even paying for it are referred to as "free riders." "Free riders" prevailing in the market will understate the true demand for the good and this will cause an underproduction of it.

According to Cooper and Keim (1983) and Demski and Feltham (1976), when the users of a public good who are paying for it cannot be excluded from those who are not paying, the price system does not work efficiently and it results into market failure. Therefore regulation is necessary to be imposed.

There comes another argument to this case where the presence of accounting regulation can result in an over production of the good. Furthermore, as investment analysts are one of the major users of the information. They may lobby for any new regulation for the disclosure of a certain kind of information to receive more benefit. This lobbying may lead to accounting standard overload, and this will be difficult for the standard setters to balance between the both situations stated above.

The regulators often state that regulation is necessary to ensure that every one has access to the same information by prohibiting insider trading. And this is in the best interest of the public.

"Crises have a long history in justifying legislative actions which affect corporations. For example: the South Sea Bubble, which was blamed on speculators, led to an act of UK parliament in 1720's which prohibited the formation of joint stock companies; the failure of the City of Glasgow Bank "under conditions of fraud", led to UK Companies Act 1879." (Watts, R.L.1977).


According to public interest theory, regulation is imposed to protect the rights of the public from unfair operations of the market. The basic concept here is that the regulation is imposed for interest of the public rather than for the interest of any influencing party. If this theory is applied in a capitalist economy, the public needs to be assured that their resources are used in profitable manner. According to this theory, regulation creates such trust and confidence.

Many famous accounting professionals criticise this approach, but Posner (1974) rejects their claims by saying that the markets are very unstable and cannot operate properly without regulation and that the regulation process by government is really very costless.

However the supporters of the free- market approach state that regulations will be imposed just for the well being of the regulator. Even if it seems that the legislation is serving the interest of general public, with the intention of winning trust of public, which will help him step up to be re-elected.

Capture Theory:

Capture theory states that if accounting regulation is imposed, it might be initially put in place to serve the interest of general public, but with the passage of time the regulated party will try to capture the regulatory party. It is difficult for the regulator to remain unbiased and out of influence of the regulated parties.

It has been a big issue all over the world that the large accounting firms have got control of standard setting process.

Walker (1987) explains this concept with the help of an example of ASRB, which was deemed as highly controlled by the accounting organizations. When ASRB was going to be established, governments received suggestions the accounting standard should be developed by other than the accounting professionals and the ASRB should be allowed to have a research director. But before the establishment of the board many accountancy firms united together to influence this decision that ASRB will have an independent research director. In 1986 almost all the members of the board had a strong and professional accounting background, and in just two years the ASRB were taken in control by the accounting firms.


Economic interest group theory is also known as private interest group theory. This theory is related to the efforts of private groups for securing their interests. It assumes that in a business market different entities have similar interest. These will join together into groups to force the government to impose certain legislation in order for them to receive economic benefits. In an economic competitive market there are conflicts between different groups thus the benefit of one group can possibly be the expense of the other.

For example Donald Stokes, Richard Morris, and Craig Deegan (1990) have investigated the interests of audit firms to lobby on proposed disclosure requirements. Their study generated results that the higher expected costs of non-conformity with legislative disclosure requirements is the major reason behind their lobbying in favour of increased professional disclosure requirements. (Morris, Deegan, Stokes, 1990)

Craig Deegan (2000) explained how the different firms form groups to accept or reject some regulations, imposed by government which, they think, are not in their interest. According to one of these examples, in Australia, government passed a regulation to be imposed in 1990, which was related to the general insurance companies. That requirement stated that the investments will be valued at their net market value. If there are any changes, these will be charged to profit and loss account. But this created a significant instability in the earnings of many firms. Therefore the insurance firms form groups to oppose this regulation. (Craig Deegan).

The supporters of this view consider that even the regulators have their own interests regarding a particular regulation. For example if the regulators put in place a regulation to secure or protect the rights of the general public, the intention behind this action could be to win the trust of the general public and get re-elected. Therefore, they can also be seen as an interest group under this theory.

If we conclude this discussion we can say that regulations are being imposed to benefit some specific parties that have the power to lobby against the decision of regulators. Another noticeable point is that the small firms which have no power to effect the decisions of regulators cannot be able to protect their different interests.


This view is an important view regarding regulation in financial accounting, because it challenges the basic concepts of accounting. However, if we follow the conceptual framework of accounting, it emphasizes that the financial statements of the firm should be true and fair view of a company's operations, and these should not be biased (should not be beneficial for just a certain group of people). The conceptual framework also states that the standard setters should keep in mind all the positive or negative effects of the accounting standards on the economy as well as society.

It is clear perceptible from the history that in US standard setting process is controlled by political forces. Congress concerns with standards have played a vital role in the substitution of ABP with FASB. Latest examples of its intervention include: SFAS 133 (accounting for derivatives and hedges, FASB, 1998); SFAS 141 (elimination of pooling, 2001a) and SFAS142 (impairment of goodwill, FASB, 2001b). (Watts, 2003; Ramanna, 2005)

It is also stated that before the implementation of certain new measures, the standard setting body should call for discussion and different parties that can be affected by it and take into consideration, the suggestions given by that party. If the body does not adhere to the above statement, its whole existence can be challenged. However if above statement is accepted then the neutrality and objectivity of accounting standards will be questionable.

Embracing the consideration of economic consequences standard setters will have to sacrifice the fairness and truthfulness of accounting information. As there can be certain information about a firm, if disclosed, that can have a negative impact on the value of the firm. Therefore, that particular standard will need to be amended. For example, there is a requirement in the Australian conceptual framework that standard setters will have to consider the economic consequences of their decisions, specifically in relation to the possibility that fairness and truthfulness might have to be sacrificed. (Collett, P 1995)

A question that comes into mind is that public or users of financial reports generally know that there is political pressure involved in the development of the financial reports. While having this type of expectation, will they be able to accept that the information provided in the reports is accurate and fair?


We have considered all the major approaches to standard setting in financial accounting. Each of these approaches carry solid arguments, however under certain circumstances they become challengeable.

After studying all the facts provided by different approaches we are now in a better position to understand how difficult it can be for the standard setter to balance between all these views and set such generalised accounting standards that can be internationally acceptable.