Critical Evaluation on the Extent of Financial Reporting Regulation - Essay Example

CRITICAL EVALAUTION ON THE EXTENT OF FINANCIAL REPORTING REGULATION AND WHETHER IT SHOULD BE REDUCED Critical Evaluation on the Extent of Financial Reporting Regulation and whether it should be reduced Course Instructor Date Critical Evaluation on the Extent of Financial Reporting Regulation and whether it should be reduced Introduction Over the years, there has been concern with regard to the problem of financial disclosure, some arguing that there is excessive regulation while others maintain that most of the firms do not disclose and such guidelines are unnecessary. The increased growth in regulation reflects on the fact that when possible defects in the world markets are identified such as the crash of the stock market in the year 1929, it is often easy to assume that regulatory measures are required to make the situation right. Although such conclusion can be justified, is can also be far fetched and gratuitous. There has been continued political as well as public pressure to have better regulation standards to ensure that there is economic growth. Scholars affirm that regulation of financial reports should start with solid corporate governance, making sure that the spirit of novelty is not negatively affected (Gibson 2012). Therefore, this paper seeks to offer a rational critical evaluation on financial reporting regulation and whether or not it should be reduced. Research shows that regulation of financial reports can be either right or wrong, depending on the nature of the firm and the extent to which such disclosures are regulated. However, it is evident that there are numerous drawbacks that come with having excessive guidelines; hence, they should be reduced to promote innovation, healthy competition, guarantee fiscal growth, and stability. Discussion Regulation is defined as a principle that governs a particular practice or behaviour. Various firms such as Enron have gone bankrupt and have reported failures in accounting because of unethical practices. As a result, most nations have focused on heavily regulating the financial reports and accounts to avoid failures such as those that happened in renowned firms like Lehman Brothers and Parmalat among others. Although regulation of financial reports is important and might appear sound, it should not be excessive as it damages the nation’s spirit of competitive innovation (Unerman &O’Dwyer 2004). Excessive regulation constrains innovation and business practices; hence, regulation of financial reporting should be minimised. It is important to understand that for a nation to be positively impacted by such standards, then, rules ought to start with solid corporate governance. It is the duty of the shareholders as well as the members of the board to examine carefully and ensure that their firms are led in the right path to realise their goals (Whittington 2006). Encouraging accountability, transparency, and stability will help in enhancing long term growth, making it possible for the financial industries to regain the trust of the public. There are numerous reasons that lead to excessive regulation of financial disclosures such as the ideal nature of transparency. Transparency is increasingly seen as the main goal to financial reporting and it gives a continuous impetus to the main requirements for greater disclosure. Another reason is with regard to the user’s priority, whereby the standard setters often allege that their work is meant to meet the needs of those who use the reported information. Moreover, according to the public interest theory, regulation is increased in response to the needs and demand of the public, in an effort to correct unbalanced and inappropriate marketing practices. There is also the regulatory logic, meaning that every time there is a crisis or failure, there is a public assumption that there has been inadequate regulation; hence, calling for tougher enforcement and rules. As a result, each perceived crisis calls for intensive disclosure, reinforcing the cumulative growth. Another reason leading to excessive regulation includes political pressure whereby the users tend to lobby for increased reporting (Verrecchia 2001; Walton 2013, pp. 109-110). Regulation of financial reporting takes place primarily through legislation, enforcement of admission requirements, and through the accounting standards. It can lead to excessive, wrong, little, poorly communicated and complex disclosures. Although most of the scholarly reports reveal that excessive regulation of financial reporting is unwarranted and should be done away with, it is important also to look at the benefits as well. Excessive regulation can be advantageous since it leads to improved behaviour and performance by the firms. This is because it is highly likely for people to perform better in case their performance is closely disclosed or observed since such an act makes them more liable. Excessive disclosure also guarantees better decision making since the firm is able to understand its strengths and weaknesses and come up with sound measures to improve on them. With regard to the public interest theory, regulation is important in enhancing confidence among the public members that the capital markets are successfully and ethically allocating their resources to prolific assets. Similarly, the supporters of pro-regulation avow that accounting information should be treated differently from other goods since it is a ‘public good’. This means that regulation is important for the interest of the public, the investors, and in balancing the costs of the standards against the social as well as the economic advantages (Bushman & Wayne 2010). Despite the few benefits that come with regulating, it is widely agreed that excessive regulation is uncalled for and should be reduced. Azikwe (2011) asserts that such form of regulation heightens the rate of self reporting bias since financial disclosure is merely concerned with the performance of the managers. Although most of the leaders are candid, heavy regulation leads to some degree of biasness to enhance the managerial optimism with regard to the organisation’s continuing prospects and projects. Moreover, excessive regulation leads to self inflicted harm since it is against the company’s interest to be fully transparent. Some of the reports offer valuable information to the competitors and contractors, which lead to a competitive disadvantage to the firm and its owners. On the same note, decisions regarding financial reporting ought to be made on the grounds of a cost-benefit analysis or test. However, it is unfortunate that the benefits of certain disclosures are often impossible to precisely measure. On the other hand, the direct costs are easy to measure, though the proprietary costs are speculative. Therefore, excessive regulation is unnecessary since it does more harm than good; hence, should be reduced. The Institute of Economic Affairs (2004) revealed that although excessive regulation is insignificant, the rate of accounting regulation has heightened by 150%, impacting heavily on companies with regard to the costs. It is unfortunate that regulation is seen as a means in which accounting failures can be reduced. However, Unerman and O’Dwyer (2004) affirm that scandals such as those that occurred in the World-Com and Enron are likely to increase in future if there is increased regulation. This can be explained by the fact that in most cases, the regulators impose risky and wrong standards that have little or less positive impact on firms. It is also likely that the excessive approaches tend to lull the users into phoney sense of transparency and security; hence, prevents the accountants and auditors from using sound judgement to guarantee that the reports offer a logical and competitive picture of the firm’s financial situation. In a changing economic environment, such measures also prevent the development of modern and effective accounting oriented practices. Although the public interest and capture theory posit that excessive regulation promotes ‘public good’, advocates of the economic-oriented assumption contend that extensive regulation of financial reporting is not meant for public interest but rather for self interest or gain. This means that legislators put in place such regulations to augment their wealth and increase their chances of being re-elected. According to the capture theory, although regulation can be maintained with an aim of protecting the interest of the public, it is difficult for the regulators to remain fully independent to the industries or parties that are regulated (De Bondt 2000, pp. 13-14; Barton & Waymire 2004). In that case, as much as regulation is important in protecting the public’s interest, it can result to self interests that are not beneficial to the public or a firm in general; hence, should be decreased. The use of excessive regulations on financial disclosures also has social as well as economic impacts. For instance, Jones (2012) argues that the adoption of the UK Pension Liabilities accounting standard had a negative effect since it increased the rate of volatility in the measurement of pension liabilities and assets. Consequently, the increased instability of the accounting numbers resulted to closing of final salary oriented pension schemes, switching the employees to less beneficial schemes. For that reason, the regulations had a negative effect on the economic as well as the social interests of the employees who are now receiving minimal pensions. The accounting standards also have an indirect effect on the managerial decisions, which have economic or social impact on the parties affected by the verdict (Beyer et al 2010, pp. 296-298). This means that although regulation has its share of benefits, it has its drawbacks, which should be focused upon. There should be development of measures aimed at ensuring that regulation result to positive changes in order to offset the downsides. The economic interest group theory also assumes that in some cases, firms or parties form to protect their economic or private interest and not necessarily that of the public. For example, the European banks lobbied against the revised regulations in the International Accounting Standard, arguing that some provisions would show a degree of volatility in their accounts, which could damage their perceived financial steadiness (Broadbent & Laughlin 2002; Olgus 2004). For that reason, excessive regulation of financial reporting is superfluous since it can be damaging to a firm and for those groups that have immense influence, it is always possible to counterattack the provisions or lobby against them. Consequently, it leads to wastage of time, uncertainty, and irretrievable damages. Just like the economic interest group theory, the proponents of the free market claim that there are private or economic incentives that cause firms to offer financial information voluntarily; hence, imposing of excessive regulations should be curtailed since it leads to inefficiencies as far as the agency costs are concerned as well as market for the corporate takeovers (Broadbent & Laughlin 2002). Conclusion In conclusion, it is apparent that although the regulation of financial disclosures can be beneficial in guaranteeing accountability and transparency, excessive regulation can somewhat be irrelevant to particular users and firms. It is also important to understand that since it is impossible to clearly specify the relevant disclosures and the fact that regulation cannot fully eliminate the challenges of subjectivity, proprietary costs, and self-reporting bias, the users continue receiving the wrong information. Various theories argue for and against excessive regulation. For instance, the public interest theory conjectures that individuals are not driven by self interests and regulation is important in protecting the public. However, there is an supposition of self interest among other researchers who support the economic interest theory as they insist that all actions by firms and individuals is traced back to the need to increase their economic wealth. Under such view, the regulators seek re-election based on self interest; hence, offer legislation to parties or groups that pay for it either by offering funds or votes. The capture theory also posits that while regulation can be put in place for genuine reasons, the regulated group tends to gain control of the regulators with time, making sure that the regulation favours the group that was supposedly being controlled. Excessive regulation also has economic and social impacts since it increases the rate of volatility; hence, cannot be considered objective or necessary. It is apparent that although financial regulation has few advantages, there are numerous drawbacks that come with excessive imposing of such guidelines that directly counterattack the benefits. For that reason, there is a need to have the regulations reduced to ensure economic development, innovation, increased transparency, and stability. Reference List Azikwe, N, 2011, ‘Regulation of Financial Reporting and Corporate Governance in Nigeria- a Critical Review’, Journal of Global Accounting, vol. 2, no.1, p. 1. Barton, J & Waymire, G, 2004, ‘Investor Protection under Unregulated Financial Reporting’, Journal of Accounting and Economics, vol.38, pp. 65-116. Beyer, A., Daniel, C., Thomas, L & Beverley, W, ‘the Financial reporting Environment: a Review of the Recent Literature’, Journal of Accounting and Economics, vol. 50, pp. 296-343. Broadbent, J & Laughlin, R, 2002, ‘Accounting Choices: Technical and Political Trade-offs and the UK’s Private Financial Initiative’, Accounting, Auditing, & Accountability Journal, vol. 15, no.5, pp. 622-654. Bushman, R & Wayne, L, 2010, ‘the Pros and Cons of Regulating Corporate Reporting: a Critical Review of the Arguments’, Accounting and Business Research, vol. 40, pp. 259-273. De Bondt, G, 2000, Financial Structure and Monetary Transmission in Europe: A Cross Country Study, London, UK: Edward Elgar Publishing. Gibson, C, 2012, Financial Reporting and Analysis, Kentucky, KY: Cengage Learning. Institute of Economic Affairs, 2004, Future Enrons will result from over Regulation of Accountancy says IEA Study, [Online] Available at < http://www.iea.org.uk/in-the-media/press-release/future-enrons-will-result-from-over-regulation-of-accountancy-says-iea-st>[viewed 14 Jan 2015] Jones, C, 2012, A Rough Guide to Calculating a Pension Fund’s Liabilities, [Online] Available at [viewed 14 Jan 2015] Olgus, A.I, 2004, Regulation: Legal Form and Economic Theory, Oxford: Clarendon Press. Unerman, J & O’Dwyer, B, 2004, ‘Enron, Worldcom, Andersen et al: A Challenge to Modernity’, Critical Perspectives on Accounting, vol. 15, no.6-7, pp. 971-993. Verrecchia, R.E, 2001, ‘Essays on Disclosure’, Journal of Accounting and Economics, vol. 32, pp. 97-180. Walton, G, 2013, Regulatory Change in an Atmosphere of Crisis: Current Implications of the Roosevelt Years, London, UK: Elsevier. Whittington, G, 2006, ‘Corporate Governance and the Regulation of Financial Reporting’, Accounting and Business Research, vol. 23, no.1, pp. 311-319. Read More