The Economic, Institutional Theories of Regulation - Assignment Example

Accounting Theories Name: Institution: Date: Answer 1 There are three theories of regulation namely the economic theory, institutionalism, and politics of ideas. Each of these theories highlights a different set of participants or factors as causing regulatory change. The Economic Theory of Regulation In 1971, Stigler introduced the positive or the economic theory of regulation. The extension to this theory was done by one of Stigler’s students, Peltzman, who had great influence on the thinking on regulation theories. This theory is described using a variety of other names including private interest theory, public choice theory, capture theory, and economic theory among many other names. Since it is a positive theory, the economic theory of regulation has a popular assumption that regulators or political actors are utility maximizers (Gaffikin 2005). No literature has adequately specified what utility means; however, it is assumed to mean securing and maintaining political power. To secure and maintain this political power, these regulators must have money and votes, and other resources which are mainly provided by people or bodies that are positively affected by regulatory decisions. Thus, regulators seem to be highly influenced such people and bodies who have interests in regulatory decisions. For the purpose of this paper, these bodies are going to be referred to as interest groups because they are always seeking to expropriate wealth or income. Income incorporates restriction on entry of new rivals in industry, direct subsidy of money, suppression of competitive and substitute goods, price fixing, and encouragement of complementary goods (Stigler 1971). Interest groups are primarily concerned with maximizing their economic welfare. As such, they seek to secure government regulations that limit competition and reduce costs (Teske, Best and Mintrom 2012). The emergence of environmental and social regulation, which significantly reduced producer groups’ advantages, forced revisions in the economic theory of regulation in the past two decades. Departures from pure protection are now recognized by proponents of the economic theory as optimal political strategies when consumer groups or competing producer groups can offer sufficient votes or money to public officials. Institutional Theory of Regulation Several regulation theorists hold an argument that institutional arrangement, structure and social processes have an ability to shape regulation, therefore, calling for understanding of these factors. The drivers of regulation go beyond individual preferences to include social and organizational setting from regulation emerges. The principals in these institutions are elected officials. This theory mainly draws from the agency theory. Similar to the agency theory, the institutional theory is characteristic of information asymmetry where agents are favored. As a result, elected officials must formulate and have in place procedures that ensure informational disadvantages faced by politicians are reduced (Gaffikin 2005). Secondly, these procedures ensure that dependable and sufficient administrators have been involved in designing the regulations. The main emphasis of institutional theory of regulation is that actors are viewed as shaped in knowledge, action, and preference for social environments and organizational rule; rather than being viewed as individuals. It also emphasizes on institutional design as shaped by characteristics of political setting. Politic of Ideas Theory of Regulation Politics of ideas emphasizes on the role of ideas in steering regulatory developments. The politics of ideas arose in the aftermath of economic deregulation in several visible infrastructural industries. The argument posed by the proponents of this theory is that deregulation, or for that matter regulation, requires coordination by influential political institutions. Every involved political institution is very protective of its interests, and each one of them possesses the capacity to block policy initiatives by competing institutions. Without simultaneous cooperation gridlock occurs, and the status quo remains unchanged. In this theory, intellectual ideas are the coordinating forces most evident in regulatory decision making, particularly in recent deregulatory initiatives. Ideas, developed and tested within academic settings, are often disseminated to regulatory agencies. Once established within an agency, these ideas gradually convert actors in other political institutions who together begin promoting policy changes grounded in these theories. The process provides incentives to institutional actors by permitting them to gravitate to these ideas on their own, without coercion, thereby allowing them to claim credit from their relevant constituencies. Rather than identifying particular participants, the politics of ideas endorses academic theories as the source of regulatory decision making. These ideas can become powerful enough to overcome strong interest groups that oppose policies shaped by these ideas. Answer 2 The normative research traditions of the 1960s and 1970s focused primarily on alternative asset valuation models for income determination. The deficiencies perceived to persist in the existing performance measures have driven stakeholders in the accounting sector to formulate alternative accounting measures. As indicated by Gaffikin (2008), much of the research conducted before the 1970s was considered to be fundamental analysis. However, the most dramatic change in the approach to accounting research was witnessed in the 1970s. One of the recent popular theories is efficient markets hypothesis (EMH) which was developed by the researchers from the University of Chicago. Two of the most influential people in the development of the EMH model are two Australians – Ray Ball and Phillip Brown, who also have their works widely cited. The efficient market hypothesis (EMH) suggests and implies that markets are efficient, and there is no apparent need for corporate financial disclosure regulations. Using explicit or implicit market models, EMH is involved as one of the four categories of explanations put forward to explain the efficiency of unregulated markets. Rahman (2013) explained this category as efficient securities market whose explanation is provided by the EMH studies. The conditions required for a sustainable and effective market are not far from the ones that economists suggested describing a perfect market including perfect information, frictionless trading, barriers to entry, willing buyer, and a willing seller, and voluntary contractual observance. This is the same similarity that has driven economists to develop some of the ‘1970s and before 1970s’’ theoretical devices such as EMH and Capital Asset Pricing Model (CAPM) which have been assisting in organizing investors’ risk. Although these theories are not accepted wholeheartedly, they empirically based. Although these theories have less support among market operators, they have more support among academics (Bloomfield 2013). The importance of these theories is that the many people are taking a completely passive approach to investing; therefore, EMH is becoming more popular among ordinary investors. In 2013, Choi (2013) equated EMH to a religion and stated that it had a dramatic influence on the way investors invest. For investors, although EMH is not the best choice, it is the best approach especially to investing. Many financial researchers have continued to test the efficiency of markets to dispel the notion that there are no efficient markets. Despite the doubts cast upon EMH model, all accounting capital markets researchers assume that market efficiency is necessary. The EMH has particularly proved to be very crucial to research on the capital market especially when there is an examination of the effect of releases of new information. The current price information is considered to be more useful than conventional historical cost information is to users in making financial decisions. For example, Paton refutes the propriety theory of accounts view by restating the theory of accounting in a way that has the consistency to the conditions and needs of the business enterprise as a distinct entity or personality. Paton’s theory of the accounting system consists of a logical discussion and justification of the accounting structure in terms of the fundamental classes of accounts; the proprietorship and liabilities; the property and equity accounts; the types of transactions; the expense, revenue and supplementary accounts; the account classification; the periodic analysis; and the concepts of debit and credit. The decision-usefulness/decision-maker/aggregate-market-behavior model is also one of the alternatives of the historical cost accounting. The importance of this relationship between accounting data and security behavior has been emphasized (Riahi-Belkaoui 2005). The argument is that it is inconceivable that optimal informational systems for investors can be selected without knowledge of how accounting data are impounded in prices because these prices determine wealth and wealth affect the multiperiod investment decisions of individuals. To those who adopt this model, the basic subject matter is the aggregate market response to accounting variables. Many authors have agreed that, in general, decision-usefulness of accounting variables can be derived from aggregate-market-behavior or, only the effects of alternative accounting procedures or speculations can be assessed from aggregate market behavior. The relationship between aggregate market behavior and accounting variables is based on the capital market efficiency model. Based on this theory, the market for securities is deemed efficient in that market prices fully display all publicly available information and, by implication, that market prices are unbiased and respond instantaneously to new information. The theory implies that on the average, the abnormal return to being earned from employing a set of extant information in conjunction with any trading scheme is zero. This change in information set will automatically result in new equilibrium. The theories that confirm the market behavior paradigm include the efficient market hypothesis, the efficient market model, the capital asset model, the equilibrium theory of option pricing, and arbitrage pricing theory. References Bloomfield, S. 2013. Theory and Practice of Corporate Governance: An Integrated Approach. Cambridge: Cambridge University Press. Gaffikin, M. 2005. Regulation as Accounting Theory. Research Online, Working Paper Series. Gaffikin, M. 2008. “Accounting research and theory” in Accounting Theory: Research, regulation and accounting practice. Frenchs Forest: Pearson Education. Rahman, A. 2013. The Australian Accounting Standards Review Board (RLE Accounting): The Establishment of its Participative Review Process. Oxon: Routledge. Riahi-Belkaoui, A. 2005. Accounting Theory. Mason: Cengage Learning. Read More