Public Interest Theory v. Economic Interest Theory - Coursework Example

5 January 2009 Public Interest Theory v. Economic Interest Theory Introduction Many research studies have examined the various regulations employing both public interest theory and economic interest theory and they have found that there is lack of harmony as to the supremacy of one theory over the other. The public interest group is wedded to the notion of ‘fair estimation’ which engrosses placing a market worth on all assets possessed by a company including derivative accounting. Whereas the economic interest group argues that the proposed new rules of reporting under market value would create massive holes in their balance sheets. This research essay analyses how to account the derivatives in corporate accounts either reporting them on the cost of their acquisition or to report their market value and strong pressure exerted by both the public interest and economic interest groups in favour of their argument. Public Interest Theory Public interest theory can be defined as positive action and also some negative action initiated by a government in the cause of the public interest. Positive action is concerned with securing a benefit to “the public” whereas a negative action is concerned with prevention of harm to ‘the public.’ The public interest theory of regulation essentially argues that regulators act to maximise the public interest. This theory indeed assumes that the public’s interest is homogeneous or ignores the conflicts of interest among different groups which make up the public. Public interest theory can be directed to negate the adverse effects of certain types of market failure. One another definition of public interest theory is regulation introduced for correcting a market failure due to manifestation of political pressure which is implemented to be safeguard the public. During the majority period of twentieth century, ‘public interest theory’ of government was widely followed. Thus, the notion is that the policy makers reacted in the paramount interest of the common public. Bureaucrats and politicians prefer to label themselves as “social workers.’ Public interest theory stresses that action by government is essential to maintain a scenario of optimum welfare for its entire citizen of a nation. (Olson 1987). The supporters of theory demonstrated that the role of the regulatory agency is to safeguard the public from private behaviour that may injurious to society. In case, there is market failures and inefficiencies occurred which resulted in natural monopolies, then government should intervene to safeguard the public interest. For instance, the Rome Convention on contractual subjects introduced the notion of mandatory regulations, which, to a large degree, constituted the regulations and rules with a public interest aroma. This utilitarian method is a logical and natural expansion of theories of private law, which deem contract or tort law as mechanisms for advancing welfare values and public interest. Modern society chiefly operates through legal mechanisms which interlace corrective justice with a social welfare scheme like protection of the weaker party or practice pure public interest theory like introduction of competition law. Mostly, public interest theory demonstrated when there is a market failure. For instance, previously there existed monopoly power in the railroad industry in U.S.A. This has resulted in levying discriminatory freight charges by these railroad companies to the disadvantages of farmers. To solve this issue, U.S government established Interstate Commerce Commission mainly to regulate the railroad freights for farm products. Environment Protection Agency (EPA) introduced Clean Air Act mainly to regulate the air pollution and this is in the interest of public. It is to be noted that public interest theory has lost its charm among economist nowadays. According to Winston, the main drawback of this theory is that it is based on the presumption that regulation is to be introduced for the maximisation of social welfare or managing the regulated corporations. One another peculiarity is that regulation is introduced even in industries that is not under threat from externalities or industries that are non-monopolists like taxicab, trucking and securities industries. Under this theory, governmental intervention is felt essential when there are discriminatory or ineffective market practices. Further, there will be always intervention when there is market failure due to accounting scams as what happened in WorldCom, Enron, Cendant and Xerox. When there is audit failures or when there is collusion between auditors and management, government intervened with strict accounting norms and heavy punishment for non-complainants mainly to safeguard the interest of public. The public interest regulations are introduced due to the pressure exerted by the public interest groups or politicians who wish to safeguard the interest of public when there is a market failure. In the case of public interest legislations, the government will be merely act as a watch-dog and play an independent role in the framing of regulation. Here, governmental role will be a neutral intermediary. Thus, public interest theory ignores the selfishness of government mechanisms and politicians. The earlier era relied on the self-regulation by professionals which utterly failed to misuse and absence of legitimacy. Further, governmental intervention will be very minimal especially in a capitalist economy. More reliance will be placed on the invisible hand or market mechanisms Government will wake up and intervene in cases of market failure only and especially in the case of public essential commodities ,oligopolies and monopolies In his research study conducted in 1982, Nelson proved that in power industry in U.S.A, public interest theory has larger explanatory supremacy in setting the price for the power consumed by gullible consumers. Under public interest theory, government is rationalised in getting involved in the economy if there exists some externalities like down turn in share market or prevalence of excessive pollution. The existence of these externalities acts as an obstruction to best possible resource allocation. Thus, a government has varied types of probable intervention for compelling the industries to observe the pollution norms and to encounter the real costs of their presence. Thus , a government may exercise various forms of retaliatory steps like imposing additional taxes , to install more sophisticated technologies to minimise pollutant emissions etc and may also stipulate monetary penalties in case if they fail to observe pollution norms fixed by the government. It is to be observed that intervention will make sure that the marginal overheads incurred to put an end to pollution are analogues to the marginal damaged created by the polluting industries. In majority cases, millions of individuals join together and form an association to press their non-economic aims in a collective style. Thus, public interest groups with millions as the members have raised their voices and have demanded a clean environment or to save the earth ball from global warming. Thus, there are many public interested groups all over the world which raises their voices for animal rights, consumer protection, gun controls, family values, clean environment, immigration, abortion rights and for other social causes. According to Foundation of Public Affairs, in U.S.A alone, there are more than 2000 public interest organisations which are very active in raising their voices. For instance, U.S government has granted a special status to the public interest nonprofits organisations through subsidised mailing rates and tax exemptions. During the past three decades, the wielding of political influence through public interest organisations has matured radically. Public interest law firms offer legal assistance and representation for customarily unrepresented or under-represented interests groups in the judicial area. . (Bagheri 113) Economic Interest Theory In the economic interest theory of regulation, the public is decomposed into different interest groups, and each of them has its own interest and its interest may be in conflict with interests of other groups. The economic interest theory deals with regulation to benefit or control the interests of various interest groups of the society. For instance, trade policy for the deterrence of fraud , the control of pooling , trusts and companies, some segments of labour laws, regulations of the business of insurance ,banking, railways, airlines and other categories of business related to public interest. Economic interest theory deals with the market regulations which mean that well-structured groups can pressure government’s decision-making in their privilege. (Oslo 1987). In 1993, a study conducted by Kaserman et al proved that supremacy of economic theory to demonstrate the choice to maintain a regulated market. In democratic form of government, states will formulate their strategies not only to appease the general public who elects them but also to cater the interest of the particular interest groups. The policies so framed will then mirror the relative electoral weight of various groups in reference to the votes and of both fiscal and non-fiscal contributions. According to Stigler, an economic interest theory is footed on the fundamentals that there exists a regulated market. Demand generally emanates from the particular interest groups who could reap advantages from the so called legislation to improve their well-being. Supply side will be handled by the said government which tries to exploit its present political support to the maximum extent possible. Contrary to the public interest theory, which stipulates that regulation arises due to the existence of market imperfections, regulations on economic theory depend upon the interplays of the aims of the groups making the request and state, which, so as to remain in power, will exercise its coercive power to please a particular group for resources like campaigning contribution and votes. Thus, according to Stigler, industry protection will supersede over the consumer’s preferences. Hence, the protection so extended by the government will mirror the influence of a smaller group with has enormous influence over the government. Peltzman and Stigler have christened this philosophy as ‘the law of diminishing returns to group size.” Superior groups will become dormant before these powerful small groups as these groups are better structured, more active and better educated or informed. Thus, certain industries have wielded much pressure to the government to have more flexible pollution norms in their favour so as to fight more aggressively against brawly international competition. Varying economic groups such as associations, unions, corporate’s and other organisational interest groups along with their entourage lobbyists have office in Washington and operate under varied federal regulations and statues. The rules of game include all manoeuvres connected with persuading the federal policy making process including election campaign financing, executive and legislative branch lobbying and the social associations between government employees and lobbyists. Special economic interest groups are those who are usually the top proficient on programs and they are intelligent enough to manipulate media support in favour of them. Economic groups usually disguise their slim private interest in public interest clothing. The Present Issue: EU wishes to introduce pan - European financial services by introducing two new accounting standards. These accounting standards compel the companies not to report their derivatives by referring how much it cost to purchase them but to quote all assets held by a company on market value. Public interest group argue that any moves to dilute the rules would prevent European accounts becoming attuned with American standards, the long-term objective of the project. Various public interest groups are of the view that accounting the financial instruments such as derivatives by referring how much it cost to purchase them and this method will not disclose value of derivatives hold by companies in their annual accounts. The public interest groups argue that new accounting standards are necessary to understand corporation’s’ factual financial health.’ They argue that the new proposed rules would have made it impracticable for Enron, the US energy company, to shift its non-earning assets into private properties, recognized as special purpose vehicles. The company went into bankruptcy after the impulsive revelation of vast debts that had not been exposed in its annual accounts. Private economic interest groups like Banks and insures are lobbying against the standards amid fears the new rules would create huge leak in their balance sheets. There is intense lobbying against the new rules, which has gained the public support of the French Government. President Jacques Chirac wrote to the European Commission last year, saying that the new standards ‘would have harmful consequences on financial stability. (Kariel 39) Economist Interest Theory and Lobbying One research study has revealed that fraudulent companies spend more for lobbying than the companies not engaged in fraud. Thus, companies engaged in fraud could able to escape fraud detection at least for 4 months and 45% of their frauds are less possibly to be uncovered by regulators. Companies use the delay in fraud detection to shift their market negative reaction and to dispose of their shareholdings as it had happened in Enron and WorldCom. Hence, a government should closely scrutinise the corporate spending on lobbying and should compare the same with the industry standards and with the figures of previous years. If the government smells something rotten, then it should immediately initiate action on the basis of their investigations. Lobbying is one of the tactics perused by corporation to camouflage their frauds and this is evident from the corporate spending about $2.15 billion on lobbying alone in 2005. Corporations employ almost half of the former senate members or congressmen as their lobbyist in U.S.A. For instance, Enron spent substantial sum on lobbying and it was able to get favourable treatments from federal, state, congress and from various regulating and monitoring agencies on about 50 occasions since 1997. Some of the favours that Enron was able to muster were to ease the government blocking on their derivative trading, doing away with controlling of natural gas prices, to obtain government approval to treat some types of book debts off the balance sheet etc. It is important to note that lobbying do impact corporate governance in the area of detection of fraud. This has been corroborated from the evidence that WorldCom and Enron was able to shun detection of frauds and able to prolong their misdeeds for years together by spending million of dollars on lobbying. Hence, it has been proved beyond doubt that lobbying doe’s impact companies which intended to avoid fraud detection either directly or indirectly. One empirical study perused by Gupta and Swenson in 2003 tried to establish that companies do engage in lobbying to reap tax benefits that end up in loss of tax revenues to government. Another empirical study made by Dyck, Morse and Zingales in 2006 tried to prove that which monitoring agencies are more vibrant in fraud detection and role of IRO’s (Internal Revenue Officer) in fraud detection efforts. An earlier empirical study carried over by Gupta and Swenson in 2003 reveal that company’s political contributions are directly connected with tax advantageous. Corporations in U.S.A do lobby to get advantageous tax laws. For instance, tax subsidisation has been recently announced for the oil industries. About $ 1.5 billion equivalent of tax benefits were given to oil companies through the Energy Policy Act of 2005 and oil industries reported extraordinary profits in 2005 due to this tax incentives. Likewise, American nuclear utilities enjoyed about $4.4 billion worth of tax incentives due to above mentioned legislation. (Badawi 8). Conclusion: Thus, in introducing fair value accounting standards for derivatives in European Union, there seems a conflict between public interest groups versus economic interest groups. The public interest groups argue that new accounting standards are necessary to understanding corporation’s’ factual financial health.’ They argue that the new proposed rules would have made it impracticable for Enron, the US energy company, to shift its underperforming assets into private partnerships, known as special purpose vehicles. The company went into bankruptcy after the sudden revelation of huge debts that had not been exposed in its accounts. Private economic interest groups like Banks, insurers and French government are lobbying against the standards amid fears the new rules would create huge leak in the balance sheets of their corporations. No one should forget how Enron spent substantial sum on lobbying and it was able to get favourable treatments from federal, state, congress and from various regulating and monitoring agencies on about 50 occasions since 1997. Some of the favours that Enron was able to muster were to ease the government blocking on their derivative trading, doing away with controlling of natural gas prices, to obtain government approval to treat some types of book debts off the balance sheet etc. Now, French government is being influenced by very same economic interest groups and European Union is being influenced by economic groups like bankers and insurers mainly to publish well-painted balance sheets. It is to be remembered if companies are allowed to engage in accounting scandals or camouflaging their poor financial results by refusing to employ new derivative accounting rules, then worst affected persons will be gullible poor investors who would loose their hard earned money in financial markets as what had happened in Cendant, Enron, Xerox and WorldCom. Hence, European Union should follow public interest theory and try to arrive at consensus among its members for introducing new derivative accounting rules mainly to safeguard the interest of the small, gullible investors of stock market. Works Cited Badawi, Ibrahim M “Global Corporate Accounting Frauds and Action for Reforms.” Review of Business 26, (2) (2005):8 Bagheri, Mahmood.” Conflict of Laws, Economic Regulations and Corrective/ Distributive Justice”. University of Pennsylvania Journal of International Economic Law, 28 U Spring (2007):113. Kariel S, Henry.”The Corporation and the Public Interest.” The Annals of the American Academy of Political and Social Science 343 (1962):39. Read More