Free Market vs Pro-Regulation Perspectives - Coursework Example

Name Course Lecturer Date Free market vs Pro-regulation perspectives The free market perspective posits that accounting information should be viewed as any other commodity that is influenced by the forces of demand and supply and (Belkaoui, 86). It is assumed that market forces will eventually create an optimal quantity of information about the business organization. Therefore, free market proponents argue that there should be no regulation of accounting reporting. The free market theory was supported by Smith and Warner (1979), and Watts and Zimmerman (1979) (Belkaoui, 81). It is based on the rationale that the market provides private economic incentives that force managers to report accounting information. Free market proponents argue that the market can provide adequate incentive to organization to entice them to give out reliable financial information. One of the incentives is the fact that the operating costs are kept at minimal (Belkaoui, 81). Organizations only have to provide information to those individuals who demand it and not to everyone. Minimizing costs is in the interest of shareholders as it serves to maximize their wealth. The proponents argue that users who desire to manipulate the market are the ones who demand accounting information most. Secondly, lenders and other investors will force organization to furnish reliable information about their operations. According to Deegan and Unerman, the cost of borrowing is likely to go up if organizations do not provide banks and other lending institution with reliable information (57). Proponents of the free market approach also argue that a number of market related incentives will prevail on organizations to release accounting information. The first of these market incentives is the market for managers. According to Belkaoui, managers are motivated to publicize financial reports as it reflects their performance (89). Their performance is important in determining their future remuneration within the firm or elsewhere. Hence, managers provide optimal amount of information as their performance will be highlighted. Thirdly, managers are likely to highlight the performance of their firms to dissuade outsiders from taking over the organization at low-cost (Belkaoui, 89). Manager focus on maximizing the firm’s value in order to discourage those intent on taking over the business. According to Belkaoui, the ultimate argument for proponent of the free market perspective is that it leads to the alignment of shareholders and managerial interests (92). Since markets judge the absence of accounting information as a sign of bad performance organizations are forced to disclose accounting information. Furthermore, managers incur reputational damage if they fail to report bad information on time. For example, money managers may stay away from firms that do not disclose bad information. Therefore, economic forces will persuade managers to disclose accounting information aligning with the interest of shareholders. In contrast, the pro-regulation perspective posits that accounting information is a public good that should be made available to all people. Proponents of the pro-regulation perspective argue that an information asymmetry exists between managers and the shareholders/stakeholders of the organization (Healy and Palepu, 442). They argue that managers are unlikely to provide accounting information if they are not looking for funding. In the absence of regulation, many managers will not submit credible and complete information. Belkaoui shows that organizations increase the amount of information available when there are about to make equity offering (102). This shows that businesses are not keen on supplying the public with complete and credible accounting information in the absence of regulations. Secondly, information asymmetry is likely to lead to “inequality of opportunity and return among investors” (Deegan, 59). Before Fair Disclosure rules were introduced in the USA, Wall Street Brokerage firms favourite customers would make quick profits as they could access information on earnings forecast and mergers faster that other investors. With accounting regulation, all investors receive uniform information and thus the inequality of opportunity and return is eliminated. Thirdly, Deegan argues that the public has a right to accounting information regardless of whether they investors in the company or not (59). He argues that the use of accounting information by one investor or non-investor does not limit its use by others. Non-investors cannot be blocked from using accounting information released for investors and they therefore become free-riders by accessing information meant for investors. As a consequence, Investors cannot agree to pay for accounting information as argued by the free market approach. Deegan argues a more collective approach to the production of accounting information is needed as it is an essential public good (65). Stakeholder Theory vs Legitimacy Theory Stakeholder theory is based on the facts that the organization operates in a dynamic and complex environment where it is responsible and accountable to various stakeholders. The basic tenet of stakeholder theory is that the success of the firm is dependent on the sum of all relationships the firm has with stakeholders (Woodward and Woodward, 1). According to Elijido-Ten, organizations will cease to exist if they lose the support of these stakeholders (19). Stakeholder theory also argues that the organization can have substantial influence on the norms of the society. Stakeholder theory tries to understand which group of shareholders is most deserving of the management’s attention. According to Woodward and Woodward, stakeholder theory identifies societal interest groups that a business is accountable to and account for activities it deems necessary to satisfy these groups (1). However, sustainable and environmental reporting based on the stakeholder theory is objective. The organization is honestly engaged in activities that are sustainable and in some cases is a pioneer in responsible management of energy and other environmental resources (Solomon, 5). As posited by stakeholder theory some organizations try to change the norms of society and promote the development of sustainable way of exploiting the environment. According to Elijido-Ten, environmental lobby groups are now considered important partners by organizations that have adopted a stakeholder perspective of their corporate social responsibility (170). Many organizations using the stakeholder approach also adopt the advice of regulatory bodies on matters of sustainability. Studies in Australia reveal that most Australian company’s report social and environmental information in their annual report. Companies that have been noted to adopt this approach include Caltex, BHP, North Ltd and WMC (Elijido-Ten, 170). These companies voluntarily disclose their environmental and social reports despite the absence of regulations compelling them to do so. In addition, these companies still compile environmental reports despite the huge cost implications of doing so. If these organizations did not think they were responsible to a wider group of stakeholders they would not engage and report on environmental sustainability. Conventional wisdom holds that business firms should not engage in activities whose benefits outweigh the costs. However, some organizations have been known to report on environmental issues to gain legitimacy in the eyes on stakeholders. Legitimacy Theory Legitimacy theory argues that organizations are in a continual struggle to gain legitimacy and justify their existence in the community they operate. According to Deegan, Rankin and Tobin, businesses want to be perceived as “desirable, proper and appropriate” within the society’s value system (312). Organization therefore attempt to make or imply their activities are congruent with the acceptable and desirable conduct in the society. Legitimacy theorists argue that Social and sustainability accounting for some organizations is concerned with legitimating the economic action of the business and aligning them with the social values of the society they operate (Wilmshurst and Frost, 11). Organizations keen on appearing legitimate will keep changing their social and sustainability strategy to fit various stakeholders and cultural groups. Organizations are likely to employ strategies that enhance their “public image” according to their perception of their level of legitimacy (Wilmshurst and Frost, 11). These organizations normally apply symbols and symbolic action to construct or enhance their corporate legitimacy. However, the organization remains focused on its primary goals, output and methods of operation(Van der Laan, 21). Organizations who adopt a legitimacy theory approach of Social and sustainability accounting are therefore doing so for the sake of public image. These type of organizations only partially report the impact of their methods of operation on the environment (Van der Laan, 21). Their social and sustainability accounting also emphasize environmental success while ignoring negative impacts (Wilmshurst and Frost, 11). They also re-frame and ignore challenges raised by the public about the sustainability of their methods of operation. Organizations seeking legitimacy have also been found to employ legitimating strategies whenever their reputation is at risk. To close the legitimacy gap, these organizations may change their methods of operation or re-educate the public on the appropriateness of their goals and methods of operation (Van der Laan, 22). Sometimes they alter public perception by associating themselves with symbols that give them a high legitimate status. Other times, they attempt to align society’s expectations to their outputs, goals and methods. The main weakness of Social and sustainability accounting based on legitimacy theory is the lack of activities aimed at improving and sustaining the environment. Instead, Social and sustainability accounting effort is aimed at creating the perception that the organization is a legitimate entity. Similarly, stakeholder theory is weak as it seeks to satisfy the expectation of various groups of stakeholders who might have competing goals. The goals of some stakeholders may not be congruent with the Social and sustainability goals of the organization. Works Cited Deegan, C., Rankin, M., & Tobin, J. An examination of the corporate social and environmental disclosures of BHP from 1983-1997: A test of legitimacy theory. Accounting, Auditing & Accountability Journal, 15, no. 3 (2002)., 312-343. Deegan, Craig Michael. Financial accounting theory. North Ryde, N.S.W : McGraw Hill Australia. (2009). Elijido-Ten, Evangeline. "Applying stakeholder theory to analyze corporate environmental performance: Evidence from Australian listed companies." Asian Review of Accounting 15, no. 2 (2007): 164-184 Healy, Paul M., and Krishna G. Palepu. "Information asymmetry, corporate disclosure, and the capital markets: A review of the empirical disclosure literature." Journal of accounting and economics 31, no. 1 (2001): 405-440. Riahi-Belkaoui, A. Accounting theory: Cengage Learning EMEA. (2004). Solomon, Jill. Does Social and Environmental reporting nurture trust and stakeholder engagement and reduce risk?. No. A2005/2. Cardiff University, Cardiff Business School, Accounting and Finance Section, 2005. Van der Laan, Sandra. "The role of theory in explaining motivation for corporate social disclosures: Voluntary disclosures vs ‘solicited’disclosures." Australasian Accounting, Business and Finance Journal 3, no. 4 (2009): 2. Wilmshurst, T. D., & Frost, G. R. Corporate environmental reporting: a test of legitimacy theory. Accounting, Auditing & Accountability Journal, 13.1 (2000): 10-26. Woodward, D. and Woodward T. (2001), “The case for a political economy of accounting: A critique of the arguments”, Conference Proceedings, British Accounting Association Conference, Nottingham, March. Read More