What are the arguments favoring regulation of financial reporting?

Question

What will be an ideal response?

Answer 1

ANSWER:
One argument supporting regulation is that it is in the public interest. Without regulation, there is the possibility of failure in the free market system because the firm is a monopoly supplier of information about itself. This situation creates the opportunity for restricted production of information and monopolistic pricing if the market is unregulated. Mandatory disclosure would result in more information and a lower cost to society. It is argued that more and better regulation is necessary to raise the quality of financial reporting in order to protect the public from fraud and failures.

Another argument in favor of regulation is that accounting information is a public good, and public goods are underproduced in a free market. Underproduction of public goods occurs because producers are not able to impose production costs on all users of the good, and are thus not motivated to meet real demand. The only way in which production can be increased is through regulatory intervention. Intervention in the form of mandatory reporting requirements is considered necessary to ensure that the real demand for accounting information is met.

It is also possible that free markets are contrary to social goals because they may not communicate enough information to the security markets, resulting in insiders having information that is not available to shareholders. In addition, the information that would be available in unregulated markets might not provide enough comparability among firms.

A philosophical justification of the standard-setting process—called codification—is based on evolutionary improvement of accounting standards in an open and democratic society. The goal of the standard-setting process should be to provide the best standards from the societal point of view.