TEORI AKUNTANSI KEUANGAN

KODE: ECAU601401
CHAPTER 12
Chapter 12 – Standard Setting: Economic Issues

AYRIN NASHFATI - 1706105201

KANIA RUCITA– 1706105340
RAUDA – 1706105536

KELAS EKSTENSI SALEMBA

JURUSAN AKUNTANSI
FAKULTAS EKONOMI DAN BISNIS
UNIVERSITAS INDONESIA
2018
 CHAPTER 12
STANDARD SETTING : ECONOMIC ISSUES

REGULATION OF ECONOMIC ACTIVITY

Reason for regulation in economic activity :
1. As an action where regulation tries to increase information production to compensate for the
under production that arises for public good nature of accounting information (externalities).
2. To protect individuals who are at an information disadvantage due to information
asymmetry.
Standard setting is the regulation of firms’ information production decisions by a regulator.
Type of information that manager may process :
1. Proprietary information. Type of information that, if released, would directly affect future
cash flow of the firm. Examples are technical information about valuable patent.
2. Non-proprietary information. Type of information that, if released, does not directly affect
firm cash flow. Examples are earning forecast

WAYS TO CHARACTERIZE INFORMATION PRODUCTION

Quantity of information produced can be seen by:
1. Finer information. Finer reporting system adds more detail to the existing financial
statements. Examples include expanded note disclosure, additional line items on the financial
statements, segment reporting and so on. Finer information production means a better ability
to discriminate between realizations of the states of nature.
2. Additional information. In decision theory terms, additional information means an expansion
of the set of relevant states of nature upon which the firm’s performance depends.
3. The credibility of information.

FIRST-BEST INFORMATION PRODUCTION

First-best amount of information production is the amount that equates the marginal social
benefits of information to the marginal social costs.
Benefit of first-best information production include :
1. Better-informed investment decisions,
2. Possible lower costs of capital for firms producing the information,
3. Better-working markets due to greater investor confidence resulting from lower adverse
selection and moral hazard ( Section 4.6.1 ),
4. Reduction of monopoly power due to improved ability of potential entrants to an industry to
identify profitable investment opportunities,
5. Timely identification of failing firms,
6. Reporting on stewardship,
7. Create a situations where information released by one firm generates information about
others
Costs of information production include the direct costs of preparing and releasing information,
possible release of proprietary information and possible increased contracting costs resulting, for
example, from greater earnings volatility produced by fair value accounting.

MARKET FAILURES IN PRODUCTION OF INFORMATION

Externalities and Free Riding
An externality is an action taken by a firm or individual that imposes costs or benefits on other
firms or individuals for which the entity creating the externality is not charged or does not
receive revenue.
Free-riding is the receipt by a firm or individual of a benefit from an externality at little or no
cost.
The crucial aspect of externalities and free-riding is that the costs and benefits of information
production as perceived by the firm differ from the costs and benefits to society.
Study by Anilowski, Feng, and Skinner (2007) shows that when firm issue issue earnings
guidance sooner, the externality effect would expand, benefiting society through better
investment decisions
Other investors can “free-ride” on every information due to the public-good nature of accounting
information, its use by one individual does not destroy it for use by another. Since all investors
will realize this, no one has an incentive to pay. As a result, it is difficult for the firm to charge
for producing accounting information, in which case it produces less information than is socially
desirable.
Adverse Selection Problem
1. Problem of insider traiding
2. When manager who are privy to bad news about the firm’s future do not release that
information, thereby avoiding, or at least postponing, the negative firm consequences
The Moral Hazard Problem
Investor also concern about moral hazard and bad earning management that may contributed to
severe market failures if ignored.
Unanimity
A characteristic of economies with markets that do not work well is a lack of unanimity, which
derives from the effects of adverse selection and moral hazard just described.

CONTRACTUAL INCENTIVES FOR INFORMATION PRODUCTION

The firm has a private incentive to produce information in all of these contracting scenarios—no
regulator is needed to force information production. The information production decision is
internalized between the contracting parties
The Coase Theorem
Coase showed conditions under which the problem of externalities can be internalized, thereby
reducing the need for regulation.
It should now be apparent that while direct contracting for information production may be good
in principle, it will not always work in practice. when a large number of people are involved, the
costs of bargaining may be high. Thus, while contracts are an important source of private
information production, we cannot rely on them completely for the information needs of society.

MARKET-BASED INCENTIVES FOR INFORMATION PRODUCTION

Several market involved in market based incentive are:
1. Managerial labor market
2. Capital market
3. Takeover market

A CLOSER LOOK AT MARKET-BASED INCENTIVES

The Disclosure Principle
A simple argument can be made that suggests that a manager will release all information, good
or bad. This is known as the disclosure principle.
Empirical Disclosure Principle Research
Verrecchia assumed that the market knows that the manager has the information.
Signalling
A signal is an action taken by a high-type manager that would not be rational if that manage was
low type

ARE FIRMS REWARDED FOR SUPERIOR DISCLOSURE

If market forces are to motivate superior disclosure, firms should benefit through higher share
price and lower cost of capital.
- Improve the ability of investors to diversify.
- Improve liquidity.
- Lowering cost of capital is to reduce investor estimation risk.
The EO model has been criticized by several authors. In addition to assum- ing a finite number of
investors, EO assumed that returns on firms’ shares are independent. Thus, there is no role for
covariances between returns in their model. Yet, the CAPM tells us that covariances, through beta,
are a crucial component of cost of capital. This leads to a related way to reduce cost of capital—
namely, to reduce market synchronicity; that is, to reduce the extent to which share prices move
together. This will be accomplished to the extent that high quality disclosure enables share prices
to reflect firm-specific information, which could be good or bad.A variety of other models also
investigate superior disclosure. In an early study, Darrough and Stoughton (DS; 1990) analyzed a
game between a monopo- listic firm (the incumbent) and a potential entrant to the industry (the
entrant).

DECENTRALIZED REGULATION
They call this flexible approach decentralized regulation (also called a “management approach”)
since compliance is decentralized to the internal decisions of management. While comparability
across firms is reduced, decentralization improves the relevance of reporting since it is adapted to
the particular firm’s circumstances.Segment reporting is an example of decentralized regulation.
Information about firm segments is potentially useful to investors, since, in evaluating the
performance of large and complex firms, relevant information, such as differing risks, rates of
return, and opportunities for growth, may be buried in consolidated totals. Furthermore, firms vary
considerably in the extent and bases of segmentation, so that segment information should better
enable investors to value individual firms. While segment reporting increases relevance, reliability
is threatened to the extent that management acts opportunistically in choosing the basis and degree
of aggregation of segment reporting. Theory predicts two motives for opportunism. One is that
reporting on segment performance may reveal information to competitors, thus incurring
proprietary costs. The second is that management wants to cover up poor performance by including
poorly performing segments in larger totals. We conclude that decentralized standards have
potential to generate decision useful information, despite reduced comparability across firms that
results from a decentralized approach.

HOW MUCH INFORMATION IS ENOUGH?

Despite market failures in information production, however, we must not assume that ever-
increasing regulation is necessarily socially desirable. This is because regulation carries with it
substantial costs. These include direct costs of the bureaucracy needed to establish and administer
the regulations, and compliance costs imposed on firms. A second indirect cost arises because, the
regulator, in practice, is unable to calculate the socially optimal amount of information to require.
Since information regulations affect firms’ financing, investment, and production decisions, the
indirect costs of any “wrong” amount of infor- mation production can be large indeed.
Given these complex cost–benefit considerations, we simply do not know how much regulation is
enough. It is safe to say that complete deregulation would not be socially desirable. The
uncontrolled impacts of information asymmetry, externalities, and moral hazard would be
sufficiently serious to cause markets probably to cease to function. Nor is complete regulation
desirable, since the costs to completely eliminate accounting policy and disclosure choice would
be astronomic. However, this leaves a considerable range over which to debate the extent of
regulation.