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From Low-Quality Accounting to Financial Crises: Politics of Disclosure Regulation along the Economic Cycle

From Low-Quality Accounting to Financial Crises: Politics of Disclosure Regulation along the Economic Cycle. Jeremy Bertomeu Robert P. Magee. A Model of Disclosure Regulation. View reporting quality as the outcome of a political process

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From Low-Quality Accounting to Financial Crises: Politics of Disclosure Regulation along the Economic Cycle

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  1. From Low-Quality Accounting to Financial Crises: Politics of Disclosure Regulation along the Economic Cycle Jeremy Bertomeu Robert P. Magee

  2. A Model of Disclosure Regulation • View reporting quality as the outcome of a political process • Reporting quality is a function of accounting standards, plus all the institutional features (auditors, SEC, etc.) that determine the ability to differentiate successful enterprises from unsuccessful ones. • Current standards “depreciate” quickly and must be reset every period. • Various parties have differing views on the desirability of reporting quality, and the quality level is set at that desired by the median voter. • How is reporting quality influenced by the state of the economy? How does it influence the economy?

  3. The Interested Parties • Each period begins with entrepreneurs receiving a good project (with probability pt) or a bad project (with probability 1- pt). Require a loan to start business. • The economy (pt) follows a geometric random walk, with a bound at pt =1. • Good entrepreneurs prefer high quality reporting, bad entrepreneurs prefer lower quality reporting (though not necessarily no reporting). • Banks with a loan of unknown quality from the previous period may receive information about that loan’s quality and may have a liquidity shock that requires that the loan be liquidated. • Banks with bad loans prefer no reporting, banks with good loans and banks with loans of unknown quality prefer high quality reporting.

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  8. One Scenario

  9. Issues Raised by the Model • Regulations are endogenous • “Bad” regulations occur because they are beneficial to a subset of the economy. • Economic consequences of regulations should identify these groups. • How is standard-setting affected by the economic cycle? • Volume of standards at different stages of cycle • Agenda setting and management • Process time • Types of standards • How is pressure exerted on the standard-setting process?

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