Exam 4: The Economics of Financial Reporting Regulation

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Capture theory and the lifecycle theory of regulation both argue that the group being regulated eventually comes to use the regulatory process to promote its own self-interest. When this occurs, the regulatory process is considered captured. The lifecycle theory of regulation argues that a regulatory agency starts out in the public interest, but later becomes an instrument for protecting the regulated group.
From 1976 to 1978, the United States Congress investigated the allegation that accounting regulation had been captured by the Big Eight group of accounting firms, who were the predominant auditors of publicly listed corporations. Prior to the FASB, accounting regulation was done primarily by AICPA subcommittees, which were undoubtedly heavily influenced by the Big Eight accounting firms. However, with the implementation of the independent FASB, the capture theory argument lost much of its validity.
Current practices of accounting regulation survived the scrutiny of Congress partly because capture theory and the lifecycle theory are less applicable to financial reporting. The number of parties directly affected by accounting regulation is much larger and more diverse than in traditional regulated industries. Auditors and other parties affected by accounting regulation, companies that must comply with regulations, and free riders who use the costless information for investment analyses have a divergence of interests, which place the accounting regulator in a more naturally neutral posture than is possible in other regulated industries.