Deck 4: The Economics of Financial Reporting Regulation

Question 1

There is usually information symmetry between the firm and outsiders.

Answer 1

False

Question 2

Accounting regulation prevents fraud.

Answer 2

False

Question 3

The stock market shows that people are willing to contract privately for information about a firm.

Answer 3

True

Question 4

Arguments supporting unregulated markets are largely inductive in nature.

Question 5

Financial reporting for publicly listed companies in the United States was first regulated in the 1950s.

Question 6

Risk in investment can be eliminated by improved accounting and auditing procedures.

Question 7

According to signalling theory, firms have an economic incentive to report bad news.

Question 8

An argument supporting accounting regulation is that the production costs of mandatory reporting requirements may be small since most of the basic information is produced as a by-product of internal accounting systems.

Question 9

An argument supporting accounting regulation is that it is better to force mandatory reporting than to have individuals competing to buy information privately.

Question 10

Early adoption of new financial accounting standards generally indicates "bad news" whereas late adoption generally indicates "good news."

Question 11

Only firms that perform well have incentives to report their operating results.

Question 12

The SEC has allowed accounting policy-making power to remain in the private sector.

Question 13

Empirical tests of the free market position are impossible since we live in a regulated environment.

Question 14

All of the arguments supporting the case for unregulated markets relate to the incentives for a firm to report information about itself to owners and to the capital market in general.

Question 15

Agency theory explains that firms have an incentive to report voluntarily to the capital market because they are competing for risk capital.

Question 16

The major agency relationship is between the management of a firm and the firm's creditors.

Question 17

Congress empowered the Securities and Exchange Commission (SEC) to regulate financial reporting in the 1930s.

Question 18

The value of a company can be increased when the firm voluntarily reports private information about itself if the information reduces uncertainty about the firm's future prospects.

Question 19

An argument in favor of unregulated markets is that because of private opportunities to contract for information, market intervention in the form of mandatory disclosure rules is both unnecessary and undesirable.

Question 20

Good financial reporting will lower a firm's cost of capital.

Question 21

Information symmetry exists when potential investors do not all have equal access to the same information.

Question 22

Proregulation arguments as well as arguments for unregulated markets are largely deductively reasoned rather than empirically researched.

Question 23

Which of the following concepts holds that anyone who genuinely desires information about a firm is able to obtain it?

A)Signalling theory
B)Agency theory
C)Information symmetry
D)Private contracting

Question 24

True market demand for public goods may be determined by the number of consumers who pay for the goods.

Question 25

An argument supporting regulation is that the only way to increase production of public goods to meet the real demand of the public is through regulatory intervention.

Question 26

Which of the following is not an argument supporting unregulated markets?

A)Agency theory
B)Private contracting opportunities
C)Signalling theory
D)Social goals

Question 27

Accounting information is a public good.

Question 28

Which of the following has been cited as a reason for the alleged low quality of financial reporting, even under regulation?

A)Not enough management flexibility in the choice of accounting policies
B)Poor accounting and auditing standards
C)Laxity by securities analysts
D)All of the above

Question 29

Which of the following concepts provides a framework for analyzing financial reporting incentives between managers and owner?

A)Signalling theory
B)Agency theory
C)Information symmetry
D)Private contracting

Question 30

Which of the following is not a possible justification for regulated markets?

A)Possible market failure
B)Natural monopolies
C)The possibility that free markets are contrary to social goals
D)Private contracting opportunities

Question 31

The present financial disclosure system imposes costs on users rather than the companies themselves.

Question 32

Which of the following concepts explains why firms have an incentive to report voluntarily to the market even if there were no mandatory reporting requirements?

A)Signalling theory
B)Lifecycle theory
C)Information overload
D)Capture theory

Question 33

In setting policy, due process means that a regulatory agency seeks to involve all affected parties in its deliberations.

Question 34

Sarbanes-Oxley has brought about a separation between auditing and management consulting.

Question 35

Overproduction of accounting information, or the problem of standards overload, has the greatest effect on large, publicly traded companies.

Question 36

Which of the following concepts holds that voluntary disclosure is necessary in order for a firm to compete successfully in the market for risk capital?

A)Signalling theory
B)Agency theory
C)Information symmetry
D)Private contracting

Question 37

An argument supporting regulated markets is that more and better regulation is necessary to raise the quality of financial reporting in order to protect the public from frauds and failures.

Question 38

There is a tendency for overproduction in unregulated markets.

Question 39

Public goods are commodities that, once consumed, reduce the opportunity for consumption by others.

Question 40

The Impossibility Theorem implies that once the free market pricing system is abandoned, and there is no way of determining aggregate social preferences.

Question 41

Lifecycle theory argues that:

A)regulation eventually becomes an instrument for protecting the information users.
B)the regulatory body often protects the regulated group from competition.
C)regulation goes through several phases, but is never in the public interest.
D)both b and c.

Question 42

Which of the following is not a reason cited in the text for the failure of the CAP and the APB as regulatory bodies?

A)The SEC did not officially endorse private-sector standard setting until 1973.
B)The CAP and the APB lacked the necessary political structure to ensure their survival.
C)Policy making was exposed to outside influence.
D)There appeared to be no due process in the determination of accounting and disclosure rules.

Question 43

What are the arguments favoring regulation of financial reporting?

Question 44

An externality exists if:

A)a producer of a good is unable to impose production costs on all users of the good.
B)true market demand for a good is revealed in the market place.
C)production of a good equals true market demand.
D)the production of a good is regulated.

Question 45

Which of the following statements is true?

A)The problems of the FASB stem from its limited use of due process.
B)The FASB has not been as successful as its predecessors were.
C)Many studies have found that large accounting firms tend to dominate policy at the FASB.
D)With the implementation of the FASB, the capture theory argument lost much of its validity.

Question 46

Which of the following theories argues that the group being regulated eventually comes to use the regulatory process to promote its own self-interest?

A)Lifecycle theory
B)Agency theory
C)Signalling theory
D)Contracting theory

Question 47

Which of the following is a reason that the FASB should closely watch the lobbying behavior of free riders?

A)Responding to the interests of free riders could lead to an underproduction of accounting information.
B)Free riders claim to be acting in the public interest but actually make the market less competitive.
C)Free riders are not affected by accounting regulation.
D)Free riders do not have the direct economic interests in information production that others have.

Question 48

The focus of accounting regulation is on:

A)mandatory reporting.
B)improving the quality of reported information.
C)standards overload.
D)underproduction of accounting information.

Question 49

Prior to the FASB, accounting regulation was done primarily by:

A)the SEC.
B)the FTC.
C)AICPA subcommittees.
D)large accounting firms.

Question 50

Which of the following does not apply to a codificational system such as accounting standards?

A)It is pragmatic because maximizing the standards is impossible.
B)Outputs are evaluated on the basis of whether they work correctly.
C)Outputs are evaluated on the basis of whether they provide information to users at a reasonable cost.
D)Outputs are correct in terms of deductive logic.

Question 51

The effect of an externality is that:

A)production of a public good equals market demand.
B)production of a private good equals market demand.
C)true market demand for public goods may be determined by the number of consumers that pay for the goods.
D)the producer of a public good has a limited incentive to produce it because all consumers cannot be charged for the good.

Question 52

When the FASB considers the effects of an accounting standard:

A)the only costs it considers are auditing costs.
B)it considers benefits primarily in terms of the information needs of the stock market.
C)it is not concerned with producer costs.
D)it is primarily concerned with the effects of the standard on small or non-publicly listed firms.

Question 53

Which of the following groups is not listed in your text as being affected by accounting regulation?

A)The FASB
B)Companies
C)Auditors
D)Free riders

Question 54

Goods that possess hard property rights so that non-purchasers are excluded from consuming them are called:

A)public goods.
B)regulated goods.
C)private goods.
D)underproduced goods.

Question 55

What are the arguments against regulation of financial reporting?

Question 56

Which of the following is not true about the FASB?

A)It considers the economic consequences of proposed accounting policies.
B)It has seriously considered the question of the desirability of corporate social responsibility accounting.
C)It is sensitive to whether there are sufficient benefits to external users to warrant the imposition of new accounting standards.
D)The FASB has commissioned studies to aid in assessing the effects of proposed standards on firms.

Question 57

Which of the following is considered a social goal related justification for imposing financial reporting regulation?

A)Information symmetry
B)Comparability
C)A competitive capital market
D)All of the above

Question 58

Which of the following is not a negative consequence of regulating accounting?

A)A wealth transfer from non-users to users of accounting information.
B)The imposition of disclosure costs on the users of financial information.
C)A potential overallocation of social resources to the production of free, publicly available accounting information.
D)Benefits are received by the users of free accounting information while non-users implicitly incur the production costs.

Question 59

Mandatory public reporting of financial information:

A)enhances the perceived fairness of the capital market.
B)increases the total cost to society of obtaining the information.
C)results in costs greater than benefits.
D)requires companies to generate a lot of information that would not otherwise be produced by its accounting system.

Question 60

Democratic paralysis refers to:

A)the tendency of decision making under due process to be extremely slow.
B)the inability to achieve a consensus in the regulatory process.
C)the argument that regulation is not a democratic policy.
D)the inability of previous standard setting bodies to develop a conceptual framework.

Question 61

Discuss Ronen's solution to the problem of companies "capturing" auditors as a result of management consulting contracts between auditor and auditee.

Question 62

What do Healy and Palepu propose as a remedy for the auditing process being reduced to a "complex checklist"?

Question 63

Describe Ronen's solution to the auditor behavior problem that involves the capture of auditors by auditees.

Question 64

Discuss the regulation question in terms of determining and meeting the demand for accounting information. Who pays for and who benefits from accounting information?

Question 65

What is due process, and how has the political nature of regulation affected the CAP, the APB, and the FASB?

Question 66

What are the capture theory and the lifecycle theory of regulation, and how do they apply to the regulation of accounting?

Question 67

What is meant by "the paradox of regulation"?