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How financial regulation evolves (Stewardship (Originated when possessors…
How financial regulation evolves
Background
Dealing with how reports on a company financial situation which are compiled for external purposes
Bromwich (1992) point out that those who want to use accounting information in negotiating with others (eg to raise finance or to sell products) have an interest in providing good quality financial information
The market will 'price in' doubts about the reliability of the financial information
They will ask a higher price when it is doubtful about the quality of the information to compensate for uncertainty
The provider of the information has an incentive to provide good information and to reassure users of its quality
Stewardship
The simplest form of financial reporting
Originally unregulated for thousands of years
Originated when possessors of wealth appointed other people to manage their money
The agents have been reporting back on what they did with it in the form of a stewardship reports
The stewardship function is a potent force in financial reporting
Enables a track record
Managing the national economy
Earliest regulation in Europe
Aimed at small businesses whose owners did not take the trouble to measure the success of their business
Stopped them from going into liquidation
Savary Ordonnance
The first national accounting rule created in the world
Introduced to prevent bankruptcies
Large businesses had to make an annual inventory - a balance sheet using current market values to assess the health of their business
One of the principle forces for regulation
Governments are concerned with the healthy functioning of the economy for which they are responsible
Politicians have thought it necessary to step into the markets and introduce controls on corporate behavior
SEC (US Securities and Exchange Commission)
Regulates US financial markets
1673 regulation in France occurred because the government observed that there has been a spate of bankruptcies
Leading to a loss of confidence in business and a downturn in economic activity
Information for investors
Much of this infrastructure of financial reporting as we know now was laid down during this period
During the Industrial Revolution in the 19th century
Sprang because of the change in size of the average business and the capital necessary
Before the revolution
Businesses were small scale
Typically one owner or a partnership
Liability was unlimited and the distinction between the owners wealth and the business's were not observable
Banks were mostly concerned with financing trade exchanges, not with lending to provide base capital for business
The revolution
Bought large investments in high risk projects
Built canals and railways, then factories
The economy needed to evolve to accommodate the new pattern of business
Produced a new sophistication in the stewardship function
There was a separation between manager and investor, and financial reporting had to evolve to meet the needs of communicating information between the two
Capital market function
Providing information about the company’s economic performance to the financial markets
First developed in the UK
The government intervened little at first only specifying that there should be a ‘full and fair’ balance sheet provided by the company to its shareholders
Borrowed finery
How financial reporting has evolved in response to economic evolution, but other influences have occurred also
Borrowing legislation from other countries
There is a strong tradition within continental Europe of looking at what the neighbors are doing and adapting their solutions for ones owns use
Forrester (1996) discusses how professional accountants from the 19th century onward encouraged exchanges of accounting rules
Commercial Code (1807)
Napoleons code similar to the Savary Ordonnance
GmbH
Corporate vehicle for small businesses
Taken up in other Europeans countries
Imperialism
Related to the idea of transferring regulation across borders
Influence of colonial tradition and of trade relations
European colonizers transferred their accounting rules to their colonies
Singapore has the same rules as Cyprus and Nigeria
Imperialism include the idea of economic domination
The links have led to countries adopting rules that have not evolved in their own economy and are not therefore necessarily well adapted to that economy
Taxation
Accounting is to provide the basis on which tax is measured
The link between taxation and financial reporting is stronger in some countries than others
Typically much more pronounced in the accounting of owner-managed business than multinational groups
The relationship between tax and accounting is the result of an accident of history
Government regulation of accounting was installed in the early 19th century
Whereas tax on income was introduced towards the end of the 19th century and early part of the 20th century
In some cultures, annual financial statements are perceived to be mostly about taxation, not reporting economic performance