Paul L. Caron

Tuesday, March 8, 2011

Cunningham: The Influence of Law & Economics on Law & Accounting

Lawrence A. Cunningham (George Washington) has posted The Influence of Law and Economics on Law and Accounting: Two Steps Forward, One Step Back, in Research Handbook on the Economics of Corporate Law (Brett McDonnell & Claire Hill, ed.) (Edward Elgar, 2012), on SSRN. Here is the abstract:

Theory can have profound effects on practice, some intended and desirable, others unintended and undesirable. That's the story of the influence the field of law and economics has had on the domain of law and accounting. That influence comes primarily from agency theory and modern finance theory, specifically through the efficient capital market hypothesis and capital asset pricing model. Those theories have forged considerable change in federal securities regulation, accounting standard setting, state corporation law, and financial auditing. Affected areas include the nature of disclosure, the measure of financial concepts, the limits of shareholder protection, and the scope of auditor duty.

Analysis reveals how agency theory and finance theory often but not always point to the same policy implications; it reveals how finance theory’s assumptions and limitations are often but not always respected in policy development. As a result, while these theories sometimes produced policy changes that were both intended and desirable, some policy changes were both unintended and undesirable while others were intended but undesirable. Examination stresses the power of ideas and how they are used and cautions creators and users of ideas to take care to appreciate the limits of theory when shaping practice. That's vital since the effects of law and economics on law and accounting remain debated in many contexts.

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I've had more than one discussion with colleagues about what should be correct Generally Accepted Accounting Principles (GAAP) and adequate Generally Accepted Auditing Standards (GAAS) vs. what the courts tell us that we have to follow if we want to avoid lawsuits and the SEC tells us to follow if we don't want it to completely take over the setting of accounting and auditing rules.

There is often quite a difference, and the results, in my view, are that GAAP and GAAS have become twisted, having been modified by compromises, special agendas, power grabs, and ignorance, rather than a pure reflection of economic activity and concern for costs vs. benefits.

What's happened to accounting is what has happened to medicine, and probably a lot of other fields -- the pracitioners are forbidden to follow their professonal training to reach the best results, and they have to spend an abnormal amount of time to avoid violating court precedence and government regulations, which results in wasted time, more costs, and departures from the best practices and end products.

Posted by: Woody | Mar 8, 2011 9:55:39 AM