Under public interest theory, governments intervene in the regulation of financial reporting in response to market failure and 'in the public interest'. The basic argument is that market mechanisms have failed and government action is necessary for the greater good. The of the Sarbanes-Oxley Act in the United States in 2002 following the collapse of the Enron Corporation and the audit firm Arthur Andersen can be viewed through the lens of 'the public interest'. New financial reporting and corporate governance requirements were introduced and new standards and oversight structures for auditors were Canada, Kuhn and Sutton argue that the Sarbanes-Oxley Act created, in the public interest, one of the greatest protections in financial markets and related corporate behaviour in Case study 3.1 at the end of this chapter provides an opportunity to consider the costs and benefits of the Sarbanes-Oxley Act.
An earlier example is the Australian government establishing the Accounting Standards Review Board (ASRB) in 1984. The government's intervention in the accounting standard setting process is seen as justified by failures in the market for accounting information, evidenced by the significant number of corporate collapses even after auditors had certified accounts as 'true and fair'. Similarly, calls for stricter accounting standards or for changes in standard setting processes following major corporate collapses in the late and early 2000s (Enron and Worldcom in the United States; HIH and in Australia) are seen as justified under the public interest theory.
Corporate collapses are deemed to indicate that there were serious violations of competitive conditions. The violations stemmed from information asymmetries between the suppliers (corporate management and accounting professionals) and external financial statement users (investors) who do not know what accounting information they need and/or are unable to determine the value of the accounting information they receive. Furthermore, financial information can be seen as a 'public good' which has led to a divergence between the marginal costs and benefits to (a) the users of financial
information and information producers (corporate management). Before government intervention the establishment of the ASRB), standards were not legislatively backed and public interest theorists argue that it was not surprising to find that the amount of the information produced by corporate entities fell short of 'the quality necessary for informed investment decisions and optimal resource allocation in the economy'."
Thus, the public interest theory framework suggests the government intervention in the accounting standard setting process is to rectify failures in the market for accounting information. In turn, public interest was served by a return of confidence in the capital markets by investors.
By concentrating on the necessity of government intervention in the marketplace to protect consumers, public interest theory generally ignores the findings of many research studies which indicate that the managers of business entities have strong incentives to 'correct' market failure perceptions about their business activities. This correction is achieved through the release of extensive voluntary disclosures of information which protects the users of financial For example, market forces will exert pressure on firms to reduce uncertainty about the quality of the firm's product, the viability of the firm, and the ability of current management to ensure appropriate returns to investors. It is claimed that failure reduce this uncertainty leads to the firm being viewed as a This, in turn, can result in additional costs to the firm in the form of, for example, higher interest charges, increased security requirements for loans and an increased threat of takeover from competitors. Thus, we find examples where we can apply public interest theory, but it is not clear that the theory is the only explanation for the observed behaviours.
Application of capture theory
Walker argues that although the Australian government originally introduced the ASRB to ensure the protection of the 'public interest, he believes capture theory is more applicable in explaining the events. He argues that the board was successfully captured by the accounting profession, the regulated The ultimate signals of capture, according to Walker, centred on events such as the fact that the 'due process' provisions were abandoned in favour of 'fast-track' approval of standards submitted by the Australian Accounting Research Foundation Furthermore, a number of disputes between the ASRB and the AARF were settled in the latter's favour and the AARF (funded by the profession) merged with the ASRB (funded by the government). The ASRB formally had power to consider standards submitted to it from any source. This was an attempt to broaden political acceptability of approved standards; however, only one out of 23 approved standards came from a source outside the profession. Thus, as with ordinary standards, it could be argued that the 'due process' mechanism within the ASRB failed to achieve its purpose.
Basically, Walker's argument is that the accounting profession needed to legitimise accounting standards (that is, ensure compliance with the standards) which could be achieved only by standards that had the 'force of law' by ensuring that accounting standards were backed by legislation. However, the accounting profession had an economic interest in retaining the standard setting process, which it did not want to relinquish to the government. In turn, therefore, the only way the profession could both legitimise accounting standards and maintain its economic interests was to 'capture' the ASRB, the body that had the power to make accounting standards mandatory for corporate entities. Under the capture view, regulatory intervention in the accounting standard setting process was designed, as with the public interest theory framework, to protect the public interest. However, Walker's study portrays the accounting profession
as an elite group that, in effect, was not accountable to the public interest, which sought and achieved control of the standard setting process for its own gain, and which was constrained only by the fear of state
The international harmonisation of accounting has raised new questions in relation to the applicability of capture theory. While there was widespread support in Australia for the harmonisation of accounting standards, the adoption of international standards strongly reflect the interests and preferences of large companies, the Australian Securities Exchange (ASX) and sections of the accounting CLERP 1 directed standard setters to have a commercial focus and to be responsive to business needs, reflecting a response by government to lobbying against Australian Accounting Standards Board (AASB) standards by the corporate sector. The ASX was a strong supporter of early adoption of international standards, presumably because it saw benefits for the ASX and listed companies flowing from the use of international standards. In one sense, the interests of all these parties have been overtaken by international events. Having exercised their influence and achieved their preference for adoption of international standards, they are now in the of having given up influence over the process of the development of those standards. I t is unlikely that these parties (large companies, the accounting profession and the ASX) can influence future Australian accounting standards in the same way as they have in the past. None of them is in the position to control or 'capture' the standard setting process post-2005.
With Australia's and Europe's decisions to adopt international standards, and the mission to have its standards adopted in countries throughout the world, the focus of regulatory capture has shifted to the IASB. Zeff notes that the IASB is under a 'steady flow of insistent views' from trade associations, major companies and banks in European He explains that there are many groups vitally concerned with the IASB output, so we can conclude that capture by any one group would be unlikely. However, the idea that the IASB has been 'captured' by the FASB has been flagged. The issue of IASB standards which are close to US Generally Accepted Accounting Principles (GAAP) does raise the question of the influence of US GAAP o n IASB standards. Zeff reports that the dissent in Europe over IFRS 8, which closely follows a FASB standard, has raised afresh the question ofwhether convergence between the IASB and FASB is good for