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Increasing costs and interest group theory of regulation

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The costs have gone up after the new regulations have been implemented! What may have happened? This can be viewed through the lens of interest group theory of regulation (Ezelle, 2011). Per previous narrative, verbatim:

Scott (2006, pp. 383-403) indicates information asymmetry is a reason for the creation of various rules and regulations governing the production of information to protect owners who are at an information disadvantage to improve the capital markets and increase the public confidence of fairness. Regulation of the professions as well as the firms and the information to be disclosed to the owners has a cost benefit trade off since the costs of regulation include enforcement as well as ill informed decisions made by the regulators. The benefits of the increased regulation are in the perception of the market success following the perceived notion of a market failure.

Interest group theory of regulation, as developed, modified and discussed by others, (Becker, 1983; Posner, 1974; Scott, 2006, pp. 415-416; Stigler 1971) contends that the formation of groups by individuals will lobby to protect their interests. Some interest groups demand regulation and legislatures supply regulations. The legislature is also an interest group and is interested in retaining its’ position by supplying the regulations to the demanders of regulation in order to retain their position. The regulatory bodies which are formed as a result of legislative action engage in compromise in an effort to create an environment of cooperation between the various interests groups by using due process to create standards. In effect, the setting of standards is political as well as economic since the demand for information to ameliorate the information asymmetry by the owners is not equivalent to the information which is provided willingly by the management of the firm. Thus, there is a demand for regulation of information. Due process is a part of the determination of standards which is characterized by conflict and compromise and acceptance by a greater than majority with the acceptance dependent upon the extent to which the conflicted parties believe their concerns were considered. The setting of standards require an increase in the information of usefulness of information a firm provides to its’ owners such as there will be a reduction in information asymmetry wherein there is not an overbearing increase in costs to society. A concern of the creation of new standards is the costs involved to the firm and management. When the costs are too great, management may engage in due process efforts to reduce the information provision requirements which are being forced by the owners.

In the event market forces are unable to control information asymmetry, resolution of issues between owners or potential owners and management of the firm are subjected to regulatory standards which provide the economic consequence of costs. Conflict between owners and management has necessitated the use of auditors to control for information asymmetry which represents a cost to the firm as well as the owners (Khalil & Lawarree, 1995).

Over time various rules and regulations have been implemented by due process through private, quasi-governmental, and governmental regulatory bodies to address issues of concern pertaining to the conflict which exists between owners and managers. The passage and implementation of the Sarbanes Oxley Act is an additional burden placed on owners and management which is instrumental in the potential for an increase in the fees charged by auditing firms.

Sir Isaac Newton actually covered this several centuries ago in his axioms of motion!

References

Becker, G. S. (1983). A theory of competition among pressure groups for political influence. The Quarterly Journal of Economics, 98(3), 371-400.

Ezelle, Jr., R. W. (2011). The impact of the Sarbanes Oxley Act on auditing fees: An empirical study of the oil and gas industry (3483923) (Doctoral dissertation). Retrieved from ProQuest Dissertations and Theses database. (3483923)

Khalil, F., & Lawarree, J. (1995). Collusive auditors. American Economic Review, 85(2), 442-446.

Posner, R. A. (1974). Theories of economic regulation. The Bell Journal of Economics and Management Science, 5(2), 335-358.

Scott, W. R. (2006). Financial Accounting Theory (4 ed.). Toronto: Pearson Prentice Hall.

Stigler, G. J. (1971). The theory of economic regulation. The Bell Journal of Economics and Management Science, 2(1), 3-21.

Business, Efficiency

Production Efficiency

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A toothpaste factory had a problem. They sometimes shipped empty boxes without the tube inside. This challenged their perceived quality with the buyers and distributors. Understanding how important the relationship with them was, the CEO of the company assembled his top people. They decided to hire an external engineering company to solve their empty boxes problem. The project followed the usual process: budget and project sponsor allocated, RFP, and third-parties selected. Six months (and $8 million) later they had a fantastic solution – on time, on budget, and high quality. Everyone in the project was pleased.

They solved the problem by using a high-tech precision scale that would sound a bell and flash lights whenever a toothpaste box weighed less than it should. The line would stop, someone would walk over, remove the defective box, and then press another button to re-start the line. As a result of the new package monitoring process, no empty boxes were being shipped out of the factory.

With no more customer complaints, the CEO felt the $8 million was well spent. He then reviewed the line statistics report and discovered the number of empty boxes picked up by the scale in the first week was consistent with projections, however, the next three weeks were zero! The estimated rate should have been at least a dozen boxes a day. He had the engineers check the equipment, they verified the report as accurate.

Puzzled, the CEO traveled down to the factory, viewed the part of the line where the precision scale was installed, and observed just ahead of the new $8 million dollar solution sat a $20 desk fan blowing the empty boxes off the belt and into a bin. He asked the line supervisor what that was about.

“Oh, that,” the supervisor replied, “Bert, the kid from maintenance, put it there because he was tired of walking over, removing the box and re-starting the line every time the bell rang.”

Teaching a MBA course concerning management accounting, I received the aforementioned while covering activity based costing. It really makes one wonder if too much time is spent in the towers of power as opposed to walking the floor and hearing a bit of common sense. The aforementioned “story” is very much in line with the experiences I had when working in a foundry. It always seemed the geniuses in the office were two steps behind those of us in the midst of the action. Sometimes a little common sense works best.