Political process model by positive theory

Do accounting numbers play a role in the political process of cost allocation in providing information to users? Discuss

I agree, because… the higher the profit the higher the intention of interest group and politician to

Political process model by positive theory

Rather than capital market, accounting information in political market is less demanded by the users because of less incentive to ask for it.

What is Political market? The market that company would enter to supply the interest group an enough information of FS. As we studied in last blog about capital market. The assumptions such as:

• people have a perfect knowledge (highlighted)
• no transaction cost (highlighted)

are considered as unrealistic and illogical when we compared to the real world, why so? It is because of people have to pay transaction cost to get an information from the management of the firm. People are not simply get all information that they want without incurring any costs at all. Therefore perfect knowledge assumptions in capital market is impossible and transaction cost is actually exists in order for someone to get information that they want.

Political market however confirms an existence of transaction costs, this cost would lead to lesser demand by the users depending on the cost benefit analysis that the user will incur higher cost than benefits that they will get from the information. Therefore it is not worthy to choose the otherwise option as we assume that individuals are the utility (profit) maximizer, they will choose to not incurring transaction cost. With this result, firms has power to decide to limit their supply of financial information and put less disclosure to the user for their vested interest (self interest).

High information cost problems to the user:

Individuals

• Individual actions are small effect to the person’s (company) wealth
• 1 individual as 1 voter will influence nothing to the management, 
• the opinion is insignificant to effect the management’s decision making
• Political cost = cost born by the user in order to lobby for challenging the decision made by the firm 
• It is ultimately high for an individual to bear political cost alone.

Interest group

• Forming interest group to make such power to influence management decision
• Once interest group is formed, it could enable the group lobbying. Which is reducing the cost of lobbying by diffusing the cost to each individuals in the group
• Cons, 

• Not easy to search people with the same interest (heterogeneity of interest)
• Cost to forming the organization (interest group) and cost to informing (communicate) members

Heterogeneity (diversity/different) of interests would also become the problem for the interest group to lobbying the information, they need to focus on certain information that they want notwithstanding individual interest only. 

Greater Residual opportunism probability to occur for the firm is still exist despite:

• having a greater information cost for lobbying
• diffused rewards by forming interest groups
• high monitoring cost by the shareholders

Example of political process in Stock market crash in US:

• US Gov pass securities act to increase gov control over public co to prevent future crash
• The act is not so effective to prevent a lot of future crashes
• Public still choose to stay rationally uninformed. Why??? Because of:
• Costly to get information
• Costly to lobby to come out with corrective action plan
• Individual are less expecting public to do so

Accounting numbers and political cost allocation

Accounting numbers is a tool for “crisis solving” and “promoting interest” to the firm and other parties. Why I said so?

Regarding crisis solving, 

Employees are very sensitive on the profit gained from the firm. Once they know the profit generated from the firm is unusually higher. Employees would criticize the firm had exploiting their labor to get unusual profit therefore they will demand for increment of wages/salaries.

Accounting numbers are used to understate the profit figure therefore it would give another point of view (window dressing) so that the censure would be minimized.

Regarding promoting interest,

Firms are also a utility maximizer, they also have interest in the profit of the firm. The benefit gained by the firm through a subsidies is something to be keep on so that the government will not have to retrieve its subsidies because the company had been matured in the industry.

To avoid from subsidy retrieval, firm has to understate their profit to keep enjoying the subsidy even though the firm has gaining a higher profit. Again the accounting figures plays an important role to this problem. 

Role of accountant in political process

Accountant is given a responsibility to window dressing the profit figure so that the unusual profit can be reduced within the scope of accounting practice (as long as it is legally to do so). Accountant has given a flexibility to choose which technique that they want in performing accounting job. This brings an opportunity for the firm to gain from unusual profit in the political process and at the same time avoid from critics and political costs. They will use conservatism principle as an excuse to understate the firms profit so that interest groups will believe the accountant is doing their job very well within the scope.

Another factor that lead to window dressing

• The size of firm, the bigger firm will be more political sensitive and have more tendency to use accounting method to reduce the reporting profit
• The volatility of the profit, the more volatile the profit, the more it attracts the political attention. The higher variance is something suspicious for someone to be attracted to.