Stability and Regime Change: The Evolution of Accounting Standards

Abstract

We examine the evolution of accounting regulation by linking disclosure policies and investments in a dynamic voting model, where the disclosure requirement is the outcome of voting. Firms’ preferences over disclosure policies are determined by their investments, which are in turn decided by current and future disclosure policies. Absent external influences, accounting regimes are stable. A disclosure regime of high (low) quality and a strong (weak) economy coexist and reinforce each other. However, regulatory interventions can result in regime changes by changing the entrepreneurs’ expectations, even without direct enforcement. Unexpected shocks could also result in regime changes by impacting economic conditions and hence voter composition. Our analysis provides a framework to study the interaction between accounting regulation and firms’ economic decisions.