Accounting Standards and the Economics of Standards

Summary

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The paper draws on the economics of standards to inform current debates on international accounting standards. It traces the benefits claimed for standards - their contribution to the division of labour, innovation, trust, etc.; and the costs, including entry barriers and compliance costs. It illustrates these benefits and costs with cases from accounting regulation. It adopts two approaches to the question whether accounting regulation is best achieved by a single set of standards for the world, or by competing systems. The first approach focuses on contributions in economics, including the theory of standards races and of optimal variety. In these analyses, only in special circumstances has a single standard emerged as the superior outcome. The second approach introduces evidence from accounting and finance on the problems of translation with globalised financial markets, and on the relative costs and benefits of multiple standard-setters or a single global scheme. The most compelling net benefits of harmonisation arise for small economies moving from idiosyncratic to international standards.

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Extract

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Accounting Standards and the Economics of Standards

1. Introduction

The aim of this paper is to explore what the distinct literatures on accounting standards and the economics of standards can learn from each other. Although some important pioneering contributions have explored the relationship between the two (for example, Bromwich, 1985; Solomons, 1986; Taylor and Turley, 1986), there is more to be done. We show that much of the recent literature on the economics of standards can help to inform our understanding of the role played by accounting standards. Moreover, we shall see that those contributions to the economics literature that try to define the right number of standards in a particular setting can also shed some light on current debates about the pros and cons of adopting a single set of accounting standards.

The rest of the paper is organised as follows. In Section 2, we review the role of standards in promoting economic efficiency and wealth creation. In Section 3, we review the role of standards in promoting more efficient capital markets. In Section 4, we start to address the question, 'how many standards should we have', by drawing out some lessons from the economics literature on standards. In Section 5, we draw out some conclusions from the accounting literature on the case for and against a single set of global standards. Section 6 provides some concluding comments before Section 7 provides a postscript on the similarity between accounting standards and World Wide Web (WWW) standards.

2. The role of standards in promoting economic efficiency

Most economists would agree that the following economic mechanisms, amongst others, lie at the heart of wealth creation in a competitive economy:

* the division of labour

* international trade

* innovation

* competition in open markets

* cooperation to exploit network effects

* trust between trading partners.

This list does not include any reference to standards or standardisation as such. But as we shall see below, all of these mechanisms may work much better in the presence of open standards and standardisation.

The pioneering study of the economics of standards is generally taken to be that by Hemenway (1975). There are incidental (and indeed, very important) references to the role of standards before that, and indeed the role of standards in the growth of international trade was not lost on economic historians (e.g. Erwin, 1960; Skinner, 1954). But Hemenway's (1975) was the first book devoted explicitly to the economics of standards. The literature took off rapidly in 1985, with the publication of three papers on the emergence of de facto standards by David (1985), Farrell and Saloner (1985) and Katz and Shapiro (1985). A very recent survey is offered by Hesser et al. (2006).

That literature distinguishes four types of standard - or perhaps it would be better to say four purposes of standardisation (David, 1987; Swann, 2000):

* standards for compatibility and interoperability

* minimum quality (or safety) standards

* standards to promote scale economies by efficient variety reduction

* standards of measurement and product/service description.

Although the economic issues involved vary across these four different purposes, they are all inter-related. Accordingly, rather than organise our discussion around these four types or purposes, we organise our discussion around the effects of standards. Much of the literature is positive about the economic role of standards, but in some circumstances there is also a downside. Accordingly, we review both the constructive contribution of standards (Section 2.1) and the downside (Section 2.2).

2.1. The constructive contribution of standards

In what follows, we identify six mechanisms by which standards contribute to economic growth and efficiency.

Division of labour

Adam Smith (1776) noted that even in the simplest forms of manufacture, it was customary to find that the production process was divided into several distinct parts. Each labourer would work on just one of those tasks. S...

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