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Chapter 4
The Economics of Financial
Reporting Regulation

TRUE/FALSE

1. Financial reporting for publicly-listed companies in the United States was first regulated in the 1950s. ANS: F

2. Congress empowered the Securities and Exchange Commission to regulate financial reporting in the 1930s ANS: T

3. The SEC has allowed accounting policy-making power to remain in the private sector. ANS: T

4. Arguments supporting unregulated markets are largely inductive in nature. ANS: F

5. All of the arguments supporting the case for unregulated markets relate to the incentives for a firm to report information about itself to owners and to the capital market in general. ANS: T

6. Empirical tests of the free market position are impossible since we live in a regulated environment. ANS: T

7. Agency theory explains that firms have an incentive to report voluntarily to the capital market because they are competing for risk capital. ANS: F

8. The major agency relationship is between the management of a firm and a firm’s creditors. ANS: F

9. Good financial reporting will lower a firm’s cost of capital. ANS: T

10. Only firms that perform well have incentives to report their operating results. ANS: F

11. According to signalling theory, firms have an economic incentive to report bad news. ANS: T

12. The value of a company can be increased when the firm voluntarily reports private information about itself if the information reduces uncertainty about the firm’s future prospects. ANS: T

13. There is usually information symmetry between the firm and outsiders. ANS: F

14. Early adoption of new financial accounting standards generally indicates “bad news” whereas late adoption generally indicates “good news.” ANS: F

15. The stock market shows that people are willing to contract privately for information about a firm. ANS: T

16. An argument in favor of unregulated markets is that because of private opportunities to contract for information, market intervention in the form of mandatory disclosure rules is both unnecessary and undesirable. ANS: T

17. An argument supporting accounting regulation is that it is better to force mandatory reporting than to have individuals competing to buy information privately. ANS: T

18. An argument supporting accounting regulation is that the production costs of mandatory reporting requirements may be small since most of the basic information is produced as a by-product of internal accounting systems. ANS: T

19. Risk in investment can be eliminated by improved accounting and auditing procedures. ANS: F

20. Accounting regulation prevents fraud.
ANS: F

21. Public goods are commodities that once consumed, the opportunity for consumption by others is reduced. ANS: F

22. True markets demand for public goods may be determined by the number of consumers that pay for the goods. ANS: F

23. An argument supporting regulated markets is that more and better regulation is necessary to raise the quality of financial reporting in order to protect the public from frauds and failures. ANS: T

24. An argument supporting regulation is that the only way to increase production of public goods to meet the real demand of the public is through regulatory intervention. ANS: T

25. Accounting information is a public good.
ANS: T

26. Information symmetry exists when potential investors do not all have equal access to the same information. ANS: F

27. Pro-regulation arguments as well as arguments for unregulated markets are largely deductively reasoned rather than empirically researched. ANS: T

28. There is a tendency for overproduction in unregulated markets. ANS: F

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