21st century scandals: the financial reporting consequences

The paper examines whether regulatory responses to recent financial reporting scandals are proving effective in preventing new scandals.

Authors

• Kees Camfferman, Vrije Universiteit Amsterdam, School of Business and Economics
• Jacco L. Wielhouwer, Vrije Universiteit Amsterdam, School of Business and Economics

Abstract

Financial reporting scandals in the 21st century have been followed by many changes in the regulatory framework of financial reporting. A natural question is whether research evidence shows that these regulatory responses have been effective in preventing new scandals. We argue that this question is difficult to answer, and may not in fact be the question we should be asking. We first show, using examples from recent accounting standard setting, that the evolution of standards is far slower and more complex than a direct and instantaneous response to scandals, significantly complicating any research into the effect of specific changes set against the objectives of these changes. Second, we argue that much extant empirical research on the effectiveness of changes in recent financial reporting regulation is of limited use in answering the question whether the risk of scandals has decreased, mainly because this research tends to concentrate on average quality improvements rather than changes in the tail of the financial reporting risk distribution. We argue as the central point of this paper that both research and regulation should be based on an explicit acceptance of a permanent risk of financial reporting failure, rather than working on the assumption that this risk can and should be ever further reduced. Acceptance of this point of view can turn what is currently a scattering of unconnected research efforts into a coherent research agenda with potentially high relevance. Facing the existence of permanent financial reporting risk leads to a series of interconnected questions including the measurement of this risk, both actual and as perceived by various stakeholder groups, communication and education concerning this risks, and mechanisms to share or transfer these risks.