Auditing firms have a tremendous incentive to please the corporations they audit. Is there a way to insulate them from pressure to approve or overlook a cooking of the books?
Joshua Ronen, an accounting professor at New York University’s Stern School of Business, has come up with a plan to do it by utilising the free market while avoiding additional layers of regulation.
Ronen calls his approach Financial Statement Insurance and here is how it would work:
Both the amount of coverage and the size of premiums would be publicly disclosed so investors would be alerted to companies that have a small amount of coverage at a high premium. As investors would automatically be alerted to situations of high risk; they would avoid buying such shares. The shares would decline in value, and the identified firms would find their capital borrowing costs increasing.
The plan brings market discipline into corporate accounting via share prices. It avoids more government regulation by harnessing the free market’s natural system of checks and balances.
Source: Susan Lee, A Market Remedy For Our Nasty Accounting Virus, Wall Street Journal, July 10, 2002.
For text (WSJ subscribers) http://online.wsj.com/article/0,,SB1026262219974906520-search,00.htm
For more on Corporations http://www.ncpa.org/iss/eco/
FMF Policy Bulletin\16 July 2002
