Man Without Qualities

Tuesday, July 30, 2002

Vuja De II

The Wall Street Journal reports on the new corporate governance bill just signed into law by the President:

Just how much change is triggered, and how effective it is, won't be known at least until the Securities and Exchange Commission works out rules implementing the law and appoints the newly created five-member oversight board with powers to investigate and punish. "Congress enacted some structural girders and then left it to the SEC to fill in all the remaining framework," says John Coffee, a law professor at Columbia University who worked with Senate staffers in drafting parts of the law. The biggest unresolved detail, he says: whether the oversight board appointees will be "people of stature and independence or flunkies and fellow travelers of the accounting industry."

Professor Coffee's comment is surprising, to say the least, since regardless of who the first oversight board appointees may be, the new "independent" nature of the oversight board greatly increases the chance of its eventual, simple regulatory capture by the accounting industry, especially the surviving "Big Four." In other words, regardless of who the first appointees are, in a little while the board is probably going to be dominated by "flunkies and fellow travelers of the accounting industry."

Why? Well, the new board is focused solely on accounting. It has a much narrower regulatory constituency than that of the Securities and Exchange Commission. The new board's "independence" should insulate it from the effects of the SEC's more general constituencies. Narrowing the board's regulatory constituency will likely, pursuant to the now-standard economic theory of "regulatory capture" developed in large part by George Stigler, over time make the "independent board" much more prone to such "capture" than is the SEC itself. One commentator described Stigler's theory this way:

In a well-known paper, 'The Economic Theory of Regulation', George Stigler shifted attention away from [the] 'public interest approach'. He looked at how the struggle over economic rents by interest groups would affect regulatory policy. The principal actors in his analysis, businesses and politicians are assumed to be self-interested income-maximisers and not at all concerned with the 'public interest'. Businesses use their resources to bargain with politicians to bring about policies that benefit them. They will favour regulation that reduces competition, and maximises economic rents.

...every industry or occupation that has enough political power to utilize the state will seek to control entry. In addition, the regulatory policy will often be so fashioned as to retard the rate of growth of new firms.

The kind of benefits that Stigler argues that the state can provide to industry include:

Barriers to entry to competitors, including tariff barriers
Aid to businesses producing complimentary outputs, and harm to businesses producing substitute products (think of bread as complimenting butter, and margarine as a butter substitute)

At the same time, there are a number of costs involved in acquiring legislation desirable to the industry. These include

The costs of securing agreement from, and co-ordinating a number of legislators sufficiently large to form a legislative majority/
The information and organisation costs to industry of becoming informed about, and acting upon measures that can potentially benefit them.
Individual consumers have relatively little to lose from anti-competitive measures (the costs are distributed throughout society so that the impact on a single individual is negligible). The benefits, on the other hand accrue to a relatively concentrated business group. Because of this, businesses have more incentive to meet the costs of making policies, and are therefore likely to get their preferred regulatory policies enacted. It is no accident that regulatory policies protect industry rather than consumers: they are designed that way.

By narrowing the constituency of the oversight board, the benefits will accrue to an even more concentrated business group.

Now, whatever else the accounting industry may lack, it does not lack for political activism and sophistication, and it has plenty of "political power to utilize the state." Indeed, with the obliging annihilation of Andersen by the Department of Justice, the accounting industry is now positioned as something approximating a good old fashioned oligopoly - complete with the new "independent oversight board" to serve as its monopolistic, rent seeking coordinator. Indeed, once the dust from the Andersen demolition job settles, it will be interesting to calculate the Herfindahl-Hirschman Index of the accounting market. Would the anti-trust division at the Department of Justice have allowed the big accounting firms to achieve by merger the same level of market concentration that the Department has itself imposed through prosecution of Andersen? A concentrated national oligopoly of a key industry with its own, private, independent regulator! How comfy cozy for the regulated.

Wasn't it nice of the Congress - and especially the Democrats in Congress - to do this for the big accounting firms, even as those firms pleaded with the Congress "please do not fling me in that briar patch."?

Brer Rabbit hollered out, "Born and bred in the briar patch. I was born and bred in the briar patch!" And with that he skipped out just as lively as a cricket in the embers of a fire.


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