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Blau: Financial Transparency and Reform

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David Jacob Blau (George Mason University) has posted “Financial Transparency and Reform: Dodd-Frank, IFRS, and XBRL“.

The abstract is as follows:

The SEC has proved it is difficult for a regulatory body to keep up with financial innovation. Generally Accepted Accounting Principles (GAAP) are designed to require adherence only to those transaction types specifically named in regulation. While International Financial Reporting Standards (IFRS) address this by enabling more abstract, principles-based regulatory compliance, they also allow as a consequence for more management manipulation of earnings, and have proven logistically and politically unlikely to be successfully integrated with GAAP in the US. Dodd-Frank attempts to adjust the regulatory framework after the fact, but does nothing to address the potential for capture, or the process of information digestion needed for accurate regulation.

Regulatory capture is more likely and more likely to be dominant in a traditionally self-regulated, highly-skilled market, which perfectly describes the market for accounting and financial information. Kenneth Button noted in an analysis of air transport regulation that, “The regulatory body had a vested interest in avoiding excessive confrontation. The industry had control over cost information, and there was no incentive to keep costs down when any increase could be passed on to customers.” In the case of the accounting industry (and accordingly, the industry for dissemination of accurate and timely financial accounting information), these cost increases could be passed to consumers initially indirectly through encouraging investment in overvalued securities, and later directly through bailouts. Button continues: “Combating this was difficult for the authorities who, in any case, had minimal incentive to be too robust in their application of the rules because the appearance of high complexity (or ‘really tough’ reform, in the case of Dodd-Frank) justified larger bureaucracies.”

The central question is how to enable regulators to regulate efficiently and effectively. How can they have real-time access to transparent financial data, cheaply, while making that data available to the entire public, including those lacking technical backgrounds in accounting, finance, or information technology? Open government data in this area is critical to educated and active democratic participation, and will help to counter corruption. The answer lies in decreasing the costs of obtaining and providing accurate and timely financial information, to provide transparency into the financial positions of not just financial institutions, but all publicly-traded companies, and the regulatory agencies themselves. How can the US government best promote democratic accountability, critical to competitiveness and the public trust required for a democratic system to function? The answer is Extensible Business Reporting Language (XBRL), a semantic-web based technology for financial data that could provide infinitely more accurate financial reporting and audit for private firms and government agencies alike.

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