Toward a Theory of Equitable and Efficient Accounting Policy.

Abstract ABSTRACT: Inequity in capital markets, defined here as Inequality of opportunity or the existence of systematic and significant information asymmetries across investors, leads to adverse private and social consequences: high transaction costs, thin markets, lower liquidity of securities, and in general, decreased gains from trade. Such adverse consequences of Inequity can be mitigated by a public policy mandating the disclosure of financial information in order to reduce information asymmetries. The equity-orientation of disclosure regulation advanced here differs markedly from the traditional, moralistic concepts of equity in accounting, which are generally phrased in terms of maintaining fairness, eliminating fraud, and protecting the uninformed investors against exploitation by insiders. In contrast to such vague, anachronistic, and unattractive notions, the equity concept advanced here is state of the art and operational, being linked directly to recent theoretical developments in economics and finance. As such it provides an economically sound justification for disclosure regulation, and furthermore, it offers accounting policymakers an operational "public interest" criterion for disclosure choices and opens up to researchers a rich agenda for evaluating regulation consequences.