Towards an Understanding of the Role of Standard Setters in Standard Setting

by Abigail Allen & Karthik Ramanna

Overview — Accounting standards promulgated by the Financial Accounting Standards Board (FASB) play an important role in the development and maintenance of capital markets worldwide, so it is important to understand how these standards come to be. Prior research has focused on the effect of corporate lobbying on the development of FASB standards, but has largely overlooked the role of the FASB members themselves. Looking at these individuals between 1973 and 2007, Harvard Business School doctoral candidate Abigail M. Allen and professor Karthik Ramanna examine how board members' professional experience, length of service on the board, and political leanings influenced accounting standards. Key concepts include:

While corporate lobbying is likely to influence the nature of accounting standards proposed by the FASB, the board members themselves are likely to shape Generally Accepted Accounting Principles (GAAP) by controlling which standards are proposed.
Length of service on the board is associated with proposing standards perceived both as more favorable by big auditors and as decreasing accounting "reliability."
Affiliation with the Democratic Party, measured by political donations, is associated with proposing standards perceived both as less favorable by big auditors and as increasing accounting reliability.
The evidence in this study can be used toward building a more comprehensive theory of accounting standard setting, which can be helpful in informing future efforts at designing standard setting institutions, including considerations on term limits and prior work experience.

Author Abstract

We investigate the idiosyncratic influence of standard setters in standard setting. In particular, we examine how FASB members' length of tenure on the board, their past professional experience, and their political contributions vary with the degree to which the accounting standards they propose are perceived as increasing accounting "relevance" and/or decreasing accounting "reliability." Among other results, we find that length of tenure on the board and a prior career in investment banking/investment management are associated with proposing standards perceived as decreasing accounting "reliability"; while contributions to the Democratic Party are associated with proposing standards perceived as increasing accounting "reliability." Broadly, the evidence, by highlighting the influence of standard setters, can broaden our understanding of the political economy of standard setting beyond the role of corporate lobbying.