On The Legitimacy of Accounting Standards

Abstract

While it is widely agreed upon that accounting standards must be legitimate, ‘legitimacy’ is not well-defined. Accordingly, I model three widely accepted hallmarks of legitimacy: (1) an increasing likelihood that independent experts with the same facts will arrive at the same classification (objectivity), (2) an increasing similarity of otherwise identically classified transactions (financial transparency) and (3) promoting management’s stewardship (governance) while providing financial statement users with a better understanding of that stewardship (governance transparency). The results indicate that factors commonly associated with increased enforcement (e.g., career concerns, securities regulation, or courts) unambiguously increase all three aspects of legitimacy, while specifying an accounting standard in more detail may have little or no effect on objectivity, or have ambiguous effects on financial transparency. Surprisingly, the model demonstrates that the level of governance and governance transparency may change in opposite directions as a standard’s specificity changes.