There has been a controversial debate on whether the government should intervene in capital markets to regulate them with best practices. According to some marketers, intervention by the government with best practices will be able to correct market failures. This will also regulate emerging capital markets.
Advocates of intervention expect the intervention to maximize social welfare and regulate stock issuance. Of course, this will follow the best practice of Initial Public Offering (IPO). Governments in most countries are also adopting the best practice of “disclosure based approach” to regulate capital markets. At the same time, there are limited regulations and interventions to ensure best practices.
As long as a company provides enough disclosure required for best practices, there will be no need for an official approval to issue additional shares. This means there is no threshold for accounting based profitability required to be met by the company. The best practice of approval will not be required before stocks can be issued by the company. This creates additional costs of accounting based regulations for customers.
If transaction costs are removed from crucial best practices, some companies will achieve resource outcomes without intervention in any form. This means that the existing regulation will worsen the outcome due to unwarranted costs. This means failure of compliance with best practices. However, when regulations are implemented as best practices the government screens new investors. The government will have to allocate resources, time and money to improve social welfare. The investors will have to bear the cost of compliance with the regulation. Moreover, with implementation of best practices with an accounting based threshold in the market, investor agencies may face some problems.
The regulation about best practices with minimum return on equity threshold is based on numbers. It provides motivation for contractors to maneuver accounting data to meet the thresholds. Managers of corporate companies use this opportunity because they believe that regulators will not be able to undo the changes made. When a manager succeeds in meeting the criteria required, and issues additional shares, it will trigger an inefficient allotment of capital resources. This will diminish best practices, compliance and the interests of investors.
Therefore, intervention by the government will have both benefits and costs associated with accounting regulations.