Private Standards, Public Governance: A New Look at the Financial Accounting Standards Board

The Financial Accounting Standards Board (FASB) presents a puzzle for those interested in the design of private governance institutions: How has this private standard-setter managed simultaneously (1) to remain independent and free of capture, (2) to achieve institutional stability and legitimacy, and (3) to operate in a politicized context in the teeth of opposition from its own constituents? This Article looks to governance design to account for this institutional success. The FASB's founders made a strategic choice between two models of a public regulatory agency, the New Deal model of an independent expert and the post-war pluralist model of a politically responsive regulator. They opted for the New Deal model, structuring the FASB to emphasize independence. Because the New Deal model calls for a normative goal to channel the agency's exercise of discretion, they also undertook to set out a coherent theory of accounting, the "Conceptual Framework," to contain and direct the FASB's decisions and thereby import legitimacy. The Conceptual Framework, however, neither determined nor justified the FASB's subsequent decisions. It nonetheless contributed to the FASB's institutional success by disavowing a neutral posture respecting the conflicting interests of the FASB's leading constituents, explicitly privileging the interests of the users of financial reports (investors and market intermediaries) over the interests of the reports' preparers (large firms and their managers). The FASB's consistent adherence to this repudiation of pluralist responsiveness has had three results. First, it made the FASB's general approach defensible as a matter of economic theory. Second, it triggered political opposition from the preparers that muted allegations of capture even as it resulted in occasional political reversals. Third, it aligned the FASB's institutional mission with that of the SEC, its public overseer, importing institutional stability if not political invulnerability. The FASB remains vulnerable to a secondary capture allegation. Critics charge that its complex, rules-based standards serve the audit firms' interest in lowering the risk of liability while sacrificing the users' interest in "fairly" stated financials; "principles-based" standards would be better. This Article endorses the rejoinder position. What some see as capture also can be characterized as "responsiveness," and the FASB serves a public interest in taking seriously the accounting firms' need for auditable standards. Even as detailed rules can distort the overall story told by a report's bottom line, they make it easier to see what preparers are doing, easing verification and making audit failures and scandals less likely. In this post-Enron era, scandal prevention arguably takes a legitimate place with transparency as a public-regarding goal for the GAAP setter. The FASB emerges as a generator of suboptimal but institutionally-defensible standards. If not ideally legitimate, the FASB has been legitimate enough.