A Congressional Hearing on “Accounting and Auditing Oversight” was held yesterday (March 28) by the House Subcommittee on Capital Markets and Government Sponsored Enterprises.  Congressman Scott Garrett (R-NJ) chairs the subcommittee, which called James Kroeker (SEC), James Doty (PCAOB), Leslie Seidman (FASB), and Robert Attmore (GASB) as the first panel of witnesses.  Congressman Garrett indicated that the hearing had three agenda items:

1)      IFRS convergence update

2)      FASB and GASB process of standard setting

3)      Auditor mandatory rotation (MAR).

Although MAR was stated as the third agenda item, it was obviously the primary reason for the hearing.  Furthermore, the congressional committee made clear throughout the hearing that they were not fond about MAR, to put things mildly.  Congressman Garrett implicitly suggested that the PCAOB was engaging in “mission creep” by deliberating on auditor rotation, i.e., crossing the line of auditor regulation into corporate governance.  Congressman Bachus (R-Ala) was more direct in his criticism stating, “Regulatory overreach, at least, appears to be alive at the PCAOB.”  (Ouch!)  Of course, the congressmen were reacting to the desires expressed by their constituents – companies located in their respective states.

A primary theme of the hearing was whether the PCAOB adequately assesses costs and benefits of their proposed standards – and by implication, whether other regulatory bodies do as well.  Chairman Doty received the brunt of the questioning with respect to MAR.  Congressman Garrett sponsors legislation that requires the SEC to identify the problem that any proposed rule is meant to address, and assess the costs and benefits of the rule – both qualitatively and quantitatively.  He quickly posed the question to Chairman Doty as to whether the PCAOB had conducted a quantitative cost-benefit analysis with respect to MAR, and embedded in his question was the following detail as to what he would like to see:

“…a) do you have a timeline on when that will begin, b) when you do that, will you be bringing in an economist to be making that examination, c) who, what sort, how many economists will be making that examination?”

As part of his response, Chairman Doty noted, “you cannot monetize the costs or the benefits.”  Congressman Garrett didn’t seem to like that response because he quickly interrupted Chairman Doty and asked,

“What specific type of economic analysis has been or will be done, what sort of data will you be looking to collect, what sort of people will be doing that, economists or otherwise?  Other than the general thought that this is an issue that should be looked at, was there any specific data that you had received from anyone to say, here is data that shows us that this is a problem area as opposed to anecdotal, just this is another topic area that we should be looking at?”

Chairman Doty’s response did not directly answer the question.  And, it’s a difficult one to answer.  The Congressman makes it clear that the type of cost-benefit analysis he wants to see includes data with monetary values, and he is suggesting that this quantitative analysis (not just qualitative) should be done early in the process.  But how do you monetize the benefits of accounting/auditing regulation?  We can’t observe the economic damages that were avoided by the issuance of a particular standard (this would be part of the benefit side of regulation).  Estimating the costs of a standard might be within the realm of possibility, but even that is not a straight-forward or simple task.  There is even some controversy as to what constitutes a cost of a standard (see this FASRI post).  Perhaps the legislation sponsored by Congressman Garrett requires something (a quantitative cost-benefit analysis) that does not itself pass the cost-benefit standard, because the benefits received from such a quantitative analysis are essentially zero due to the inherent uncertainty of what exactly the net benefits from any standard will be.  Slapping a monetary number on an analysis does not make it worth much, if anything, when there is such extreme uncertainty underlying the analysis.  In other words, the appearance of precision doesn’t make something precise.

Congress does not seem to realize that accounting regulators have debated how to measure costs and benefits of accounting standards for over 40 years.  At no point within this debate has there been a reasonable proposal on how regulators can quantify costs/benefits of accounting standards.  And yet, is the FASB now expected to perform such an analysis for every standard that is promulgated?  I really wanted to ask Congressman Garrett how he suggests this is to be done.  Has he really given it sufficient thought?  Does he really think that economists hold the secret to measuring the benefits of individual standards?

Consider some other comments made during the hearing.  In response to the pressure placed on him from Congressman Garrett concerning the cost-benefit analysis, Chairman Doty essentially said that since MAR is still in the “Concept Release” stage, that a quantitative cost-benefit analysis would be premature.  But, the congressmen were eager to pin him down that this needed to take place, even at the early stages.  From Congressman Bachus:

“There seems to be a misinformed public that you are well on your way to [making MAR an auditing standard].  I don’t know why that is….  Will [a C/B] analysis be part of the process?”

Doty: “It would be putting the cart before the horse to start evaluating costs and benefits of some form of rotation before you had any sense of whether you were going to go there or what it would be.”

Bachus: “Let me ask the SEC…will you do a C/B or an economic analysis of the effect?  And I know sometimes It’s hard to measure what is the cost of skeptism.”

Kroeker: “As Chairman Doty says, they’re not anywhere close to that point.”

Bachus: “Of course you know if you made a proposal, we’re gonna go to that, and if you hadn’t done a cost-benefit analysis, you know…”  The implication went unspoken.

Mr. Kroeker then indicated that of course, a cost-benefit analysis would be done prior to that point – the message I got was it would be a conventional cost-benefit analysis that monetizes the net benefit.  So, how is that going to be done again?

Then, there was this from Congressman Fitzgerald (R-PA):

” We really believe it is incredibly important to have a cost-benefit analysis at the very beginning.  Are you committed to doing a cost-benefit analysis, if so when, who is going to do it, and how’s it going to be done?”

Doty: “Before we came in with a proposal on MAR, we would be doing a very careful analysis of costs, unanticipated consequences, and benefits.”   

While Chairman Doty does not commit to an economic analysis that includes monetizing these factors, it’s clear that a quantitative analysis is what Congress wants.  So there you go; Congress effectively pinned down the PCAOB in conducting a conventional cost-benefit analysis that monetizes the net benefits.

Assessing costs and benefits is a significant current issue at the FASB, which is only going to become more important in the wake of the hearings yesterday.  It’s also an issue where academics might be uniquely positioned to contribute in developing methods to measure costs, and especially, benefits.