Paradox of Writing Clear Rules: Interplay of Financial Reporting Standards and Engineering

Abstract:     
Attempts to improve financial reporting by adding clarity to its rules and standards through issuance of interpretations and guidance also serve to furnish a better roadmap for evasion through financial engineering. Thus, paradoxically, regulation of financial reporting becomes a victim of its own pursuit of clarity. The interplay between rules written to govern preparation and auditing of financial reports on one hand, and financial engineering of securities to manage the appearance of financial reports on the other, played a significant role in the financial crisis of the recent years.

Fundamental rethinking about excessive dependence of financial reporting on written rules (to the exclusion of general acceptance and social norms) may be necessary to preserve the integrity of financial reporting in its losing struggle with financial engineering.

Keywords: Financial Reporting, Financial Engineering, Written Standards, Social Norms, Regulatory Equilibrium

JEL Classification: G24, M41

Accepted Paper Series