Relationship between Business and Providers of Capital

The three main external sources of capital for business enterprises are individual investors, banks, and government. In most advanced countries, all three sources are important. In the United States, for example, business firms can raise capital by selling shares and bonds to individual investors through the stock market and the bond market. They can also borrow capital from banks and, in rather limited cases (particularly to support investments in defense-related R&D), from the government. The

Figure 19.2

Determinants of National Accounting Standards

importance of each source of capital varies from country to country. In some countries, such as the United States, individual investors are the major source of capital; in others, banks play a greater role; in still others, the government is the major provider of capital. A country's accounting system tends to reflect the relative importance of these three constituencies as providers of capital.

Consider the case of the United States and Great Britain. Both have well-developed stock and bond markets in which firms can raise capital by selling stocks and bonds to individual investors. Most individual investors purchase only a very small proportion of a firm's total outstanding stocks or bonds. As such, they have no desire to be involved in the day-to-day management of the firms in which they invest; they leave that task to professional managers. But because of their lack of contact with the management of the firms in which they invest, individual investors may not have the information required to assess how well the companies are performing. Because of their small stake in firms, individual investors generally lack the ability to get information on demand from management. The financial accounting system in both Great Britain and the United States evolved to cope with this problem. In both countries, the financial accounting system is oriented toward providing individual investors with the information they need to make decisions about purchasing or selling corporate stocks and bonds.

In countries such as Switzerland, Germany, and Japan, a few large banks satisfy most of the capital needs of business enterprises. Individual investors play a relatively minor role. In these countries, the role of the banks is so important that a bank's officers often have seats on the boards of firms to which it lends capital. In such circumstances, the information needs of the capital providers are satisfied in a relatively straightforward way--through personal contacts, direct visits, and information provided at board meetings. Consequently, although firms still prepare financial reports, because government regulations in these countries mandate some public disclosure of a firm's financial position, the reports tend to contain less information than those of British or US firms. Because banks are the major providers of capital, financial accounting practices are oriented toward protecting a bank's investment. Thus, assets are valued conservatively and liabilities are overvalued (in contrast to US practice) to provide a cushion for the bank in the event of default.

In still other countries, the national government has historically been an important provider of capital, and this has influenced accounting practices. This is the case in France and Sweden, where the national government has often stepped in to make loans or to invest in firms whose activities are deemed in the "national interest." In these countries, financial accounting practices tend to be oriented toward the needs of government planners.