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Competition of Accounting Standards, Comparability of Financial Information, and Critical Masses: An Evolutionary Approach

In recent years, the remaining global standard setters of generally accepted accounting principles, IASB and FASB, have consented to harmonize their standards in the medium term with the aim of the emergence of one dominant global accounting standard. In accounting literature, however, it is argued that not necessarily the harmonisation of accounting standards, leading to one single “monopolistic” set of rules, will lead to an overall optimum of financial information quality. In contrast, it was suggested that, with greater probability, the mechanism of competition, that means: the persistence of several competing accounting standards, will emerge in the evolution of optimal financial information quality.The paper will analyse the hypothesis of the expansion of the superior standard by competition between different accounting standards from the viewpoint of evolutionary game theory. The argument is based on a two Players/three strategies coordination game of the type “tender trap”. Players, i.e. firms which adopt a particular accounting standard, have the choice between three strategies: (i) adopting the “good” standard; (ii) adopting the “bad” standard and (iii) multiple strategy.In the evolutionary game, two firms are randomly drawn from a great population and matched against each other. We analyse the evolutionary stability properties of the game as well as evolutionary dynamics starting from an out of equilibrium point. Evolutionary stable equilibria include the adoption of one single standard – “good” or “bad” – by the entire population. For the evolution towards the “good” or the “bad” equilibrium, critical masses play a crucial role, which is further analysed.Among our results are the following: There is an equilibrium in which all three strategies (good, bad, multiple) coexist; but this equilibrium has not the property of evolutionary stability. There are two equilibria which own the property of evolutionary stability: (i) all members of the population adopting the good standard; (ii) all members of the population adopting the bad standard. Whether the “good” equilibrium or the “bad” equilibrium will finally evolve is dependent on critical masses of adopters. For the “good” equilibrium, the critical mass will be lower compared with the “bad” equilibrium. The role of multiple strategies as a trigger for the “good” equilibrium is ambiguous: Very low cost c will lead to very low critical masses for the “good” equilibrium; but there is a range, where positive but finite values of c will lead to higher critical masses in order to reach a “good” equilibrium, compared with a situation without the possibility of multiple strategies. If starting from an out-of-equilibrium point, the evolution moves towards the “good” equilibrium, the adoption of multiple strategies will expand on the medium term; if the evolution is towards a bad equilibrium, multiple strategies will soon decline in their relative weight.The regulatory implications are ambiguous: With low adoption cost for multiple standards, it follows that the regulator should in tendency renounce enforcement of one single standard. With medium and high cost of multiple strategies, regulatory intervention in this sense may have a better legitimation. At the time, the temporary spread of multiple strategies may indicate a spontaneous evolution towards the Pareto-superior evolutionary stable equilibrium.