The Influence of Regulatory Approach on Tone at the Top

We discuss how the approach taken by regulators to address financial reporting issues has a significant influence on tone at the top. While tone must ultimately be established internally, regulators are more likely to have a positive impact on the quality of financial reporting by addressing organizational tone. A strong tone at the top should ensure that the financial reports are characterized by greater transparency and complete disclosures, and a regulator’s response will depend upon their perspective as to what motivates management. A compliance-based approach, rooted in agency theory’s assumption that managers act in their own best interests, seeks to mandate desirable behavior through elevated monitoring and reduced managerial discretion. Alternatively, an empowerment-based approach rooted in stewardship theory views managers as trustworthy guardians and grants them greater discretion without burdensome external monitoring. In practice, regulations fall on a continuum between these two approaches. To illustrate the continuum between compliance and empowerment, we present three cases in financial and tax reporting and examine the outcomes of these recent regulatory responses. We then provide conclusions regarding the effectiveness of each regulation by considering how tone was influenced within organizations. Copyright Springer Science+Business Media Dordrecht 2015