How psychological bias shapes accounting and financial regulation

Abstract

Most applications of behavioral economics, finance, and accounting research to policy focus on alleviating the adverse effects of individuals' biases and cognitive constraints (e.g. through investor protection rules or nudges). We argue that it is equally important to understand how psychological bias can cause a collective dysfunction - bad accounting policy and financial regulation. We discuss here how psychological bias on the part of the designers of regulation and accounting policy (voters, regulators, politicians, media commentators, managers, users, auditors, and financial professionals) has helped shape existing regulation, and how an understanding of this process can improve regulation in the future. Regulatory ideologies are belief systems that have evolved and spread by virtue of their ability to recruit psychological biases. We examine how several psychological factors and social processes affect regulatory ideologies.