This problem illustrates the Becker (1983) interest group theory of regulation, under which affected groups compete for the extent of regulation they desire.
Assume two groups, investors and managers, and, to simplify somewhat, that the pressure applied by each group can be measured by the amount of money it spends. Suppose that investors desire higher- quality accounting standards. Managers, however, object to higher- quality standards. Each group must decide to exert pressure for their desired extent of regulation or not to exert pressure.
Costs to managers of higher- quality standards include greater difficulty in using earnings management to disguise shirking (Section 9.3.1), release of proprietary information (Section 12.2), and/ or concern about increased earnings volatility, leading to debt covenant violation ( Section 8.5 ) and increased compensation risk. Assume that managers perceive these costs as totalling 100.
But the benefits to investors may be much greater than the costs to managers, since more information production reduces adverse selection, leading to better investment decisions, and reduces moral hazard, leading to more efficient corporate governance and contracting. Suppose that investors perceive these benefits as 125.
If neither party brings pressure to bear, nothing happens— no new standard. However, to bring pressure to bear, a group must organize. Suppose that the cost of investors to organize is 25. Assume that costs for managers to organize and oppose the standards are only 10, since an industry interest group is already in place. Given that they organize, investors are willing to spend an additional 100 to lobby for the standard. Given that management organizes, it is willing to spend an additional 100 on lobbying against it.

a. Prepare a payoff table for this game, similar in format to Table 8.1. Note that in the Table 8.1 game, payoffs were in terms of benefits. Here, payoffs are in terms of costs.
b. Identify the Nash equilibrium of this game, and explain why it is the predicted outcome.
c. Suppose that the benefits of the proposed standard to investors are now 90. Organization costs remain at 25. Other assumptions are unchanged. What is the predicted outcome of the game now? Explain.

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