Question #2
Reading: Reading 7 Economics of Regulation
PDF File: Reading 7 Economics of Regulation.pdf
Page: 1
Status: Unattempted
Correct Answer: A
Question
The requirement for firms to carry out an annual independent audit is best described as a regulation implemented to address:
Answer Choices:
A. externalities
B. sub-optimal allocation of resources
C. information asymmetry
Explanation
Management have greater knowledge than investors, a situation known as informational
asymmetry which the independent audit seeks to address. Audits promote high quality
financial reporting, which reduces the information asymmetry between management and
investors. Externalities are costs and benefits affecting a party that did not choose to incur
that cost or benefit. Externalities often lead to sub-optimal production decisions.