Accounting Standards and Capital Market Development

Abstract

Financial development, broadly defined to include not just financial sector deepening but also improvements in the efficiency of the financial sector, I is vital for pro-poor growth (Mavfotas, 2009). Financial development enhances domestic resource mobilization and also allows these resources the most productive uses. The cross-country literature on the relationship between financial development and economic growth is vast - and most studies show that financial development unambiguously and positively impacts on economic growth (Aghion and Bolton, 1997; Levine, 1997; Athukorala and Sen, 2002). While the effects of financial development on economic growth are well understood, it is less clear how financial development may affect poverty, and whether financial development can bring about a reduction in poverty directly, and not just by an indirect route through economic growth. Nor is it clear what are the determinants of financial development and, in particular, the role of accounting standards. In this chapter, we assess the theoretical arguments on the relationship between sound accounting standards and financial development, and between financial development and economic development, including poverty reduction. We also examine the cross-country evidence on the relationship between accounting standards and financial development, with particular reference to the South Asian experience. The rest of the chapter is in four sections. In Section 2, we examine the relationship between financial development and economic development. In Section 3, we discuss why accounting standards matter for financial development. In Section 4, we present evidence on the cross-country relationship between accounting standards and financial development and summarize the South Asian experience with the development of sound accounting standards. Section 5 concludes.