Tài liệu Research " ABSTRACT OF THE THESIS MANAGEMENT''''S PREPERENCES FOR ACOUNTING STANDARDS " pptx

There were some efforts on the part of the government, the accounting profession and the New York Stock Exchange to devise formal rules to govern financial reporting and accounting.’ The

MANAGEMENT’ S PREFERENCES FOR ACCOUNTING STANDARDS

By Claudia Ruth Tyska

A dissertation submitted to the

Graduate School-Newark

Rutgers, The State University of New Jersey

in partial fulfillment of requirements

for the degree of

Doctor of Philosophy Program in Management Written under the direction of Professor Paul J Miranti, Jr

Copyright 2000 by Tyska, Claudia Ruth All rights reserved

®

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MANAGEMENT’ S PREFERENCES FOR ACCOUNTING STANDARDS

By Claudia Ruth Tyska

Thesis Director: Professor Paul J Miranti, Jr

This study evaluates three hypotheses concerning the

qualitative characteristics of financial accounting and reporting standards promoted by issuers of financial statements The

hypotheses stem from three schools of thought - capture,

contracting and conflicting paradigms Each gives rise to

predictions about the nature of standards promoted by issuers along the dimensions of flexibility, income effect, transparency

sheet model

ii

drafts issued by the Financial Accounting Standards Board (FASB)

Content analysis is used to identify specific aspects of the Board’s proposal of concern to issuers and their preferred policy responses These policy recommendations are evaluated in

terms of the constructs flexibility, income effect, transparency

and accounting model From the combination of policy

characteristics with level of support for the policies,

respondents’ profiles along the constructs are derived These

profiles are used to evaluate the explanatory power of the three hypotheses

The results indicate there is a more complex phenomenon occurring than implied by these rudimentary hypotheses Whereas

on average the results support the characterization of issuers’

demands proposed by capture theorists, there is some support for

contracting theorists’ ideas along the three constructs The results also reflect a strong preference among issuers for an

income statement model

iii

Many people have contributed to this dissertation through their support, encouragement and patience My committee chair, Professor Paul Miranti deserves special thanks Without his

whole-hearted commitment to this project, it would never have reached fruition His guidance and his confidence in my work and

in me were essential and I am eternally grateful to him

However, I take full responsibility for any and all sins of

commission and omission within this document

Others have provided thoughtful criticisms of this work that enhanced my understanding of the material and improved the

results These include my committee members, Drs Dan Palmon, Gary Kleinman, and Louis Orzack, my brother-in-law, Jeff

Schnepper, Dr Richard Pannell, Al Tomlinson and Robert Collmier

Over the years I have talked to members of the FASB, public accountants, academicians and management accountants who spoke of

their experiences in their fields These conversations helped to sharpen my understanding of accounting I would like to

specially thank Robert J Swieringa and Eugene Flegm for taking time to talk with me about their experiences with the standard

setting process I would also like to thank my students whose

“dumb” questions caused me to rethink what I thought I knew

I would like to acknowledge my family’s contribution to this seemingly interminable venture My husband Ray, besides

offering love, support and encouragement, did all the yard work

and more than his share of household chores Our children,

iv

mother, father and sisters for forgiving my physical, emotional and intellectual absences and my parents especially for their unconditional love and encouragement to “get an education.”

List of Tables 2 1 2 1 1 ww we eww ee ee ee Y

Chapter 1: Statement of Problem +6 -

I Introduction vo ko 2 ew ee ee eee

II An Analytical Framework for Evaluating the Introduc— tion of Economic Institutions and Public Policy - III The Evolution of U.S Financial Accounting Institu-

tions 2 1 6 ee ee ee ew ee we we

IV Scholarly Controversies over the Utility of U.S

Financial Accounting Institutions -

V Review of the Literature .-. + -

VI Hypotheses 2 2 2 ee ee we ee ee ee

VII Research Design - 2 © «© «© © © © © © we ee C Chapter 2: Research Design ¬—

I What is the Issue and why is it Important

II Organization of the Study 2 2 «2 2 ss III The Hypotheses 2 © 6 © 2 6 we ee ew ee

IV Definition of Concepts and Their Related Constructs

IV Results of the Test 2 2 2 te 2 ee eee

V Summary and Implication of the Changes for This

Chapter 4: Analysis of the Proposed Policy Recommendations

and Their Relationship to the Hypotheses

I Introduction 2 2 2 6 ee ee we we ee eee

II Description of the Constructs and Rankings

III Evaluation of Policy Recommendations

IV Accounting for Investments in Certain Debt and

Equity Securities .+.+-+ + + +4 .e-.-s

V Employers’ Accounting for Pensions .-

VI Comparison of Results over All Three Exposure

Drafts 2 1 1 ew we ew ww ee ee ee

VII Summary of Results 2 2 © 2 © © «© ew ew

Chapter 6: Conclusions so vo 2 2 26 © © «© © © © e we ee Bibliography - 2 2 2 6 ee 8 ew ee ee eee eee Vita 2 2 ee ew we we ee ee ee ee ee

Chapter 3:

Table 3-1: Income Taxes, Issue Identification Agreement 70 Table 3-2: Investments, Issue Identification Agreement 72 Table 3-3: Pensions, Issue Identification Agreement 73

Chapter 4:

Table 4-1: Description of Constructs and Rankings 78 Table 4-2: Expected Results under Each Hypotheses 79 Table 4-3: Evaluation of Policy Recommendations for

Accounting for Income Taxes .- 85

Table 4-4: Evaluation of Policy Recommendations for

Accounting for Investments in Certain Debt

And Equity Securities 101 Table 4-5: Evaluation of Policy Recommendations for

Employer's Accounting for Pensions 112 Chapter 5:

Table S-1: Key to Rankings + 26.4 6 126 Table 5-2: Reproduction of Table 4-2 from Chapter 4 126

Table 5-3: Income Taxes, Profiles and Model Preference 128

Table 5-4: income Taxes, Frequency Counts 129 Table 5-5: Income Taxes, Summary Statistics 130 Table 5-6: Income Taxes, Evaluation of Hypotheses 131

Table 5-7: Investments, Profiles and Model Preference 133

Table 5-8: Investments, Frequency Counts 134 Table 5-9: Investments, Summary Statistics 134 Table 5-10: Investments, Evaluation of Hypotheses 135

Table 5-11: Pensions, Profiles and Model Preference 136

Table 5-12: Pensions, Frequency Counts 137 Table 5-13: Pensions, Summary Statistics 137 Table 5-14: Pensions, Evaluation of Hypotheses 138

Table 5-15: Overall, Profiles and Model Preference 139

Table 5-16: Overall, Frequency Counts 140 Table 5-17: Overall, Summary Statistics 140

Table 5-18: Overall, Evaluation of Hypotheses 141

vil

By Claudia R Tyska

I Introduction

In the 1933 and 1934 Securities Acts, the U.S Government recognized corporate financial accounting and reporting as a

matter of public interest by establishing the right of government

to regulate corporate financial disclosures The express goal of U.S policy makers was and is full and fair disclosure of

relevant financial information Comparable and reliable

financial information to allow evaluation of investments and

monitoring of management’s activities was necessary to support the development of an efficient capital market and complex

industrial organizations The modern industrial organization, developing by the turn of the century, is characterized by a

class of professional managers, separation of ownership and

management and a need to accumulate and retain large amounts of capital During the 1920's these corporations increased their reliance on equity as opposed to debt financing and the stock market correspondingly became more active Perceiving a need for

a control mechanism, the U.S government established a regulatory agency, the Securities and Exchange Commission (SEC), to, among its other responsibilities, promulgate accounting and reporting standards for corporations whose stock was issued and sold on national exchanges Traditionally, the SEC encourages the

private sector to develop its own standards of accounting and

fails to act “appropriately.”

This study addresses a problem in the scholarly literature relating to the quality of the financial accounting information generated by the unique U.S standardization process involving

business, professional and governmental elements The

conclusions of scholars about the utility of this system of

standardization are sharply divided into two polar views The first school contends that the institutions and organizations established to govern this function have contributed to the

promotion of financial market efficiency These scholars argue that over time the capacities for defining useful accounting

standards have been enhanced by interest group debate and

interaction The positive result of such efforts to formalize accounting expression was the reduction of the asymmetric

distribution of information about corporate entities, which

separates professional managers from external stakeholders This fostered the growth of the financial markets by reducing investor risk perceptions about enterprise economic performance It also served the public interest by creating a more effective means for monitoring agent probity Proponents of this view also see the process of information standardization as essentially accretive and influenced by a process of path-dependent learning Thus at any particular time, prevailing standards encapsulate what are thought to be the most effective ways of structuring the

The first school, however, stands in sharp contrast to the

conclusions of other scholars who contend that the process fails

to serve the public interest because representatives of public

corporations, the objects of regulation, and their professional allies have captured it The quality and objectivity of this information is believed to be low because of the purported

dominance of business interests This, in turn, is believed to have undermined the effectiveness of accounting information to function as a means for monitoring management activities or for providing useful insights into the economic processes that

influence enterprise operating performance or financial

condition

This study evaluates these two opposing perspectives by focusing on the dynamics of a key aspect of the standardization process, the Financial Accounting Standards Board’s (FASB)

solicitation of comment letters about prospective standards As

I explain more fully below, inconsistencies in the conclusions of earlier theoretical and empirical studies of this information standardization process provide the basis for the formulation of three testable hypotheses The hypotheses, described more fully later in this chapter, are:

H1: Self-interest leads to demand for flexible, profit-— enhancing and opaque standards Firms do not want

transparency because asymmetric information is to their advantage Conflict arises because standards have a

differential impact across corporations and industries

This implies the role of the Board is to balance competing interests by arranging compromises among its constituents

H3: Resistance to FASB proposals is not reflective of a preference for or resistance to flexible, profit-enhancing and opaque standards, but rather reflects fundamental

disagreements over the appropriate accounting model to use

as a basis for formulating standards

These hypotheses will be evaluated through a detailed

analysis of comment letters relating to major standards

promulgated by the FASB during the period 1973 - 1993 This

analysis will be supplemented with an historical study of the prevailing public and economic circumstances

The remaining sections of this chapter are organized into six sections The following section provides a brief review of the scholarly literature that deals with the significance of

institutions and organizations to economies and governments The third section explains the evolution of the predominant U.S

institutions and organizations that are vested with the

responsibility of promulgating financial accounting standards The fourth section compares the opposing conclusions put forth by scholars about the overall effectiveness and broad purposes of the system for corporate governance and information

standardization The fifth section, on the other hand, focuses

more narrowly on the scholarship dealing exclusively with the factors that shape the process of formalizing financial

accounting information This same section will also identify basic differences in the findings between scholars that will

serve as the basis for defining testable hypotheses for this

about research design

It An Analytical Framework for Evaluating the Introduction of Economic Institutions and Public Policy

Institutions can facilitate or prohibit certain kinds of exchanges and determine the ability of a society to realize

economic growth North (1992) defines institutions as the formal

and informal rules devised by humans to constrain behavior and the institutional framework as the matrix of formal and informal rules and their enforcement The function of rules is to

facilitate exchanges, political or economic, by reducing the

uncertainties in human interaction They affect the performance

of the economy through their effects on the costs of exchange and production

Organizations represent social units with the potential for achieving economic efficiency Organizations, according to North (1992), come into existence to take advantage of opportunities Made available by the extant institutional framework Davis and North (1971) for example, identify four sources of economic gains derivable through institutional innovation The first is

institutional developments that are capable of reducing costs associated with high-risk perceptions associated with asymmetric distributions of information The second is institutions that lower transaction costs by allowing for the exploitation of

economies of scale The third is institutions that are effective

in surmounting market imperfections And the fourth is

finance emphasize the role of institutions in reducing risk

deriving from asymmetric information Innovations in financial instruments, monitoring devices and information systems for

management and external stakeholders have contributed to the

reduction of risk perceptions, and, thus, have helped to enhance

financial market efficiency (Baskin and Miranti, 1997; Davis and

North, 1971)

Much of the organizational literature has concentrated on institutions and organizations as devices for lowering

transaction costs and overcoming market imperfections Ronald

Coase (1990), for example, proposes that firms would not exist if there were no transaction costs Chandler (1977) develops this theme in The Visible Hand, a history of the development of

American industry Chandler’s “visible hand of management” has replaced Adam Smith’s “invisible hand of competition.” Firms have incentives to internalize market functions carried out

inefficiently or not at all given the extant contracting

technology In a similar vein, Williamson (1985) says the main purpose of organizations is to economize on transaction costs

It is more useful to think of the firm as a governance structure rather than as a production function His study focuses on “the comparative costs of planning, adapting and monitoring task

completion under alternative governance structures.” Williamson

(1985) compares these transaction costs to the concept of

complex exchanges are precluded due to the prohibitively high transaction costs

The opportunistic behavior of organizations is a source of change in the institutional framework, affecting either the

formal or informal rules or the nature of their enforcement

North proposes that only when it is in the interests of those with sufficient bargaining strength will there be major changes

in the formal rules However, there is a hierarchy of

institutions ranging from the Constitution to private contracts

It is clearly more difficult and costly to change the

Constitution than to change the terms of a contract Changes tend to occur at the margin Also, changes in the formal and informal institutions do not occur simultaneously Time lags create inconsistencies and conflicts as innovations are

incorporated into the framework This links past decisions to the present

A model for the role of organizations in shaping public policy has been put forth by Louis Galambos (1982) Galambos develops the theme that in the United States, the nature of

governing has evolved from a two-party political system to a

triocracy of interest groups, government regulatory agencies and Congress The growth of government regulatory agencies stemmed from the need to impose order over an increasingly complex

environment These agencies were designed to house the necessary technical expertise to articulate rules to promote efficient

to be buffered from nontechnical exigencies but subject to the discipline of the electorate

According to Galambos, the relationship between government agencies and the regulated in the U.S is one of mutual

dependence The agencies rely on the private sector to provide experts to staff the agencies, to supply the information needed

to formulate policy, and to comply with the policies The

private sector relies on the agencies to enforce the policies because although it might be in the interest of the private

sector as a whole to adhere to the policies, any individual

organization could benefit from violating the policies Since individuals are expected to behave opportunistically, the ability

of the government agency to sanction deviations is important to Maintaining the viability of its rules

Some scholars, however, believe that the American political system is more complex and interactive than implied by Galambos’ triocracy For instance, a proposed policy change by one agency may impinge on the domain of several other agencies and produce differential social or economic effects across different

constituencies According to Salisbury (1984), interests are created during policy debates Galambos’ work falls into the category of regulatory literature referred to as the “iron

triangle” theory

than iron triangles, with policy domains encompassing a variety

of government agencies and constituencies Thurber (1991), for example, divides policy-making systems into three subsystems: macropolicy (broad policy decisions with a high level of

visibility and conflict and many participants), policy subsystems (ranging from dominant to competitive to disintegrated) and

micropolicy (narrowly focussed issues involving a small, often closed group of decision-makers) Policy issues can move up and down this hierarchy, or not move at all from the point or

origination A similar pattern analysis involving policy domains defined by the interaction of private and public bodies was also provided in the study of Lauman, Knoke, and Yong-Hak (1985)

Policy subsystems develop from the need to divide tasks and

promote the development of knowledge One role interest groups

play in the political arena is to provide an information link within policy-making systems The political science literature

on lobbying says the most important currency a lobbyist has is information Their success depends on their reputation for

credibility

The work of Thurber encompasses that of Galambos but

provides a broader perspective of the complexity of introducing change in the formal rules He describes two dominant modes

within policy subsystems, one, the iron triangle described by

Galambos and, two, issue networks, closer to the policy domains described by Lauman, Knoke and Yong-Hak Thurber describes issue

networks as “fragmented, open and extraordinarily complex systems

not well-suited to resolving conflicts or reaching decisions

quickly” (Thurber, 323) Both the iron triangle and issue

networks are part of the spectrum of policy subsystems, each

characterized by networks of actors, their substantive policy domain and various modes of decision making

The following section will describe briefly the broad goals

of institutions dedicated to business accountability It will also explain how such concerns led to the formation of

specialized organizations with the responsibility for defining the standards for communicating information about business and economic affairs

III The Evolution of U.S Financial Accounting Institutions

Generally accepted accounting principles (GAAP) are the set

of formal and informal rules governing communications between internal and external parties informing these organizations in their contracting activities A system of accountability

performs the following functions: identify, classify, measure, record, summarize and communicate useful information to decision- makers The primary means of communication of a financial

accounting system is a set of general-purpose financial

statements, with accompanying notes and supplemental information

Underlying the financial accounting system are concepts,

principles and procedures that have evolved over time through the practice of accountancy These concepts, principles and

procedures are collectively referred to as GAAP They guide the

accountant in designing and maintaining accounting systems for organizations

In the U.S., the earliest efforts to standardize accounting information came about through the efforts of state and federal government to govern natural monopolies such as railroads and electrical and gas utilities Perhaps the most comprehensive of these early accounting regimes was the one first promulgated by

the Interstate Commerce Commission (ICC) at its inception in

1887 The ICC’s model sought to assist regulators to judge the reasonableness of transportation rates and also to provide

investors with useful data about the financial condition and

operations of the nation’s railroads The basis of

standardization was uniformity both in terms of reporting formats and also in accounting methods Although the railroads were the nation’s first “big business,” the impact of its accounting

system lessened in the 20 century with the rise of a

multiplicity of great industries, which were not fettered by the same high degree of governmental oversight

Prior to 1933, the market for financial information

primarily developed GAAP for industrials There were some

efforts on the part of the government, the accounting profession and the New York Stock Exchange to devise formal rules to govern financial reporting and accounting.’ These efforts were

forestalled by the stock market crash of 1929 and the resultant

* See Carey (1970) and Zeff (1972) for a history of these

efforts

prolonged depression In 1933, the government gave the Federal

Trade Commission the right to set rules of financial accounting and reporting for corporations issuing stock interstate on an

exchange In the 1934 Securities and Exchange Act, the

government established the Securities and Exchange Commission (SEC) to take over this responsibility and also to establish

rules of accounting and reporting for corporations whose stocks were listed on interstate exchanges They also required that a public accountant licensed by a state to perform audits and issue

an opinion on financial statements certify reports filed with the Commission

This centralization of control within the public sector

recognized both the importance of such communications in

facilitating the growth of the economy and the failure of the market to provide adequate control over the function of financial disclosure This was a critical juncture in the development of accounting in the U.S Besides devising requisite reports, the SEC policy was to enforce the informal rules already in

existence However, the SEC found there was a diversity of

practices in use, making enforcement difficult During this

time, the SEC explicitly considered whether to define standards

of accounting and reporting itself or to rely on the private

sector to articulate such rules James M Landis, an architect

of the Securities Acts and an administrative scholar, focused on the problem of implementation and maintenance of government

control He was instrumental in helping to promote a system of

“participatory regulation”? that would explicitly draw the

private sector into the process of articulating standards of

reporting and accounting This approach was favored by the

Commission's chief accountant, Carmen Blough, and was adopted by the Commission with a 3:2 vote

Since 1973,’ these arrangements involve a private-sector organization, the Financial Accounting Standards Board (FASB, or Board) promulgating standards with SEC oversight The FASB-SEC relationship represents a cooperative governance effort between the public and private sectors to formulate accounting rules The FASB is an independent, private sector organization funded by contributions and revenues from its publications It has seven voting members drawn from its major constituencies: public

accounting, business, academia, government and the financial

community Members sever employment ties and work full time with remuneration Its pronouncements are recognized as authoritative

? For a history of the development of this strategy, see Thomas

K McCraw, Prophets of Regulation, especially Chapter 5; also,

Joel Seligman, The Transformation of Wall Street, Chapters 5

and 12

3 prior to 1973, the Committee on Accounting Procedure (1939 ~

1959) and the Accounting Principles Board (1959 - 1973), both senior technical committees of the American Institute of

Certified Public Accountants (AICPA) were primarily responsible for articulating standards of financial accounting and

reporting The AICPA is a national organization of CPAs See Carey (1970) and Zeff (1972) for a history of the work of these organizations

by the SEC (Accounting Series Release 150) and by the AICPA

(Ethics Rule 203 and designation by Council)

IV Scholarly Controversies over the Utility of U.S Financial Accounting Institutions

The scholarly literature that evaluates contemporary

financial accounting regulation in the U.S has rendered

disparate views about the effectiveness of this system Chatov

(1975) views the SEC’s reliance on the private sector to

establish accounting and reporting standards as an abdication by the SEC of its responsibilities and a violation of its public trust He views a private sector organization as too weak to act decisively and with authority to impose its will on other

organizations Chatov argues that since the Securities Acts were passed, we have come full cycle and the corporate financial

sector is once more in control of the process He predicts the resulting policies will be more flexible and profit-enhancing, leading to less informative financial reporting Similarly,

Kripke (1985, 68), besides disputing the legitimacy of a private- sector organization to establish public policy, expresses concern that the current organizational arrangements give the public

accountants too much control over the outcomes, resulting in an

imbalance of power among affected constituencies This leads to policies that favor the public accounting profession by

increasing the need for audit and accounting services without due consideration of the needs of corporations

Although Van Riper (1996) is not a critic of private-sector standard setting per se, he argues that certain business

organizations such as the Business Roundtable, the Financial

Executives Institute (FEI) and the leaders of several of the

largest U.S companies are attempting to gain control of the

process to the detriment of the public interest and that the

major accounting firms are being co-opted by their large clients

Like Chatov, he is concerned that the quality of accounting

standards will suffer and financial reports will be not only less informative but also misleading

In opposition to concerns expressed by Chatov and Van

Riper, contracting theory’ suggests it is in the corporation’s interest to reduce the inherent problems of unequal access to information between corporations and current and potential

external contracting parties by developing and enforcing formal rules of accounting and reporting Financial markets assign a premium to the cost of capital to compensate for the problem of

unequal access to information At least for stronger companies,

revealing standards that reduce these information differentials are preferred to flexible, profit-enhancing standards This

theory predicts firms will lobby for standards that reduce rather than increase information differentials

Drawing on contracting theory, Baruch Lev (1988) attempts

to develop a rationale for regulating disclosure by publicly-held

* See Jensen and Meckling (1976) for exposition of contracting

theory.

companies to explain the persistence and cross-cultural

pervasiveness of regulation of accounting and to use this

justification as a criterion for evaluating accounting standards Lev discusses an “equity theory” of regulation, defining equity

as “equality of opportunity.” It is in the best interest of

society to have an efficient capital market Asymmetry of

information leads to “high transaction costs, thin markets, lower liquidity of securities, and in general, decreased gains from trade” (Lev, 1) Although it is in the best interests of the public companies to reduce the information imbalance, any

collusive effort would be unstable given the profits to be earned

by breaking trust with the group Therefore, some type of

coercive regulation is necessary In structuring rules,

compliance costs are generally a consideration Given the

presence of bounded rationality, opportunism and asset

specificity, i.e., transaction-dependent assets, third-party

enforcement of the rules is essential to allow impersonal

contracting to occur

The concerns expressed by Chatov, Kripke, and Van Riper

stem from “capture theory.” This theory predicts that regulated organizations fight for and gain control over the regulatory

agencies called into existence to control their activities

Underlying assumptions of these critics are that, one, corporate participation in the process is essentially negative and directed

at resisting improvements in financial accounting and reporting

and, two, there are insufficient checks on opportunism in the

current system

One of the failures of the current literature on

formulating accounting policy is the failure to incorporate the extant institutional framework in the analysis of decision

making According to the work of North, Chandler, Coase,

Williamson and others, the institutional framework does matter Their work does not suggest that the extant institutional

framework will promote economic growth, only that it has a

significant effect on the economy by enabling or foreclosing the capture of gains from trade

An objective of this study is to evaluate the significance

of this failure by comparing the ability of hypotheses drawn from the literature on accounting policy formulation to predict

corporate preferences This statistical evaluation will be

supplemented with a description of the institutional framework and an analysis of its implication for the resultant change in formal rules This study will focus on corporate participants and a small set of issues affecting a broad cross-section of the Board’s corporate constituents

The next section discusses the literature on accounting

policy formulation, including both analytical and empirical

studies of the nature of the process, who participates, what they are asking of the system and who seems to be successful in

achieving their expressed objectives

Vv Review of the Literature

The scholarly literature dealing with the formulation of accounting policy may be arrayed into three thematic categories which, as we shall see in a subsequent section, provides the

basis for positing three testable research hypotheses about this process This section initially focuses on the findings of those studies that evaluate standards in terms of the competition

between rival interest groups Secondly, this section will also

analyze a second line of inquiry, which stresses the role of

accounting information as a mechanism for enhancing financial

market efficiency by reducing risk perceptions and by lowering transaction costs The closing portion of this section discusses the conclusions of those scholars who attribute the conflicts

within standards setting to the need to reconcile conflicting paradigms about the purpose and structure of financial

accounting

Va Standards Setting and Interest Group Competition

Much of the scholarly literature on the formulation of

accounting policy is concerned with balance of power among

competing interests Common themes in this literature are that constituencies have conflicting objectives due to different

incentive structures, that participants in the process are

motivated by self interest, this self interest conflicts with the goals of other participants, and the resulting standards are what important parties agree to Based on empirical evidence, large

corporations and the major public accounting firms are actively involved in the process Academia and investors are less

visible The capture theory - the fear that control of the

process and outcome will be usurped by corporations and/or public accounting firms to the detriment of the public interest - is pervasive Concern with the ability of the Board to maintain its independence and neutrality is reflected in the work of numerous scholars, including Chatov (1975), Kripke (1985), Van Riper

(1994), Miller and Redding (1986), Haring (1979), Mezias and

Chung (1989), Brown (1981), Dereshiwsky (1985), Tichich (1989)

and the focus of numerous government investigations of FASB

activities, e.g., U.S GAO (1996)

Chatov concludes that the corporate-finance sector is in control and the government needs to establish a new regulatory agency with authority to promulgate accounting standards To

support his conclusions, Chatov presents a study of the

government’s and the APB’s responses to the merger mania that

gripped the nation in the sixties He describes the

unwillingness of the government to take a firm stand in

opposition to the trend and the inability of the APB to eliminate

“pooling-of-interest” accounting Many considered that whatever merits “pooling-of-interest” accounting had were more than offset

by the abuses of the system and it would be better to just

disallow it altogether The failure to eliminate pooling is

perceived as an indictment of the SEC’s reliance on the private

sector to establish accounting standards Chatov’s” conclusion that centralizing accounting policy formulation in a government agency would have resulted in timely, decisive action and

Significantly decreased the number of mergers’ may be unfounded His study notes the variety of government agencies involved in the controversy, including Justice, Treasury, Congress, and the SEC Thurber points out that, in general, when an issue moves from a relatively closed policy subsystem to a more open, complex

network of actors, conflict resolution is more difficult to

achieve These mergers involved accounting, antitrust and tax

policies

Many studies express concern that corporations have or are

trying to obtain too much control over the process Miller and Redding (1986), for example, note the preponderance of corporate responses to proposed standards as opposed to other group’s

participation Tandy and Wilburn (1992) find the majority of

letters, in both relative and absolute terms, coming from

preparers and their representative associations They also find relative response rates among all constituencies to exposure

drafts low and usually opposed to the proposal The GAO study did not find evidence to support the hypothesis of domination of the Board by any particular constituency although concern is

° Chatov is a proponent of formulating accounting standards to

achieve public policy ends See David Solomons (1985) for a

spirited defense of keeping public economic policy issues out

of standard setting and Hawkins (1974) for defense of the

argument that the government is another constituency of the

Board whose needs must be considered in formulating policy

expressed about the preponderance of corporate responses,

corporate lobbying activities and the dearth of investor

responses Van Riper chronicles struggles over various issues

and efforts of corporate leaders to intimidate the Board by

proposing studies of its operations, increases in corporate

membership both on the Board and on the Financial Accounting

Standards Advisory Committee (FASAC) and the establishment of a

special group to set the Board’s agenda Van Riper, a retired

senior staff member with the Board, bases his conclusions on his

experience His work is marred by a lack of objective analysis

of opposing viewpoints and a pervasive “us versus them” attitude

Much of this literature deals with the primary role of

public accountants in defining the agenda for financial

accounting standards setting Kripke for example believes the process is basically a struggle between corporations and public accountants and that the balance of power favors the public

accountants The public accounting profession does hold more seats on the Board than any other constituency (currently three out of seven down from four out of seven) and initially, proposed Board members had to be approved by the AICPA Newman’s (1981) study of coalitions on the APB and FASB found that although the major public accounting firms had a voting advantage observed votes indicated these Board members did not form a stable

coalition Selto and Grove (1982) offer confirming evidence

those FASB members drawn from public accounting firms did not

vote as a bloc Public accounting firms are not homogeneous in their preferences for accounting standards Puro (1984)

formulates an interesting hypothesis that their cost structure and comparative advantages with particular accounting policies influence public accounting firms’ positions The lack of

available data precluded testing her hypothesis

Research findings are inconsistent with the view that large corporations control the process and there is conflicting

evidence about public accountants Haring’s study concludes that the Board tends to align with the public accounting profession and not with business, academia or investors Mezias and Chung find stronger correlation between the Board’s decisions and

positions taken by public accountants and government respondents

Beresford (1993), former chair of the FASB, comments that letters

from analysts and lenders are often not as good as letters from corporations, auditors and CPA societies Users are less well organized and equipped to participate and are not used to FASB jargon Brown and Feroz (1992) study of changes in successive exposure drafts on general price level accounting finds the Board responsive to large, diversified corporations but not smaller or undiversified businesses Given their focus on one exposure

draft and only corporate respondents, their results are not

generalizable Brown, Tichich, and Dereshiwsky suggest that on any given issue, the Board is equally likely to be aligned with

corporations as auditors, but over several issues the Board is

not clearly aligned with either constituency group The

corporations used in their studies were larger corporations

Brown used repeat respondents and Dereshiwsky drew her

corporation sample from the Fortune 200 Their results do not contradict the findings of Brown and Feroz

Several researchers have attempted to develop profiles of participants by developing hypotheses based on political and

economic theories of regulation These studies indicate who has

a sufficient interest in the outcome of the process to expend resources in attempts to influence the outcome and under what

conditions lobbying will occur

Employing Olson’s theory of collective action, Lindahl

(1987) addresses the issue of who is likely to lobby the FASB and conditions necessary for lobbying to occur: the benefits exceed the cost for an individual within a group, or, a subset of the group, for lobbying to occur He proposes large firms are more likely to lobby than small firms, assuming benefits are

positively correlated with size Small, homogeneous groups are more likely to lobby than large, heterogeneous groups because in

a small group the possibility for selective incentives exist Therefore one would expect more lobbying on standards affecting particular industries and, consequently, the development of a comprehensive set of industry-specific standards

Using theories about groups, Feroz (1987) proposes that

lobbying will not be gratuitous In addition to significant

economic benefits, there must be a probability of success

Lobbying will be greater where consensus is low because there is

a higher probability of being effective Because of the costs of information gathering and specialization, more and more interest groups will rely on trade and professional associations to

represent their interests

Sutton (1984) proposes lobbyists tend to be producers of financial statements because producers are more homogeneous and

it is easier for them to create a temporary organization to

lobby Also, producers have more incentive to lobby as their interests are less diversified than users He includes auditors and corporations as producers Beresford suggests participation

in the process of formulating accounting policy is a lower

priority for users

Some scholars have refuted the claim that any one

constituency is capable of dominating the FASB Drawing on

institutional and power theory, Hussein and Ketz (1991)

characterize the Board as a social contract, with each

constituency ceding some power to it in return for a forum for conflict resolution, rationalization of accounting standards and resolution over uncertainty about accounting reports They

proceed to identify rational and structural constraints within

the system and sources of power held by corporations, auditors

and investors Rational constraints do not prohibit activity, but they make certain actions too costly to be reasonably

undertaken Hussein and Ketz identify maintaining credibility of financial reports as a rational constraint common to

corporations, auditors and investors Dyckman (1988) says there

is a generally held assumption that the failure of the FASB will lead to more government control and a fear that the government would use the standards setting process to promote its own

objectives, undermining the objectivity and neutrality and,

hence, reliability of the reported data 4Zeff (1984) concludes

that the profession’s fear of government standard setting has

been the strongest force for voluntary changes in accounting

standards Structural constraints prevent certain actions from occurring or even being contemplated A major structural

constraint is dissonance within the various constituencies that

inhibits concerted action Studies by Brown (1981), Tichich

(1989), Mezias and Chung (1989), Karlinsky, Manegold and Cherry

(1987) find a lack of homogeneity within and between groups

Beresford (1993) comments that users are not a homogeneous group

They do not all support or all oppose a proposed solution

Hussein and Ketz’ (1991) conclusion that the Board

represents a mixed power system, with no one group able to

dominate the process all of the time, suggests the resulting

standards will represent compromises In support of Hussein and Ketz’s description of the process as a “mixed power system,”

Brown, Dereshiwsky and Tichich suggest the Board is equally

likely to be aligned with preparers as auditors, but over several issues the Board is not clearly aligned with either constituency group

Hussein and Ketz’ characterization of the process implies

that the Board is a mere conduit for its constituent’s demands.

Dyckman suggests a more proactive role for the Board based on its perceived need to maintain its credibility and Fogarty (1992)

suggests institutional survival is a driving force for the Board

On this issue, Brown comments he is unable to distinguish between two competing hypotheses: the Board aggregates the demands of the

participants or that the Board ignores them

Vb Standards Setting, Transaction Costs and Financial Market

Efficiency

Another school of thought identified in the literature on accounting policy formation stresses the role of accounting

information as a mechanism for enhancing financial market

efficiency by reducing risk perceptions and by lowering

transaction costs Baruch Lev incorporates the importance of credible financial reporting to market efficiency in his “theory

of equity” described earlier in this chapter

Scholars interested in the history of economic and

political developments of the latter 19° and early 20™

centuries, describe the increasingly complex nature of business

organizations, the rise of a professional class of managers with

its concomitant separation of ownership from management and the need of these firms to accumulate large amounts of capital

Chandler traces the development of the railroads, the first of

these modern organizations Along with increasing complexity came the need to coordinate activities that taxed the extant

accounting technology and resulted in innovations that had a

significant impact on the development of accounting, e.g.,

accounting for long-term capital investments, consolidations

Besides their own information needs, these professional managers

had to report on profitability and their performance to

investors The separation of the owners from the daily

operations of the business led to an agency preblem Independent

auditors were employed before the law required audits As

complex forms of organizations developed in other industries, the problem of providing credible financial reports to investors

spread into other sectors of the economy Merino and Neimark (1982) argue that an objective of the Securities Acts was to

encourage widespread ownership in stock by reducing information

asymmetries They are not convinced by arguments that an

unregulated market would have met the needs of investors although

they do not suggest the current system meets those needs Baskin

and Miranti (1997) argue that the growth of the equity market in America was facilitated by developments in finance and the

greater availability of reliable financial information During the early twentieth century, public skepticism of common stock was high because of difficulties encountered in gathering

reliable information useful in assessing future corporate

earnings trends The conventional wisdom was to invest in debt securities with clear liens These attitudes changed with the steady development of knowledge about finance and the general

improvement in the quality of information about corporate

operations This shift was reflected in the dramatic increase in individuals owning common shares during the 1950's

Researchers from the transaction cost economics and

contracting theory schools view accounting as part of efficient contracting technology and suggest there are incentives in the labor, capital and product markets to encourage management to report truthfully and punish misleading reporting The

professional managers are more dependent on the success of the business because of their personal investment in developing the expertise necessary to manage a complex organization and

therefore less able to limit their exposure to business failure Watts (1988) argues there are incentives to reduce agency costs because such costs generate “dead weight losses.” In support of the notion that the market assigns a cost to information

asymmetries, Imhoff (1992) addresses the question do security analysts’ perceptions of accounting quality differentiate firms

in any economically significant way and finds some evidence that

it does Although Imhoff found little consensus among security analysts concerning “the set of accounting attributes used by individuals in assessing accounting quality,” he cites previous work by Imhoff and Thomas (1989) suggesting high quality is most closely associated with conservative accounting methods and full disclosures (Imhoff, p 99) Dyckman identifies incentives for truthful reporting regardless of formal rules and their

enforcement Firms needing public support, financing and to make and enforce contracts would find accurate reporting to be in

their self-interest In addition to the importance of a

reputation for credibility in the labor market and the benefits

of an efficient equity market, Dyckman cites the discipline of

the corporate takeover market and existence of alternate sources

of information, e.g., activities of credit-rating services and security analysts as salient incentives to truthful reporting

Ve Standards Setting and Conflicting Accounting Paradigms

Although accounting historians® have identified and traced the development of conflicting schools of accounting thought,

scholarly research on the standard-setting process has ignored or downplayed the role of fundamental beliefs about the nature and purpose of accounting in their studies of the standard-setting process This implicitly assumes that expediency is the guiding principle in formulating standards and theory does not inform the

Process Watts and Zimmerman (1978) explicitly argue that there

is no overriding accounting theory and that theory is used to support decisions arrived at by some other means Yet Flegm

(1984) proposes that a primary source of conflict between the Board and preparers stems from a theoretical debate over whether the primary task of accountants is valuation of the business or reporting on operating activities, e.g., management’s performance

and income trends The logic of the double-entry system does not

* This section draws on the work of Gary John Previts and Barbara

Dubis Merino (1979), Eldon S Hendriksen (1977), and Eugene

Flegm (1984)

permit both objectives to be equally well satisfied within the

body of a single set of general-purpose financial statements

because shared information links the financial statements The procedures used to measure earnings are reflected in the

valuation of assets, liabilities and stockholders’ equity Flegm also identifies the concern that while a valuation approach may

result in more relevant data for investors, it sacrifices

reliability by requiring the use of more subjective, i.e.,

“soft,” data as opposed to transaction-based or “hard” data

This conflict has fueled concerns that accounting is ina state of crises Kuhn identified changing perceptions about the nature of external realities as creating barriers to consensus formation in the development of science (Cushing 1989) Drawing

on the work of Kuhn, Glautier attributes the current crises in accounting not to the inability to solve technical problems,

e.g., accounting for leases, pensions, etc., but “more

fundamentally to the absence of a stable definition of accounting

- and a supportive theory of accounting” (Glautier 1983, 51)

Cushing attempts to explain the current crisis in terms of

paradigms, loosely defined herein as fundamental beliefs about reality that serve as the basis for solving problems Since at least the late fourteenth century through the latter part of the nineteenth century, the basic approach to solving accounting

problems has been for the owner/manager, possibly with the help

of accountants, to resolve accounting problems in terms of the

double-entry framework, developing or selecting solutions that

seemed efficacious under the circumstances Two developments

since the late nineteenth century have seriously challenged the

ability of this paradigm to resolve contemporary accounting

problems: the creation of complex modern corporations with

concomitant separation of ownership and management and their

concentration of economic power and, secondly, the imposition of government regulation over the accounting function

The problem of defining the nature and social role of the modern corporation was identified in the late nineteenth and

early twentieth centuries by accounting scholars such as D R Scott and can be seen in the debate over the nature and purpose

of the firm Scholars such as Sprague articulated what is known

as the proprietary theory They argued that the stockholders were the owners of the firm’s assets and income; the purpose of the corporation is to maximize shareholders’ wealth and the

central accounting problem is accounting for shareholder wealth and changes in their wealth These early theorists focused on asset valuation and viewed income as a stock of wealth accruing

to the owners As opposed to this view of the corporation,

scholars such as Paton articulated the entity theory The basic idea of this school of thought is that the corporation is a

separate entity with different types of equities, both specific and residual The creditors’ relationship to the firm differed from the stockholders’ relationship to the firm only in that

liabilities could be measured independently of other valuations

unless the firm was insolvent Income determination and the