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
Trang 2Copyright 2000 by Tyska, Claudia Ruth All rights reserved
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Trang 4MANAGEMENT’ 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 or accounting model
Capture theorists propose issuers have usurped the process and we will see more flexible, profit-enhancing and opaque
standards In contrast, contracting theorists propose issuers will favor uniform, profit-deflating and transparent standards A third school of thought proposes that contention between the Board and issuers stems from a paradigmatic argument over the appropriate model to use in formulating solutions to identified accounting problems Issuers base their solutions on an income statement model and the Board bases its solutions on a balance
sheet model
Trang 5drafts 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
Trang 6Many 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
Trang 8TABLE OF CONTENTS ABSTRACT OF THESIS - 2 2 2 2 ee 6 we we ee le ee Acknowledgements eee ee we ee ee ee le
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 â ôâ «© © © © © © 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 V Research Design - 6 ô ôâ ôâ â © © © © ew
VI Summary 2 6 2 6 2 ee ew ee ew ee ee
Chapter 3: Content Analysis .- 26 + 2+ ô+ ô+ ôâ s - I Introduction 2 2 2 6 2 ee we ee ee ee TT Design of the Content Analysis - III Test of the Content Analysis + -
IV Results of the Test 2 2 2 te 2 ee eee
V Summary and Implication of the Changes for This
Study 6 6 6 RUN
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 Summary + 2 6 2 6 6 ew ee ee ee et L R
Chapter 5: Evaluation of Hypotheses oe ee I Introduction 2 2 2 2 2 ee ee we ww ee ee II Procedures for Evaluating Hypotheses III Accounting for Income Taxes .- 4 + -
Trang 9Chapter 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
Trang 10By 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
Trang 11fails 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
Trang 12The 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
Trang 13H3: 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
Trang 14about 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
Trang 15finance 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
Trang 16complex 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
Trang 17to 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
Trang 18than 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
Trang 19networks 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
Trang 20accountant 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
Trang 21
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
Trang 22control 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
Trang 23by 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
Trang 24Although 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
Trang 25companies 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
Trang 26and, 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
Trang 27Vv 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
Trang 28corporations 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
Trang 29sector 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
Trang 30expressed 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
Trang 31vote 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
Trang 32corporations 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
Trang 33a 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
Trang 34is 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
Trang 35Dyckman 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
Trang 36significant 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
Trang 37operations 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
Trang 38their 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
Trang 39permit 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
Trang 40seemed 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