theory of accounting and control shyam sunder, yale university kozminski university, warsaw, poland...

Theory of Accounting and Control

Shyam Sunder, Yale University

Kozminski University, Warsaw, Poland

May 16, 2009

ACCOUNTING AND CONTROL IN ORGANIZATIONS:ACCOUNTING AND CONTROL IN ORGANIZATIONS: A CONTRACT THEORY A CONTRACT THEORY

PART I:PART I: CONTRACT THEORY OF THE FIRMCONTRACT THEORY OF THE FIRM

CHAPTER 1: INTRODUCTIONCHAPTER 2: ACCOUNTING AND CONTRACT MODEL OF THE FIRM

PART II:PART II: MICROTHEORY OF ACCOUNTING AND CONTROLMICROTHEORY OF ACCOUNTING AND CONTROL

CHAPTER 3: CONTRACTING FOR MANAGERIAL SKILLSCHAPTER 4: MANAGERS AND ACCOUNTING DECISIONSCHAPTER 5: INCOME AND ITS MANAGEMENTCHAPTER 6: INVESTORS AND ACCOUNTINGCHAPTER 7: ACCOUNTING AND THE STOCK MARKETCHAPTER 8: AUDITORS AND THE FIRM

PART III:PART III: MACROTHEORY OF ACCOUNTING AND CONTROLMACROTHEORY OF ACCOUNTING AND CONTROL

CHAPTER 9: CONVENTIONS AND CLASSIFICATIONCHAPTER 10: DECISION CRITERIA AND MECHANISMSCHAPTER 11: STANDARDIZATION OF ACCOUNTINGCHAPTER 12: GOVERNMENT, LAW AND ACCOUNTINGCHAPTER 13: ACCOUNTING FOR PUBLIC GOOD ORGANIZATIONS

ACCOUNTING AND CONTROL IN ORGANIZATIONS: A CONTRACT THEORY

Part I: CONTRACT THEORY OF THE FIRMPart I: CONTRACT THEORY OF THE FIRM

Chapter 1: IntroductionChapter 1: Introduction

THREE BASIC IDEAS– Organizations as a Set of Contracts– Shared Facts for Conflict Resolution g– Control in Organizations as Balance and Equilibrium

MICROTHEORY OF ACCOUNTING AND CONTROL– Functions of Accounting and Control– Managers and Income– Shareholders, Stock Markets, and Auditors

MACROTHEORY OF ACCOUNTING AND CONTROL– Basic Features of Accounting– Social Choice Criteria, Mechanisms, and Standardization– Government and Public-Good Organizations

Chapter 1 ReferencesChapter 1 References

Chapter 2: Accounting and the Contract Model of the FirmChapter 2: Accounting and the Contract Model of the Firm

THE FIRM AS A SET OF CONTRACTS

ACCOUNTING AND THE FIRM– Measuring Contributions– Measuring Entitlements– Distribution of Information about Contract Fulfillment– Liquidity of Markets for Contractual Slots– Common Knowledge for Renegotiation of Contracts

CORRESPONDENCE BETWEEN ORGANIZATIONAL AND ACCOUNTING FORMS– Bookkeeping– Managerial Accounting– Financial Reporting


Part II: MICROTHEORY OF ACCOUNTING AND CONTROLPart II: MICROTHEORY OF ACCOUNTING AND CONTROL

Chapter 3: Contracting for Managerial SkillsChapter 3: Contracting for Managerial Skills

CHARACTERISTICS OF MANAGERS– Human Capital– Measuring Managerial Contribution– Contact with Other Agents

FORMS OF CONTRACTS FOR MANAGERS– Manager’s Preferences– Contracts of Top, Middle, and Lower Level Managers


Chapter 4: Managers and Accounting DecisionsChapter 4: Managers and Accounting Decisions

HIERARCHY OF ACCOUNTING DECISIONS– Discretionary Decisions on Expensing-Capitalization of Costs– Accounting Estimates– Accounting Principles– Disclosure Policy– Internal Controls– Accounting Standards

CERTAIN FEATURES OF CONTROL SYSTEMS– Cost of Accounting– Transfer Pricing– Cost Allocations– Participative Budgeting– Standards and Variance Analysis

MANAGERIAL CONSEQUENCES OF ACCOUNTING DECISIONS– The LIFO Puzzle– Accounting for Leases– The Restructuring of Troubled Loans– Cost of Exploration, Research and Development– Recognizing Option Value as Compensation Expense– Rationality of Apparently Irrational Decisions

OBSERVABLE BEHAVIOR OF MANAGERS– Preference for Status Quo– Income Management– Prediction of Accounting Methods by Firm Characteristics


Chapter 5: Income and its ManagementChapter 5: Income and its Management

INTRODUCTION TO INCOME

FUNCTIONS OF INCOME IN A FIRM– Assessing Viability of the Firm– Managerial Evaluation and Contract Renegotiation

ATTITUDES OF AGENTS TOWARD INCOME– Shareholders– Managers– Determination of Entitlements

MANAGEMENT OF INCOME– Statistical Measures of Smoothness– Income Processes: Smoothness vs. Smoothing– Income-Smoothing vs. the “Big Bath” Hypotheses– Instruments of Income Management– Summary of Empirical Findings


Chapter 6: Investors and AccountingChapter 6: Investors and Accounting

DESCRIPTION OF THE INVESTOR CLASS– The Lack of Active Participation– Transferability of Contract– Heterogeneity of Preferences– Information and Speed of Price Adjustments– Information Intermediaries– Creditors

INVESTOR ATTITUDES AND PREFERENCES– Reporting on Contract Performance– Incentives to Managers– Aggregation Adds Information

ACCOUNTING CHOICE MECHANISMS FOR INVESTORS– Organization of the Firm– Trading in Capital Markets– Voting and Proxies– Sociopolitical Institutions

CONSEQUENCES OF ACCOUNTING POLICY FOR INVESTORS– Accounting Information as Public Goods– Production of Information By Intermediaries


Chapter 7: Accounting and the Stock MarketChapter 7: Accounting and the Stock Market

INTRODUCTION– Limited Role for Valuation Rules– Role of Information Intermediaries

QUESTIONS ABOUT ACCOUNTING AND THE STOCK MARKET– Money from Accounting Numbers– Money from Advance Access to Accounting Numbers– Effect of Accounting Methods on the Stock Market– Effect of the Stock Market on Accounting– Accounting Without the Stock Market– The Stock Market Without Accounting

PROBLEMS OF INFERENCE– The Needle in a Haystack Problem– The Expectations Problem– The Self‑Selection Problem


Chapter 8: Auditors and the FirmChapter 8: Auditors and the Firm

INTRODUCTIONINTRODUCTION

THE FUNCTION OF AUDIT IN THE FIRMTHE FUNCTION OF AUDIT IN THE FIRM

AUDITOR DECISIONSAUDITOR DECISIONS Allocation of Resources in an Audit Assignment Audit Opinion Pricing of Services and Bidding for Clients Audit Policies, Training, Quality Control, and Self Regulation Technology of Audit

Institutional Structure of the Audit ProfessionInstitutional Structure of the Audit Profession Development of Audit Standards Development of Accounting Standards Who Sets the Standards? Auditors’ Responsibility for Detection of Fraud Competition, Entry, Discipline


Part III: MACROTHEORY OF ACCOUNTING AND CONTROLPart III: MACROTHEORY OF ACCOUNTING AND CONTROL

Chapter 9: Conventions and ClassificationChapter 9: Conventions and Classification

CONVENTIONSCONVENTIONS ACCOUNTING CONVENTIONS

ECONOMIC FEATURES OF ACCOUNTINGECONOMIC FEATURES OF ACCOUNTING Entity Going Concern or Continuity Period Valuation Accrual

TEMPORAL STABILITY OF ECONOMIC FEATURESTEMPORAL STABILITY OF ECONOMIC FEATURES Double Entry Economic Resources

UNIFORMITY AND CLASSIFICATIONUNIFORMITY AND CLASSIFICATION


Chapter 10: Decision Criteria and MechanismsChapter 10: Decision Criteria and Mechanisms

CRITERIA FOR SOCIAL CHOICECRITERIA FOR SOCIAL CHOICE Technological Efficiency Simple Economic Efficiency Multi-Person Economic Efficiency Multi-period Problem Uncertainty Problem

SOCIAL COST‑BENEFIT ANALYSISSOCIAL COST‑BENEFIT ANALYSIS Which costs and which benefits? Problems of partial analysis Nonlinear utilities Measures of Efficiency

MECHANISMS FOR SOCIAL CHOICEMECHANISMS FOR SOCIAL CHOICE Limitations of Voting Mechanisms Market Mechanisms in Accounting Standards Legal Rights and Markets


Chapter 11: Standardization of AccountingChapter 11: Standardization of Accounting

RULES AND ECONOMIC RULES AND ECONOMIC DECISIONSDECISIONS

Rules as Constraints Rules as Payoff Functions Voluntary and Mandatory

Behavior

ECONOMICS OF RULES AND ECONOMICS OF RULES AND STANDARDSSTANDARDS

Benefits Costs Distribution and Equity Adjustment to New Standards

ECONOMIC THEORIES OF ECONOMIC THEORIES OF STANDARDSSTANDARDS

Monopoly and Limiting Competition

Provision of Public Good

ACCOUNTING STANDARDSACCOUNTING STANDARDS Types of Standards Enforceability of Standards Market Argument Argument for Market Failure A Synthesis

INSTITUTIONS FOR SETTING INSTITUTIONS FOR SETTING ACCOUNTING STANDARDSACCOUNTING STANDARDS

Models of Social Institutions Force of Standards Capture of Institutions

EFFECTS OF STANDARDSEFFECTS OF STANDARDS• On Accounting Systems• On Accounting Education• On the Auditing Profession


Chapter 12: Government, Law, and AccountingChapter 12: Government, Law, and Accounting

GOVERNMENT AS A CONTRACTING AGENTGOVERNMENT AS A CONTRACTING AGENT Government as Tax Collector Government as Customer

GOVERNMENT AS A SUPER-FIRMGOVERNMENT AS A SUPER-FIRM Charter of Firms Sale of Securities Certification, Licensing, and Discipline of Auditors


Chapter 13: Accounting for Public Good Chapter 13: Accounting for Public Good OrganizationsOrganizations

NOMENCLATURE AND CLASSIFICATIONNOMENCLATURE AND CLASSIFICATIONECONOMIC CHARACTERISTICS OF NRIOsECONOMIC CHARACTERISTICS OF NRIOs Markets for Resources Agents

CHARACTERISTICS OF ACCOUNTING IN PUBLIC GOOD ORGANIZATIONSCHARACTERISTICS OF ACCOUNTING IN PUBLIC GOOD ORGANIZATIONS

Entities and Funds Government Funds Proprietary Funds Fiduciary Funds

Consolidation and Detail Recognition and Accrual Fixed Assets, Depreciation and Long Term Liabilities Budgets, Appropriations, and Encumbrances

INTERACTION BETWEEN ACCOUNTING FOR NRIOs AND ARIOsINTERACTION BETWEEN ACCOUNTING FOR NRIOs AND ARIOsChapter 13 ReferencesChapter 13 References

CHAPTER 1

SHARED FACTS FOR CONFLICT RESOLUTIONDisputes, waste of resourcesRole of evidence (shared info)Common knowledge Theoretical abstraction Practical ApproximationGames of imperfect, incomplete informationFirm as a game of incomplete informationRole of public disclosure

CONTROL IN ORGANIZATIONConflict and cooperationBargaining exampleBalance & EquilibriumContrast from control OF organizations

CHAPTER 3CHAPTER 3CHARACTERISTIC OF MANAGERSCHARACTERISTIC OF MANAGERS Wealth as human capital Contribution hard to measure Procedural centrality

HUMAN CAPITALHUMAN CAPITAL Stock of human capital is inalienable Long term contracts are on flow, which are not enforceable

– Contracts must be self-enforcing Human capital used at work but not used up (actually it is accumulated at

work) Compensation: current + accretion of human capital

(Accounting is important for both) Short run supply of managerial human capital is inelastic

– Opportunity to extract rents– Vulnerable to expropriation

Managers cannot sell their job slots Managerial market transactions rely on reputation

– accounting permanence data Managers have an un-diversified portfolio of personal wealth which is

sensitive to small changes in current performance Performance data extrapolated by investors/superiors Performance smoothing by managers

MEASURING MANAGERIAL CONTRIBUTIONSMEASURING MANAGERIAL CONTRIBUTIONS Not directly measurable More difficult at higher levels Difficulty in designing their contacts

PROCEDURAL CENTRALITY:PROCEDURAL CENTRALITY:

CONTACT WITH OTHER AGENTSCONTACT WITH OTHER AGENTS Procedural centrality of managers Managing contracts Surprises: nature, unanticipated behavior of others Privileged access to info about other contracts Info asymmetry in favor of managers Problems of adverse selection

– they know what others don’tMoral hazard– others do not know what they didCould sell info to competitors for personal gainProhibition on sharing services of managers across competitors

FORMS OF CONTRACTS FOR MANAGERSFORMS OF CONTRACTS FOR MANAGERS

Enforcement difficult because ofEnforcement difficult because of Nature of work human capital involvement in contracts of othersLegal system could help if shared

information is available

HOW DO WE MAKE IT SELF-ENFORCING?FLAT SALARY: IN PUBLIC GOOD ORGANIZATIONSEVEN OUTPUT IS DIFFICULT TO MEASUREPOOR MOTIVATIONAL TOOLPERFORMANCE CONTINGENT CONTRACTS

NO SINGLE MEASURE IS PERFECTFACTORS OUTSIDE MAN. CONTROLSUBJECT TO MAN. MANIPULATION

CONDITIONS FOR JOB LOSS LEFTUNSPECIFIED

RIGHT TO UNILATERAL TERMINATION

WITHOUT CAUSEROLE OF ACCOUNTING INMANAGERIAL CONTRACTS

MANAGERS’ PREFERENCESPECUNIARY VARIABLESNONPECUNIARY VARIABLES (FUTURE COMP.)SALARY IS ABOUT HALF OF TOTAL FOR CEOSBENEFITS DRIVEN BY TAX LAW, TRANS.

COSTS, SIGNALINGINTERACTION BETWEEN

PECUNIARY AND OTHERS

Chapter 4Chapter 4Managers and Accounting DecisionsManagers and Accounting Decisions

Accounting and control includesAccounting and control includes– Basic data collection– Performance reports– Financial reports

Choice of organizational form includes the choice of accounting and control

Managers directly in charge of accounting and control

Other agents participate less directlyOther agents participate less directly– Reacting and “voting with their feet”– Managers must anticipate and consider

such reactions

Managers also participate in shaping accounting regimes

Consider the range of managerial Consider the range of managerial accounting decisionsaccounting decisions

– Review some features of accounting from contract perspective

– Consequences of accounting decisions for managers

– Consequences for observable managerial behavior

Hierarchy of Accounting DecisionsHierarchy of Accounting DecisionsBy frequency of decisionsBy frequency of decisions

Expensing-Capitalization decisionsExpensing-Capitalization decisions– Managerial unique access to causes and

consequences– Create facts by classification– Discretion unavoidable, no perfectly

mechanical solution for classification is possible

– Demarcation of capital improvements, repairs, overhauls, rebuilding, salvaging and maintenance

– Managers can choose timing of transactions

– Law of conservation of income– Performance measures and contractual

consequences– Short-term contracts induce capitalization– Countervailing factors: smoothing, longer

term compensation plans, and auditing

Accounting estimatesAccounting estimates– Bad debt allowance, warranty costs, NRV

of byproducts, salvage values and economic life

– Varying degrees of flexibility– Same motivations as the expensing

decisions

Accounting PrinciplesAccounting Principles– Short term consequences for

compensation– Longer term consequences and

constraints– Image and signal– Auditing

Disclosure PolicyDisclosure Policy– Compliance with the law and

disclosure beyond the required level

– Better information for participating/other agents

– Temptation to disclose selectively– Trade off between credibility and

cost of verification– Effect on liquidity of factor

markets– Consequences of performance

forecasts by managers– Competitors and investor

diversification– (Competing against privately held

firms)– Disclosure to limit opportunism of

managers– Is less disclosure necessarily good

for managers?– Is more disclosure necessarily

good for shareholders?

Internal ControlsInternal Controls– Broad managerial discretion– Foreign Corrupt Practices Act

1977 requirements– Sarbanes-Oxley 2002

requirements– Cost Accounting Standards Board

for government vendors– Manager is a principal as well as

an agent in different contractual relationships within the firm

– Consistency of internal controls helps balance motives

– Ideal: self-enforcing contract for control

Accounting StandardsAccounting Standards– SEC, FASB, IASB make rules– Managers often participate on

behalf of the firm– Can we distinguish managerial

and firm interests?– Bank loan restructuring example– Reflexivity of accounting: does it

only represent reality or does it also create reality?

– What should be role of firms/managers in setting standards?

Transfer PricingTransfer Pricing Standard textbook solution discards the

problem Essence of decentralization: trade-off

between benefits and costs– Benefits of central coordination– Informational disadvantage of the

center Heart of organizational design problem

Cost AllocationCost Allocation– Declared a dead issue many times, but

not dead yet– Does allocation of sunk costs to

divisions make sense– Ex post efficiency of resource

utilization versus ex ante efficiency of resource acquisition decisions

Participating BudgetingParticipating Budgeting– Empowerment vs. dispersed

information argument– Hayek: Information is dispersed in the

economy– Trade-off: better decisions based on

more information– Worse decisions shaded by information

agents choose to share– Management consulting fads wax and

wane– People bring their own expectations,

no blank slate

Standards and Variance AnalysisStandards and Variance Analysis– Budgets and standards imply a

discontinuity in managerial reward functions

– Anticipation by agents– Complex non-linear dynamics

Managerial Consequences of Managerial Consequences of Accounting DecisionsAccounting Decisions– The LIFO Puzzle– Accounting for Leases– Restructuring of Troubled Loans– Cost of Exploration, Research and

Development– Recognizing Option Value as a

Compensation Expense– Rationality of apparently irrational

decisions?

Observable Behavior of ManagersObservable Behavior of Managers– Preference for status quo– Income management– Prediction of accounting methods

by firm characteristics

Certain Features of Control SystemsCertain Features of Control SystemsCost-benefit analysis of accounting and control systems

Chapter 5Chapter 5Income and Its ManagementIncome and Its Management

Firm as a source of “income” for all Firm as a source of “income” for all participantsparticipants

– Wage income– Personal service income– Interest income– Land rent– Sales income, etc.– Each agent looks at own return from

the contributionsShareholder income—a narrower Shareholder income—a narrower

perspectiveperspectiveWhat is special about shareholder What is special about shareholder incomeincome

– Residual nature– Defined independently of others’

income– The Degree of freedom problem—n

pieces of a pie

– Timing of transfer of income to claimants: delay for shareholders’

– Other agents get their share on predefined schedule

– Dividend is discretionary– Diffuse of body of shareholders cannot

enforce contracts on timing of transfer of income

– Taxation makes it difficult to automatically transfer income

– Income to equity cannot be measured precisely and in a timely manner

– No “ship accounting,” no periodic liquidation of assets, continued long term asset investments with imperfect and incomplete markets

– Indeterminacy of valuation, combined with the control of management over valuationopportunity for income management

– Difficulty of measuring managerial inputlinking compensation to output/income use of managerial discretion for self-serving purposes

– Shareholders rely on information in possession of the mangers but cannot be sure that management will use this information only for shareholders’ benefit

– Independent audits to put constraints– Imperfections of monetary representation of

income vs. real income

Law of Conservation of IncomeLaw of Conservation of IncomeLaw of Conservation of Discounted Residual IncomeLaw of Conservation of Discounted Residual Income

Functions of Income in the FirmFunctions of Income in the Firm– Assessing viability– Everybody makes projections to

the future

– Managerial evaluation and contract renegotiation

Attitudes of Agents towards IncomeAttitudes of Agents towards Income– Shareholders: money income as an estimate of real income– Would like to get the first best estimate– Fundamental model of valuation—relevance?

– Managers: Use of accounting to advance their own welfare (job security, level, compensation, firm size all linked to corporate income), risk: dislike abrupt changes in income

– Employment horizons shorter than firm horizon

Look at income management from the point of view of managers (bonus, options, could be terminated before the fruits of labor appear in the financial statements)

– Managers’ expectations of what the shareholders would do– Manager cannot iron out the kinks in the income streams (no retrospective

adjustments)– Limits on choice of accounting methods– Not certain about the consequences of choices they make

How do you “smooth” a random walk series?

Determination of EntitlementsDetermination of EntitlementsManagement of Income

– Statistical measures of smoothness– Smoothing = smoothness?– Income smoothing and big baths– Instruments of income smoothing– Incentives for covering the tracks

CHAPTER 6CHAPTER 6INVESTORS AND ACCOUNTINGINVESTORS AND ACCOUNTING

WHAT IS SPECIAL― PRECOMMITMENT― TIME DELAY― RESIDUAL CLAIM ONLY― MEASUREMENT AND CONT.

FULFILLMENT CRUCIALDESCRIPTION― LITTLE PARTICIPATION

― ON PURPOSE, DESIRABLE, DIVERSIFICATION

― ROE ON OWNER MANAGED FIRMS SAME

― TRANSFERABILITY― MINIMAL COST, RAPID PRICE

ADJUSTMENT― SYMMETRY OF INFO (PUBLIC

DISCL.)― CONTRAST PRIVATELY HELD FIRMS― COST OF TAKING THEM PRIVATE

― PREFERENCE HETEROGENEITY― LIQUID MARKET GIVES A UNIQUE

MEASURE― PRICE ADJUSTMENTS TO

INFORMATION― DETERMINE DISTRIBUTION OF

WEALTH― EQUITABLE RELEASE OF

INFORMATION

― INFORMATION INTERMEDIARIES― DEMAND FOR INFORMATION― COST OF INFORMATION― DIVERSIFICATION BY INDIVIDUAL― INFORMATION INTERMEDIARIES

― PROBLEM OF EVAL. PORTFOLIO MAN.

― DO NOT ASK FOR DISCL.― ANALYSTS DEMAND

DISCLOSURE,

DETAIL― CREDITORS― NONPERMANENT COMMITMENT― SHORT TERM CREDITORS― SECURED CREDITORS― UNSECURED LONG TERM

CREDITORS― LARGE CREDITORS-LITTLE INTEREST― DESIGN OF DEBT COVENANTS--

GAAP― WHY RELIANCE ON GAAP

― AUDIT COST― INTERDEPENDENCE OF FIRM

CONTRACTS― SPECIAL GAAP FOR EVERY AGENT

INVESTOR ATTITUDES AND INVESTOR ATTITUDES AND PREFERENCESPREFERENCES

― REPORTING ON CONTRACT PERFORMANCE

– IMPORTANCE OF CONTRACT FULFILLMENT– CONTROLS AND REDUNDANCY– SYMMETRY OF INFO DISTRIBUTION

― INCENTIVES TO MANAGERS– TOP MANAGER CONTRACTS– LIMITS ON RELEVANCE AND RELIABILITY– RRA IN OIL INDUSTRY

― AGGREGATION ADDS INFO– INFORMATION IN AGGR. FUNCTION

ACCOUNTING CHOICE MECHANISMACCOUNTING CHOICE MECHANISM― ORGANIZATION OF THE FIRM

– NATURE OF CHARTER– GOING PUBLIC

― TRADING IN CAPITAL MARKETS– DIVIDENDS AND VALUATION– ANALOGY OF BUYERS AND CARS– REACTIONARY MODE– MANAGERS ANTICIPATE INVESTOR PREF.

― VOTING AND PROXIES– NOT AN EFFECTIVE INSTRUMENT FOR INV.

― SOCIO-POLITICAL INSTITUTIONS– LEGISLATURE, REGULATORY BODIES– CHANGES IN REGIME

CONSEQUENCES OF ACCOUNTING CONSEQUENCES OF ACCOUNTING POLICY FOR INV.POLICY FOR INV.

― ACCG. INFORMATION AS PUBLIC GOOD

– UNDER PRODUCTION?– COMMON COST OF CONTRACTS– SPECIAL VULNERABILITY OF

INVESTORS– NOT IN DIRECT TOUCH WITH

OPERATIONS– FREE DIST. OF INFO--DYNAMIC

STABILITY – ADVERTISING ANALOGY

― PRODUCTION BY INTERMEDIARIES– WHO PAYS, WHO BENEFITS– EARLY EFFICIENT MARKET

EUPHORIA– ECONOMICS OF INFORMATION

MARKET– CRITICISM OF DETAILS FOR

ANALYSTS OPEN ENTRY TO ANALYST

MARKET

Chapter 7: Accounting and the Stock MarketChapter 7: Accounting and the Stock Market

Accounting interface with Accounting interface with shareholdersshareholders

1. Contributions: cash or real, made in advance

2. Entitlements: real capital on basis of accounting records, converted to money in financial reports through valuation rules

3. Reports of contract fulfillment: unnecessary

4. Liquidity: verified reports to potential investors

5. Public disclosure: to reduce information asymmetry

Limited role for valuation rulesLimited role for valuation rulesEntitles to real capital, not moneyImperfection of valuation rules, vulnerability to manipulationOnly function (4) affected by valuation rules

Role of information intermediariesRole of information intermediariesPrimary, secondary and tertiary markets: firm involved in PDerived demand in P market, bankers’ compensationReputation of banker as protection against collusion (effectiveness??)Change of auditors, insurance

Money from Public Accounting Money from Public Accounting NumbersNumbersDiscovery and use of informationCompetition in the market for informationTrade off between the speed of dissemination and depth of marketsProspecting for goldAcademic studies vs. practical implementation of money makingImpossibility of informationally efficient markets

Money from Advance Access to Money from Advance Access to Accounting NumbersAccounting Numbers

We would like to have direct evidence about the money that can be made from advance access

Insider trading studies Ball & Brown (event studies) don’t

quite do it

Effect of Accounting Numbers on Effect of Accounting Numbers on Stock MarketStock Market

Investor expectations stock prices

Accounting data investor expectations

Difficulty of doing studies on formation of investor expectations (not from field data)

Role of accounting in preserving the resources of the firm (control)

Role of accounting in managerial/employee motivation

Linking investor and employee behavior into an equilibrium

Managerial selection

Effect of the Stock Market on Effect of the Stock Market on AccountingAccounting

Not much research on the topic Beginning of efforts to standardize

accounting after creation of the SEC Reynolds example Managerial concerns about stock

market reaction (LIFO)

Accounting without Stock MarketAccounting without Stock Market Choice of going public

Stock Market without AccountingStock Market without Accounting Think about the question before the

next value relevance study Accounting a must for mutual

observables to contract on Stock market would be impossible

without accounting

Problems of InferenceProblems of Inference Needle in the Haystack Problem The Expectations Problem The Self-selection Problem

Chapter 8: Auditors and the FirmChapter 8: Auditors and the Firm

Functions of the Audit in the FirmFunctions of the Audit in the Firm

Auditor DecisionsAuditor Decisions Allocation of resources in an audit assignment Audit Opinions Pricing audit services and bidding for clients Audit policies, training, quality control, and self-regulation

Institutional Structure of the Audit ProfessionInstitutional Structure of the Audit Profession Development of Audit Standards Development of Accounting Standards Who Sets the Standards? Auditors’ Responsibility for Detection of Fraud Competition, Entry and Discipline

Chapter 9: Conventions and ClassificationChapter 9: Conventions and Classification

Examination of the traditional terms Examination of the traditional terms of accounting in terms of contract of accounting in terms of contract theory of the firmtheory of the firm

Link them to familiar social science concepts

– Features of accounting as economic choice of convention

– Temporal stability does not mean convention

– Distinction is important for setting accounting standards

Rules as systems of classification– Importance of the nature of

classification for standard settingConventionsConventions A coordinating device in a game Games in which coordination can yield

Pareto superior outcomes but communication is difficult or impossible

Applied to recurrent situations Must be common knowledge It is in the interest of everyone that

one more person will conform to the convention

Existence of an alternative which is just as good

– Driving on the right or left– Debits on the right or left– Balance sheet in order of decreasing or

increasing liquidity In accounting literature a lot of confusion

and confusing definitions of conventions (Gilman, Kohler’s Dictionary)

Stake in maintaining the status quo Differentiated from economic choicesEconomic Features of AccountingEconomic Features of Accounting Features which are not conventions

– Will changing the feature affect any agent?

Conservatism Entity Going concern: use and disposal values Period Valuation Accrual AccrualTemporal StabilityTemporal StabilityDouble EntryDouble Entry Causal and classificational interpretations Economic resources Uniformity and classification

Chapter Chapter 10. Decision Criteria and Mechanisms10. Decision Criteria and Mechanisms

Criteria for social choiceCriteria for social choice Technical efficiency Simple economic efficiency Multiperson economic efficiency Multiperiod problem Uncertainty problem

Social cost benefit analysisSocial cost benefit analysis Which costs, which benefits? Problem of partial analysis Nonlinear utilities Measures of efficiency

Mechanisms for Social ChoiceMechanisms for Social Choice Market or Political/Administrative Limitations of voting mechanisms Market mechanisms for accounting standards Legal rights and markets

Outline of Current Research In AccountingOutline of Current Research In Accounting

Contract Model of the FirmContract Model of the Firm A Useful Framework for Organizing Accounting Research

Micro-Level ResearchMicro-Level Research Research on Decisions of Various Participants Research on Effects on Various Participants

Macro-Level ResearchMacro-Level Research Research on characteristics of the system Research on alternative designs of the system

Survey the research work being carried out in each categorySurvey the research work being carried out in each category What are interesting questions in each category? What have we learned so far? What questions remain open? (Use of Table of Contents of the Sunder book manuscript)

Functions of accounting and controlFunctions of accounting and control

Chapter 5:Chapter 5:

Managers and incomeManagers and income

Difficulty of measurement Link compensation to output Choice of accounting methods Income: role in organization multiple management

Share holders, stock market & auditorsShare holders, stock market & auditors Basic features: conventions, economic features Social choice mechanism &criteria Standards Government & law Accounting for public good organization

theory of accounting and control shyam sunder, yale university kozminski university, warsaw, poland...

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