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1、ABSTRACTThis paper reviews and critiques the positive accounting literature following publication of Watts and Zimmerman(1978,1979).The 1978 paper helped generate the positive accounting literature which offers an explanation of accounting practice,suggests the importance of contracting costs,and ha
2、s led to the discovery of some previously unknown empirical regularities.The 1979 paper produced a methodological debate that has not been very productive.第1页/共47页ABSTRACTThis paper attempts to remove some common misconceptions about methodology that surfaced in the debate.It also suggests ways to i
3、mprove positive research in accounting choice.The most important of these improvements is tighter links between the theory and the empirical tests.A second suggested improvement is the development of models that recognize the endogeneity among the variables in the regressions.A third improvement is
4、reduction in measurement errors in both the dependent and independent variables in the regressions.第2页/共47页StructureI.Evolution and State of Positive Accounting TheoryII.Criticisms of Positive Accounting ResearchIII.Summary and Conclusions第3页/共47页I.Evolution and State of Positive Accounting Theory1.
5、1 Evolution1.2 Contemporaneous Positive Accounting Theory1.3 Evidence on the Theory第4页/共47页I.Evolution and State of Positive Accounting Theory1.1 EvolutionModern positive accounting research began flourishing in the 1960s when Ball and Brown(1968),Beaver(1968).and others introduced empirical finance
6、 methods to financial accounting.The subsequent literature adopted the assumption that accounting numbers supply information for security market investment decisions and used this information perspective to investigate the relation between accounting numbers and stock prices.The information perspect
7、ive has not provided hypotheses to explain why entire industries switch from accelerated to straight-line depreciation without changing their tax depreciation methods.第5页/共47页I.Evolution and State of Positive Accounting Theory1.1 EvolutionAn important reason that the information perspective failed t
8、o generate hypotheses explaining and predicting accounting choice is that in the finance theory underlying the empirical studies,accounting choice per se could not affect firm value.To predict and explain accounting choice accounting researchers had to introduce information and/or transactions costs
9、.The initial empirical studies in accounting choice used positive agency costs of debt and compensation contracts and positive information and lobbying costs in the political process to generate value effects for and,hence,hypotheses about accounting choice.Finance researchers had introduced costs o
10、f debt that increase with the debt/equity ratio to explain how optimal capital structures could vary across industries.第6页/共47页I.Evolution and State of Positive Accounting Theory1.1 EvolutionThe agency costs were of particular interest to accountants because accounting appeared to play a role in min
11、imizing them.Debt contracts apparently aimed at reducing dysfunctional behavior use accounting numbers.Accounting researchers recognized the implications for accounting choice and began using the accounting numbers in debt contracts to generate hypotheses about accounting choice.Accounting numbers a
12、lso are used in managers compensation contracts and it is hypothesized that such use again minimizes agency costs.This use of accounting numbers in bonus plans suggested the possibility that accounting choice could affect wealth and so accounting researchers began employing that use to explain accou
13、nting choice.第7页/共47页I.Evolution and State of Positive Accounting Theory1.1 EvolutionBorrowing from the industrial organization literature in economics which assumes positive information costs and lobbying costs,accounting researchers postulated that the political process generated costs for firms.T
14、hese political costs are a function of reported profits.Thus,incentives are created to manage reported accounting numbers.Information and lobbying costs are part of the costs of contracting in the political process.The extent and form of the wealth transfers created by the political process(such as
15、the tax code)are affected by these contracting costs.第8页/共47页I.Evolution and State of Positive Accounting Theory1.1 EvolutionWhile the early literature concentrated on using debt and compensation contracts and the political process to explain and predict accounting choice,the theory underlying the e
16、mpirical work was more general and had its foundation in an economic literature on the theory of the firm.Since the 1970s economists have strived to develop a theory of the firm by attempting to explain the organizational structure of the firm(e.g.,choice of corporate form,structure of contracts,man
17、agement compensation,centralization-decentralization).The underlying notion is that competition among different forms of institutions leads to the survival of those forms most cost-effective in supplying goods and services.第9页/共47页I.Evolution and State of Positive Accounting Theory1.1 EvolutionIt wa
18、s a short step to suggest that accounting methods affect the firms organizational costs and so the accounting methods that survive are the result of a similar economic equilibrium.Accounting researchers have recently returned to using that notion of an efficient set of accounting methods to explain
19、accounting choice.The agency costs associated with debt and management compensation contracts and the agency,information,and other contracting costs associated with the political process provided the hypotheses tested in the early empirical accounting choice studies.第10页/共47页I.Evolution and State of
20、 Positive Accounting Theory1.1 EvolutionHowever,the more general approach suggested agency and other costs associated with other contracts could also affect accounting choice,this potential for many contracts to play a role in explaining organizational choice(including accounting choice)and the fact
21、 that agency costs used to explain the contracts often arise in contractual scenarios that differ from those of the standard agency problem led researchers to start to use the term contracting costs instead of agency costs.The concept of contracting costs and the notion of accounting methods as part
22、 of efficient organizational technology play key roles in contemporaneous positive accounting theory.第11页/共47页I.Evolution and State of Positive Accounting Theory1.2 Contemporaneous Positive Accounting TheoryContracting costs arise in(1)market transactions(2)transactions internal to the firm and(3)tr
23、ansactions in the political process(e.g.,securing government contracts or avoiding government regulation requires lobbying costs).Contracting costs consist of transaction costs(e.g.,brokerage fees),agency costs(e.g.,monitoring costs,bonding costs,and the residual loss from dysfunctional decisions),i
24、nformation costs(e.g.,the costs of becoming informed),renegotiation costs(e.g.,the costs of rewriting existing contracts because the extant contract is made obsolete by some unforeseen event),and bankruptcy costs(e.g.,the legal costs of bankruptcy and the costs of dysfunctional decisions).第12页/共47页I
25、.Evolution and State of Positive Accounting Theory1.2 Contemporaneous Positive Accounting TheoryThe existence of contracting costs is crucial to models of both the organization of the firm and accounting choice.Meckling and Jensen(1986)suggest that within the firm the lack of a market price is repla
26、ced by systems for allocating decisions among managers,and measuring,rewarding,and punishing managerial performance.Accounting plays a role in these systems and so appears to be part of the firms efficient contracting technology.Trying to predict and explain the organization of the firm with zero co
27、ntracting costs is pointless.The extent to which accounting choice affects the contracting parties wealth depends on the relative magnitudes of the contracting costs.Thus,developing a positive theory of accounting choice requires an understanding of the relative magnitudes of the various types of co
28、ntracting costs.第13页/共47页I.Evolution and State of Positive Accounting Theory1.2 Contemporaneous Positive Accounting TheoryContracts that use accounting numbers are not effective in aligning managers and contracting parties interests if managers have complete discretion over the reported accounting n
29、umbers,then we say the managers acted opportunistically.“The set of accounting procedures within which managers have discretion is called the accepted set.It is voluntarily determined by the contracting parties.The accepted set is predicted to vary across firms with the variation in the costs and be
30、nefits of restrictions.These restrictions produce the best or accepted accounting principles even without mandated accounting standards by government.The restrictions are enforced by external auditors.Reacting to the incentive of managers to exercise accounting discretion opportunistically,the accep
31、ted set includes conservative and objective“accounting procedures.第14页/共47页I.Evolution and State of Positive Accounting Theory1.2 Contemporaneous Positive Accounting TheoryRelation Between the Accepted Set of Accounting Methods and the Choice of Method from within the Accepted Set.A 1 denotes the se
32、t of accepted methods for firm 1A2 denotes the set of accepted methods for firm 2X1 denotes the choice of method from within the accepted set by firm 1X2 denotes the choice of method from within the accepted set by firm 2第15页/共47页I.Evolution and State of Positive Accounting Theory1.2 Contemporaneous
33、 Positive Accounting TheoryVariations across sets of accepted accounting procedures(e.g.,A1 and A2)explain some cross-sectional variation in accounting choice(e.g.,managers in firm 2 cannot choose method X1).Most accounting choice studies assume managers choose accounting methods to transfer wealth
34、to themselves at the expense of another party to the firm because they can take the firms observed contracts as given and then determine managers incentives for accounting choice.However,no study to date has explained both the ex ante choice of the accepted set and the ex post choice of accounting m
35、ethod from within the accepted set.Most studies that assume opportunistic choice of accounting methods do not control for the fact that managers in different firms likely are choosing accounting methods from different constrained accepted sets.第16页/共47页I.Evolution and State of Positive Accounting Th
36、eory1.2 Contemporaneous Positive Accounting TheoryThe accepted set of accounting methods is one part of the firms implicit and explicit contracts including the firms capital structure,compensation plans,and ownership structure.All the contracting provisions(including the accounting policies)are endo
37、genous.Capital structure choice is related to compensation policy and to accounting policy.But,the relation is not necessarily causal.Capital structure changes do not cause changes in the accepted set of accounting methods.Rather,some exogenous event,such as a new invention or government deregulatio
38、n occurs and this causes changes in the contracting variables including accounting methods.第17页/共47页I.Evolution and State of Positive Accounting Theory1.3 Evidence on the TheoryTwo types of tests of the theory have been conducted:stock price tests and accounting choice tests.The stock price tests ha
39、ve been reviewed extensively elsewhere.Stock price tests of the theory reveal some price reactions to mandatory accounting changes,especially involving oil and gas accounting.Stock price studies are probably relatively weak tests of the theory.The more promising ones are accounting choice studies.Mo
40、st accounting choice studies attempt to explain the choice of a single accounting method instead of the choice of combinations of accounting methods.Focusing on a single accounting method reduces the power of the tests since managers are concerned with how the combination of methods affects earnings
41、 instead of the effect on just one particular accounting method.Accounting accruals aggregate into a single measure the net effect of all accounting choices.But use of accruals as a summary measure of accounting choice suffers from a lack of control of what accruals would be without managerial accou
42、nting discretion.第18页/共47页I.Evolution and State of Positive Accounting Theory1.3 Evidence on the TheoryMost accounting choice studies use combinations of three sets of variables:variables representing the managers incentives to choose accounting methods under bonus plans,debt contracts,and the polit
43、ical process.The literature has tended to state each of these hypotheses as managers behaving opportunistically.The early tests of the bonus hypothesis are not very powerful tests of the theory because they rely on simplifications of the theory.A bonus plan does not always give managers incentives t
44、o increase earnings.If,earnings are below the minimum level required for payment of a bonus,managers have incentive to reduce earnings this year because no bonuses are likely paid.Taking such an earnings bath increases expected profits and bonuses in future years.By using bonus plan details to ident
45、ify situations where managers are expected to reduce earnings,Healys(1985)tests encompass more kinds of manipulation.His results are consistent with managers manipulating net accruals to affect their bonuses.第19页/共47页I.Evolution and State of Positive Accounting Theory1.3 Evidence on the TheoryThe de
46、bt/equity hypothesis predicts the higher the firms debt/equity ratio.the more likely managers use accounting methods that increase income.The evidence is generally consistent with the debt/equity hypothesis.The association between leverage and accounting method choice is an empirical regularity unkn
47、own prior to the positive accounting studies.The political cost hypothesis predicts that large firms rather than small firms are more likely to use accounting choices that reduce reported profits.Size is a proxy variable for political attention.the assumption that it is costly for individuals to bec
48、ome informed about whether accounting profits really represent monopoly profits and to contract with others in the political process to enact laws and regulations that enhance their welfare.Given the cost of information and monitoring,managers have incentive to exercise discretion over accounting pr
49、ofits and the parties in the political process settle for a rational amount of ex post opportunism.第20页/共47页I.Evolution and State of Positive Accounting Theory1.3 Evidence on the TheoryThe evidence is consistent with the political cost hypothesis.However,the result only appears to hold for the large
50、st firms and is driven by the oil and gas industry.Difficulties with using firm size to proxy for political costs,including the likelihood that it can proxy for many other effects,such as industry membership etc.The interesting finding is the consistency of the sign of the relation between size and