ShyamSunder YaleSchoolofManagement EIASMWorkshoponAccountingandEconomics Universit Bocconi,Milan,Italy June1920,2008

1.UniversalStandards
Universalstandardsoffinancialreporting appliedacrosstime,economies,industriesand corporatesizeandorganizationalformsbest servetheconstituentinterests
Standardizationdoessavecostsandeffort, (electricalplugs,clothing,cars,streetgrids, commercialcodes) Becomescounterproductivebeyondcertainlimits Howdoweknowwheretostop? Rhetoricofuniversalaccountingstandardsand universallanguage
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2.TheStaticIdeal
Thereexistsasetoffinancialreporting standardsthat,oncediscoveredand implemented,willinducecorporationsand theirauditorstopreparethebestattainable financialreports
Dynamicsofthegamebetweenmanagersand standardsettersmakesanysuchstaticidealall butimpossible Standardsisonlya(small)partoftheproblem

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3.PeopleorStructure
Ifweselectknowledgeable,experienced, selfless,publicspirited,andwise individualstoconstitutebodiesthatdevise accountingstandardsthroughdeliberation anddueprocess,wecanimprovefinancial reporting
Individualsstandwheretheysit Muchemphasisonthequalityofindividuals,too littleattentiontothestructureofgametheyare askedtoplay
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4.EngineeringStandards throughDeliberation
Itispossibletoconstructordiscoverbetter financialreportingstandardsthrough deliberationinproperlyorganizedcorporate entities(suchastheIASB,theFASB,etc.).
Assumesthatsuchbodiescanknowthe consequencesoftheiractions Historydoesnotsupporttheproposition

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5.SpecializationinSetting Standards
Specialiststandardsettingbodies,standing readytoaddressnewproblems,inquiries andrequestsforclarificationshelpimprove financialreporting
Theirexistenceencouragesanewclarification gametargetedatthem Theymustkeepafullagenda(performance) Revenueandbudgetpressures Overtime,theiroutputmustaccumulatetoa thickrulebook
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6.WhatisGoodandBad?
Standardsetterscantellwhichstandards arebetterandwhy.
Littleevidencethattheyknow,orcanknow Costofcapitalistheresultofcomplex interactionsamongmanyfactors(including accounting) Theseinfluencescannotbesortedoutbyex anteanalysis Expostanalysisofdatatoassesstheimpacton costofcapitalmaybepossible
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7.StandardsMonopolies
Grantingmonopolypowerinagiven jurisdictiontostandardswrittenbyagiven bodycanhelpimprovecorporatefinancial reporting
Informationaldisadvantageofamonopoly Noopportunityforexperimentation Noopportunitytolearnfromtheexperienceof alternatives Nopressuretodobetter,ortocorrecterrors
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8.CompetitionandRacetothe Bottom
Aregimethatencouragesreportingentities tochooseamongthestandardswrittenby competingorganizations(andpayingthem aroyaltyfortheprivilege)inducesaraceto thebottom todeviselessdemanding standards
Counterexamples(Stockexchanges,bond ratingservices,appliancestandards,college accreditation,bankregulation,corporate chartersacrossU.S.states,etc.)
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9.ForceandEffectiveness
Increaseinthepowerofenforcement behindauthoritativestandardsimproves complianceandqualityoffinancial reporting
Increasedenforcementalsoincreasesresources devotedtoevasion Draconianpunishmentsdonotnecessarily inducebetterbehavior Crime,alcoholanddrugabuse
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10.StatutoryApproach DominatesCommonLaw
Thequasistatutoryapproachtosetting accountingstandardsdominatesacommon lawapproachtofinancialreporting
Evidence? Constitution(U.K.,U.S.,Europe)

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11.WrittenStandardsDominate SocialNorms
Writtenstandardsbackedbypowerof enforcementworkbetterthanunwritten socialnormsbackedonlybyinternaland externalinformalsanctions
Socialnormsgoverngreatpartsofourlives includingmanyaspectsoflaw Insidertrading Guiltybeyondreasonabledoubt Privatecommercialcodes(cotton,diamond trades)
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12.Whodefendsthemiddle ground?
Theidealaccountingregimewouldconsist ofallwrittenstandardsorallsocialnorms
Easiertomaketheextremecasesforstandards ornormsalone Difficultyofdefendingthemiddlegroundwhere bothmaycoexist,astheydoinmanyother aspectsoflife

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13.NewProblems,New Solutions
Financialreportingandgovernance problemsoriginatedinthe20thcentury
Historytellsusotherwise GovernanceproblemsoftheEastIndia Company Clive,Hastings,andtheCompanysCourtof Directors

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14.FinancialReportingis GettingBetter
Seventyyearsofstandardizationoffinancial reports(inU.S.)hashelpedimprovethe qualityoffinancialreporting
Evidence? Isathickerrulebookindicationofbetter financialreporting? Perfectcorrelationbetweenaccountingand stockreturns? Howdowejudgeifourfinancialreportsare gettingbetter?
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15.FewerAlternatives,Better Reports
Fewerthealternativetreatmentsthe reportingentitiesareallowedtochoose from,thebetterthequalityoffinancial reporting
Feweralternativesalsotiethehandsofthe managementofwellruncompanieswhomay wishtosignaltheirconfidence,competenceand prospectsbychoosingreportingpractices othersfinddifficulttoemulate

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16.AuditorsBargaining Power
Wellspecifiedstandardsenhancethe bargainingpoweroftheauditorvisvisthe client
Standardsalsoencourageclientstodemand: showmetherule Reducedrelianceonjudgment Moredetailedthestandards,greaterthepartof accountantsworkthatcanbereplacedbya computer,andlowerthevalueoftheservice

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17.Accounting&Auditing Games
Writtenstandardsconstrainthetendencyof managers,auditorsandinvestmentbankers toplayaccountingandauditinggames
Onthecontrary,theyencourageandfacilitate gameplayingbyreducinguncertaintyaboutwhat is,andisnot,acceptable 3percentSPEs=>Enron

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18.Individual responsibility
Writtenfinancialreportingstandards strengthentheindividualresponsibilityof managers,auditors,andinvestment bankersforfairrepresentation
Onthecontrary,theyundermineindividual responsibilityforfairrepresentationandthebig picturebyshiftingattentiontomeetingthe letter,notspirit,ofthespecificprovisionsand theirwording

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19.Education
Writtenstandardsmakeiteasiertoeducate betteraccountantsandattracttalenttothe profession
Writtenstandardsdegradetheclassroomfrom reasoningandintellectualdebatetorote memorization,reinforcestreetimageof accountingasboringandmechanical Theymakeitlessattractivetoyoungtalent

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20.NothingsNewunderthe Sun
HaveIsaidsomethingnew?
Iwish.WilliamT.Baxter(ProfessorEmeritus, LSE),mademanyoftheseargumentsoverhalf acenturyago(Recommendationson AccountingTheory inBaxterandDavidson, StudiesinAccountingTheory,1stedition).

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BewareofConsensus
Adifferentperspective Youwouldbeleftbehindifyoudonot followthecrowd WashingtonConsensus AccountingConsensusfivemainelements

AccountingConsensus1
Thestandardsdevelopedshouldbe confinedtoprinciples,andnotbecome detailedrules
Nobodycantellwhichiswhich IFRSvs.FAS,yetplanstoadoptFASwholesale Fairvalues:principleorrhetoricaldevice

AccountingConsensus2
Asinglesetofhighqualitywrittenstandards offinancialreportingappliedtoallcompanies (atleastthepubliclytradedones)intheworld willimprovefinancialreportingbymaking financialreportsmorecomparable,andthus assistinvestorsandotherusersoffinancial statementsmakebetterdecisions
Allpreferhighquality,butwhatisit(Joyceetal. Principlescomparabilitycontradiction Accountingforresearch&developmentcosts(FAS2) Evidencethataccountingstandardshelpinvestorsor managersmakebetterdecisions?

AccountingConsensus3
Thebestwaytodevelopsuchstandardsisto createasingledeliberativecorporatebody consistingofappropriateexpertswithaproper governancestructureandlegallyassuredfunding, functioningundertheoversightofstatutory regulatoryauthoritiessuchastheSECandtheEC
Difficultyofassessingproposedstandards Evensimpleengineeringdesignneedfieldtrials Complexityofsocialinstitutions,riskofgettingboxedinto awrongstandards Divisionofsimplicityandcomplexitybetweenstrategyand institutions Ecosystemviewoffinancialreportingsystem Competitionwithnotaxrevenues

AccountingConsensus4
Tothisend,theoperationsoftheFASBand theIASBshouldbegraduallymergedinto onecorporatebodyandonesetof standardstobecalledIFRS
Fromsocialnormstouniformwrittenstandards Effectofuniformityofeducation,researchand profession Compareaccountingeducationtoeducationfor otherprofessions

AccountingConsensus5
Thissinglesetofstandardsshouldbe practicedintheU.S.,EC,andelsewhere,and theU.S.educationalsystemshouldprepare itselftointegrateIFRSintoitscurriculasoU.S. graduateswillbeabletoprepare,use,and auditfinancialreportsbasedonIFRS
Educationalconsequencesanafterthoughtatbest Effectofexpansionofwrittenstandardsonclassroom discourse Educationalcapacity:chancetoshifttogeneral principlesofaccounting Placeofaccountingintheuniversity:medicineor plumbing

TheProblemofSetting EfficientStandards
Criteria Generationofalternatives Evaluationofalternatives Complexinteractionsamongaccounting,capital andlabormarkets Facilitationofevolutionofaccountingnorms Balancingstatutoryandcommonlaw Balancingadjustmentspeedanderrors Nosubstituteforpersonalresponsibility Thenannydoesnotknow,butcanhelp
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HowCantheNannyHelp?
Government,quasigovernmentorprivatesector bodiescanplayapositiveroleinevolutionof normsofaccountingthroughoversight
Nomonopolyjurisdiction Competitionwithalternatives(royalties) Opportunitytoexperiment Coexistenceofmultiplesetsofstandardsfordifferent clientelesdiversityessentialtoevolution Excelconversionworkbooks(highRsquare) Personalresponsibilityforfairrepresentation AccountingCourt:guiltybeyondreasonabledoubt
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InContrasttoIASB(FASB) Command&ControlView
Todevelopaccountingstandards:
Asingleset(monopoly?) Ofhighquality(whatdoesthatmean?) Understandable(towho?) Enforceable(stick,notnorms) Global(noclienteleordiversity)

Arewereadyforanalternativemindset aboutfinancialreporting?
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WhitherAccounting:Windows orOpenSystems
Comfortvs.choice Uniformityandstagnationvs.dynamicchange Predictabilityvs.somedisorder Highpricesortheadvantagesoftechnological progress Financialreportingasanecosystemora machine(gardenorabuilding) HuxleyorHayek Nannyorpersonalresponsibility Roleofaccountingresearchers/professors?
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ConcludingRemarks
IntheprefacetohisDictionary,Johnson wroteabouthisfortuitousandunguided excursionsinto theboundlesschaosofa livingspeech."Canauthoritativeuniform standardswithoutcollaborationwithsocial normsbringasemblanceofordertothe chaostofinancialreporting?Afterseven decadesofincessantefforts,theanswer staresusintheface

Shyam.sunder@yale.edu www.som.yale.edu\faculty\sunder