1

Accounting: Labor, Capital and Product Markets

Shyam Sunder

Yale University

Zhytomyr State Technological University, Zhytomyr, May 18, 2006

2

Dominant Theme: Harmonization and Convergence Harmonization and convergence of

accounting practice is a dominant theme in today’s accounting

Descriptive validity: probably, with IAS Normative validity: doubtful, considering the

links between accounting and markets Build on this theme in this talk Perhaps you would not mind a discordant

note in the chorus of support for international harmonization of accounting standards

3

Accounting Convergence or Differentiation by Economy and Sector Accounting practices vary in different economies Accounting practices also vary in different sectors of

the same economy (e.g., private and public sectors, and in different industries)

Convergent development of markets generates convergent pressures on accounting

Globalization is development of cross-economy markets

We examine the sources, consequences and limits of these convergent forces

4

Cross-Economy Overview

Contract model of organizations and accounting

Markets shape the organization Differences in markets Differences in accounting Market development and cross-economy

convergence of accounting Limits to convergence

5

Contract Theory of Organizations

Organizations can be seen as sets of contracts among people

Chester Barnard, President, Bell Telephone Company of New Jersey– Functions of the Executive 1937

Herbert A. Simon, Administrative Behavior, 1946

Terms of contract depend on the conditions prevailing in the respective markets

6

Figure 1

Resource Flows in Private-Good Organization

Employees

Shareholders

Creditors

Customers

VendorsGovernment

Managers

Public

Goo

dsTax

es

Goo

ds a

nd

Serv

ices

Cas

h

Compensation

Skills

SkillsCompensation

Res

idua

lR

ight

s

Equ

ity C

apita

l

Interest

Loan

Capita

l

CashGoods and Services

7

Markets Shape Organizations and Their Accounting Market for capital Market for labor Market for products Will consider two markets of special interest

to accountants today– Markets for audit services– Markets for systems of governance (Tiebout)

All these markets are not equally developed in the same or in different societies

8

Functions of Accounting

Accounting to help define, implement, renegotiate and enforce contracts– Measures resource contributions– Determines inducements– Compares contributions to inducements to

determine fulfillment of contracts– Distribution of information to factor markets– Public disclosure to reduce conflict

(American Airlines)

9

Markets for Labor (Managerial)

Classical double entry: – For traders, – Causal links in transactions (ijiri)– Aid to memory, no hired managers

Managerial Accounting– For hired managers– Hierarchy or organization– Stewardship or agency problem– Rise of business schools to supply this market

10

Contracting Problems in Markets for Labor Problem of differential expectations of various

parties– Importance of public disclosure to reduce conflict

Recent problems in US Corp. governance: asymmetric information– Managers defining their own contracts– Stealing from the firm

Very old issues (East India Company) As labor markets developed in societies, so

did organizations and their control systems

11

Informal Evidence: U.S. and Japan Differ in their industrial organization => definition of

entity and consolidation Importance of debt markets and control Managerial and labor markets=> differences in

employment contracts Weak equity markets and financial reports Non-existent market for corporate control Changes in markets=>changes in accounting With time, we could develop better field evidence on

this correspondence

12

Markets for Capital

Closely-held firms: equity supplied by one person or tight group who can control management

Publicly-held firms: equity supplied by a large, diverse group of investors who cannot directly control the managers

Gave rise to financial reporting form of accounting

13

Consequences of Capital Markets

Robust accounting (less judgment) Introduction of rules and auditors Management of income less acceptable Competition among source of information Shift from stock to flow variables Most firms’ shares not traded Firms choose their organizational forms and their

accounting regimes US-Japan comparison of equity-bond markets

and their financial reporting systems

14

Markets for Products

Private good organizations produce and sell goods for a price to customers

Customers can impose discipline on them

Shareholders control managers by offering them net income based compensation

15

Public Good Organizations

Public good organizations have beneficiaries, not customers

Weaker or no customer discipline Efficient production of public goods is

very difficult Solution to the control problem is

bureaucracy and a different accounting system

16

Comparing Private and Public Good Organizations Resource flows Residual Claims Product Market Discipline Decision Making

– Product

– Investment Accounting and Control

17

Accounting and Controls

Differences between internal control and financial reporting

Differences often misinterpreted as prima facie evidence of poorly designed or poorly run public good organizations

18

Accounting and Control Differences Entities Funds Consolidation Assets/Depreciation Revenue (cash versus accrual) Budgets

19

Bureaucracy

Bureaucracy is the oldest form of management

Does not receive a fair shake in press Perhaps overused in welfare state But it is necessary for many functions Lack of understanding leads to

misguided attempts at reform that can backfire

20

Unequal Race

Efficient production of public goods is more difficult than private goods (lack of customer discipline on managers)

Always room for improvement in current practices

21

Market for Audit Services

Recent collapse of auditing in US Blamed on “bad” people But there is a larger story of “bad” policy We need to trace what happened over

the preceding quarter century in the audit market in US

The we can better able to understand both the causes as well as the cures

22

Market for Accounting Governance Desirability of a single set of rules has

become a consensus There are good reasons to question this

consensus Does there exist a right set of standards that

will fix our accounting troubles: wrong search Even if the answer is yes, what is the major

hurdle that standard setters face in their search– They can’t tell which rules are better

23

What can we do to help them find better rules? Better information about the consequences of

their prescriptions This can’t happen with an accounting

monopoly of FASB in US or IASB in the world Likely to get stuck in a corner solution, with

no possibility of getting evidence on what can be better

Consider regulatory competition– Unfortunately, the accounting world is headed in

the other direction

24

Summary

Sectoral differences in accounting arise from market differences

Market developments will not necessarily eliminate them

We should expect sectoral differences in accounting to persist globally, even as economy-wise differences diminish over time

25

Thank You

The paper and slides will be available at http://www.som.yale.edu/faculty/

sunder/research.html or email to shyam.sunder@yale.edu