contract theory of organizations, accounting and control shyam sunder, yale university third...
TRANSCRIPT
Contract Theory of Organizations, Accounting and Control
Shyam Sunder, Yale UniversityThird International Conference on Accounting and Finance
University of Namibia, Windhoek, June 13-14, 2011
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Three Basic Ideas• Organizations as a set of contracts• Shared facts for conflict resolution• Control in organizations as balance and
equilibrium among various interests
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Organization as a set of Contracts
• Economic agents• Contracts• Contributions• Resource Entitlements• Necessary Conditions• Satisfies each individual• Aggregate feasibility
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Figure 1
Resource Flows in Private-Good Organization
Employees
Shareholders
Creditors
Customers
VendorsGovernment
Managers
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Figure 1
Resource Flows in Private-Good Organization
Employees
Shareholders
Creditors
Customers
VendorsGovernment
Managers
Compensation
Skills
Resi
du
al
Rig
hts
Equit
y C
ap
ital
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Contributions and Entitlements of Various Agents
Type of Agent
contribution entitlement
Shareholder equity capital dividend Manager skills salary, bonus, benefits Employee skills salary, wages, benefits Vendor goods, services cash Customer cash goods, services Lender/creditor loan capital interest, principal Government public goods taxes Auditor services fees
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Assumptions• Economic agents• Preferences• Consistency of actions• Contract as mutual understanding or expectation• Not necessarily explicit• Role of social conventions
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Goals and Scope• Goals of each individual• Organization’s goals not considered– Organization as an arena– Organization as a tournament
• Applicable to all organizations• Focus here on business firm
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Functions of Accounting• To Help
– Assemble– Implement– Enforce– Modify– Maintain
• the contract set through five processes
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Five Processes of Accounting• Measuring resource inflows• Measuring resource outflows• Determination of contract performance• Information for factor markets• Common knowledge for contract renegotiation
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Measuring Resource Inflows• Vendors: At the receiving dock• Customers: cashier, accounts receivables• Labor: clock, inspection• Managers: intangible• Shareholders: shareholder accounts
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Measuring Resource Outflows
• Employees: payroll• Customers: shipping• Vendors: account payables• Government: tax accounts
• Data organized by cause-effect in double-entry bookkeeping
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Contract Performance• Compare resource inflows and outflows• Determine who has fulfilled contracts, how much• Comparative reports• Examples: • Customer account statement• Managerial accounting
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Information for Factor Markets• What resources are expected• What resources are available for disbursement• Find people who have/want them• Markets for labor, goods, and capital• Proforma financial statements, business plans and budgets by
the entrepreneur • No permanent occupants, must find replacements• Costs and benefits of occupying contractual slots
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Common Knowledge for Renegotiation• All contracts have finite terms (except shareholders)• Conditions Change• Potential for Empty as well as Serious Threats and
Bluffs• Public Disclosure and Common Knowledge• Cut Deadweight Losses to Society
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Necessary Conditions• 1) Individual Condition: Each participants expects
to receive at least the opportunity cost of contributions he/she makes to the organization
• 2) Aggregate Condition: Contributions of all participants can produce enough output to meet the expectations of all
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Income/Value of the Firm• Extensive income as the sum of:• To the shareholders• To customers• To Vendors• To employees• To creditors• To government• To community, etc.• Inducement from the firm – O.C. of contributions
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Income/Value to Investors• Residual income and corresponding
shareholder value created• Focus of current financial reports• Apply similar perspective to other
participants in the firm
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Income/Value to Customers• Customer’s “investment” in the form in the form of search,
learning, negotiation, payments, settlement of disputes• Expected PV of benefits from goods received should exceed the
PV of investments• Includes immediate transaction as well as the consequences of
the transaction for resource flows associated with any future transactions (reduction in time, cost, search etc. for later transactions)
• In a perfect product market, consumer’s surplus from the firm is zero (may be +ve from industry, and the economy)
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Value to Government• Various levels of government provide mostly non-priced
services plus some priced goods• Resources from taxation• Value of the firm to the government from providing priced
services is the same as for vendors• Value of the firm to the government from providing non-
priced services is taxes plus fees minus O.C. of resources spent on providing services
• Major challenge to put this into practice
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Value of the Firm to Community• Local, national and global• Most exchanges in form of externalities• Value of the firm to the community is
the sum of net externalities plus the net payments
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Measurement of Income/Value• J.M. Clark (1936): Three fundamental challenges
to determining the value of private enterprise– Imperfect and incomplete markets– Fundamental values not as exact as market values– Fundamental concepts should be independent of
specific institutions of exchange (generality)
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Problems in Control of Managers• At the procedural hub of the contracts• Control resources, have information• Monitor and negotiate with others• Difficult to measure their contributions• Can appropriate resources and information• Misappropriation difficult to detect• Devising a scheme to induce managers to contribute what is
expected of her
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Organizations and Accounting By Markets• Organization operate in a variety of markets• Markets vary by the degree of development, frictions,
information conditions, competition, and characteristics of resources
• Organizations vary by the markets they operate in• Accounting, like electrical system of a building, varies by the
nature of organization• We can classify organizations and their accounting on the basis of
market characteristics
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Classification by Markets• Market for managers (Hatfield, 1924))• Market for capital (Hatfield, 1924)• Market for product (Sunder, 1999)
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Classification by Product Markets• Private good producing organizations (cars,
furniture) can be denied revenue by their customers• Shareholders delegate production decisions to hired
managers motivated by residual based contracts• Driven by developed product markets
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Management Controls Again• A viable concept of control from organizations as sets
of contracts, expectations, common knowledge and culture
• An organization or group is in control when its members find it in their own best interests to behave in a manner that is expected of them by the other members of the group
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Control In Versus Control of• Control in organizations distinct from control of
organizations• Control in emphasizes
– Balance and equilibrium – Symmetry of points of view of agents
• Control of emphasizes– Manipulation, even exploitation
• Disparity in bargaining powers of agents
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Comprehensive View of Control• Rules, incentives, monitoring, enforcement to align behavior
and expectations• Consider two traders on eBay
– Buyer expects to have the appropriate goods delivered– Seller expects to be paid– When expectations of both are met, the system is in control
• The concept extends well beyond the traditional scope to employees and managers to include shareholders, customers, vendors, and others
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Traditional Locus of Control• Processes internal to the firm• Involving people who often have social relationships• In transactions governed by social relationships, shared
norms of social exchange play an important role• E-Commerce transactions strip the social context• Scope of e-commerce has expanded well-beyond the
traditional boundaries of transactional relationships
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Threats to Control• Environment of organizations changes continually (factor
and product market conditions)• A contract set which is in control today, will not be in
control tomorrow if conditions change• Left to itself, the organization will collapse because a
fixed set of contracts cannot remain in expectational equilibrium except by sheer chance
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Functions of Top Management• This function goes by many labels (long term planning, strategic
management, etc.)• It always amounts to the same thing:
– Monitor your environment– Anticipate changes in factor and product markets– Redesign contracts to be in control under the new conditions– Renegotiate contracts– Implement new contracts
• Perpetual revision of corporate plans to retain their desirability from the point of view of all participants
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Let Me Summarize• Control a key concept in management• Need an appropriate model of organizations to
study control• Help do accounting and control better• Find appropriate place for control in the intellectual
structure of the discipline of management
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Role of Accounting• Organizations as sets of contracts or alliances among
people• Agents seeking their own goals contribute resources in
exchange for inducements• Accounting helps define, implement, enforce and
modify contracts, serving a critical function in organizations
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Design of Organizations and Controls• Both designs depend on conditions prevailing in the
appropriate markets• Market for managerial labor differentiated stewardship
model from bookkeeping• Market for capital differentiated financial reporting
model from stewardship• Market for products differentiates government and not-
for-profit model from private good organizations
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Culture and Control• Culture of a group can be thought of as
expectations its members hold about the behavior of others in the group
• An organization is in control if the behavior of its members corresponds to the expectations of others
• Control is a state of expectational equilibrium
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What’s Management For• Changing environment threatens control• Top management must anticipate and deal with these threats
to control• Set of feasible corporate plans is too large to contemplate and
analyze• Due to time limitations, managers search in the neighborhood
of existing plans and settle on satisficing solutions• Simon’s boundedly rational behavior
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Finally …• Accounting enables organizations to function, serve all participants• Broad perspective on functions of accounting; accounting systems
designed for organizations functioning in different environments• Bookkeeping, managerial accounting, and auditing serve small
proprietorship, large proprietorship, and public corporations• Understanding accounting and control in public good-producing
organizations that do not have customers, only beneficiaries.
Thank [email protected]
www.som.yale.edu/faculty/sunder Theory of Accounting and Control, 1997
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