karim jamal, university of alberta shyam sunder, yale university second interdisciplinary accounting...

Karim Jamal, University of AlbertaShyam Sunder, Yale UniversitySecond Interdisciplinary Accounting ConferenceDeloitte in Copenhagen, DenmarkJune 23-24, 2008

U.S. securities laws induced a shift to written standards The right to write accounting standards is vested in the

SEC which has delegated it to the FASB/IASB (monopoly model)

This is not the norm in the economy at large; multiplicity of standard setting organizations is the norm

Quality and co-ordination demand for standards Compare accounting to other aspects of the economy They seem to flourish under competing standards

(including financial services) What is so special about accounting that we have (and

should have) a monopoly instead of competition? Could we have Internet services today with the ITU-T

monopoly? Could accounting get better under competing SSOs?

04/19/23 Jamal and Sunder, Public and Private Standards 2

Since the passage of U.S. federal security laws, financial reporting has had a sustained movement away from social norms towards written standards

Today, this change in the character of financial reporting is taken as a given, and hardly questioned

Most research on financial reporting standards examines them in their own domain, with little comparison to the non-accounting world

However, standards are used widely in virtually all aspects of modern economies

Seek a better understanding of financial reporting through the study of standards in the context of the extent, role, and processes of standardization in the economy at large


Government agencies (U.S. Department of Agriculture, NIST)

Professional associations (IEEE, U.S. Pharmacopeia)

Industry organizations (ATIS, American Petroleum Institute)

Other not-for-profit organizations (American Association of Blood Banks, Underwriters Laboratory)

For-profit organizations (AT&T, Linux, Microsoft)

These organizational forms may cooperate


Periodic surveys by NIST (Martino 1941, Booth 1960, Hartman 1967, Chumas 1975, Toth 1984, Toth 1991, and Toth 1996b)

Most recent edition (1996) lists in the U.S. 80 government SSOs 604 non-government SSOs Out of the 100 government and 1200 non-

government organizations invited to participate, 80 + 604 responded


Started soon after the creation of the Union Bureau of Alcohol, Tobacco and Firearms: 1789 U.S. Mint and U.S. Customs: 1792 By 1878 there were 12 government SSOs

Private sector organizations had a late start U.S. Pharmacopeia: 1820 Bureau of Shipping: 1862 American Association of Nurserymen: 1876

Figure 1 for the formation during the past 13 decades



Figure 1Formation of Private and Public Sector

Standard Setting Organizations in the U.S.

0

2

4

6

8

10

12

14

16

18

20

PriorTo

1878

1880-1889

1890-1899

1900-1909

1910-1919

1920-1929

1930-1939

1940-1949

1950-1959

1960-1969

1970-1979

1980-1989

1990-1996

Decade

Per

cen

tag

e o

f O

rgan

izat

ion

s

Private

Public

Formation of private sector SSOs peaked in the 1930s with 97 new organizations created in the New Deal era

Sustained decline since then; only 10 new private SSOs in the 1990s

Formation of government SSOs seems to follow a generational cycle with peaks in The Progressive era (1900s with Pure Foods & Drug Act 1906;

Federal Reserve Act 1913 New Deal era (1930s with securities acts, agricultural

products, occupational health and safety, housing and health and human services)

Post-Vietnam era (1970s, EPA, mining, transportation and consumer product safety, etc.)

Should we expect another peak in the 2000s (PCAOB?) Cheit (1990): Private standard setting is pro-active;

government standards are reactive


Accounting literature tends to focus on securities acts of 1933-4 as the major regulatory events for business

But securities regulation was only a small part of the broader trend of government standards listed above

In the private sector: grains, scientific testing, adhesives, air transport, plastics

and paediatrics in the 1930s construction materials, bar coding, publishing, furniture

and accounting standards in the 1970s Many activities which are standardized by the

government in the U.S. are handled in the private sector elsewhere (and vice versa)


Number of government standards rose from 39,500 in 1967 to 52,500 in 1991

1990s saw a concerted effort to reduce government in favor of private standards and reduced the former to 49,000 by 1996

For the first time, no. of private stds > no. of public stds

Rapid increase in international standards from 650 in 1967 to 10,745 by 1996

General trend in increasing private and international standards (as well as national standards in individual countries)

Accounting standards are late and small entrants to the field



1967 1984 1991 1996

Government 39,500 49,000 52,500 44,000

Private 14,000 32,000 41,500 49,000

U.S. National Standards

53,500 81,000 94,000 93,000

ISO Standards 650 5,692 8,205 10,745

Total Standards

54,150 86,692 102,205 103,745

FASB Standards 0 82 108 127

IASB Standards 0 1 4 8

#1: American Society for Testing and Materials (1898): 9,900 standards

#11: Underwriters Laboratory (1894): 780 standards

#15: American Petroleum Institute (1919): 500 standards

By comparison, FASB (1973) had 127 standards in 1996 and 159 in 2007



Rank Name Founded 1984 1991 1996

1. American Society For Testing and Materials 1898 7200 8500 9900 2. US Pharmacopeial Convention 1820 2900 4450 5000 3. Society of Automotive Engineers International 1905 4200 5100 4550 4. Aerospace Industries Association 1919 2800 3000 3000 5. Association of Official Analytical Chemists International 1884 1500 1900 2100 6. American National Standards Institute 1918 1330 1100 1500 7. Association of American Railroads 1934 1350 1350 1400 8. Electronic Industries Association 1924 480 600 1300 9. American Association of State Highway and Transit

Officials 1914

176 1100 1100 10. Cosmetics, Toiletry and Fragrance Association 1894 630 800 800 11. Underwriters Laboratory 1894 465 630 780 12. American Conference of Government Industrial

Hygienists 1938

500 700 750 13. Institute of Electrical & Electronics Engineers 1884 500 575 680 14. American Society of Mechanical Engineers 1880 550 745 600 15. American Petroleum Institute 1919 350 880 500 Total Standards Issued By Top 15 Private Standard

Setting Organizations -----

24,931 31,430 33,960 Standards Issued by Top 15 Standard Setters as a % of

Total Private Standards In The U.S. -----

78% 76% 69%

Economic rationale for standards (Sunder 1988, Krislov 1997)

Limitations of standardsGenerally applicable to all industries

including accounting Quality standards Coordination standards


Specified minima for product attributes Useful when buyer preference (and cost to seller)

are monotonic in these attributes Assure buyers of minimum quality Inform seller of the minimum level of buyer

expectations Example:

Russian milling wheat, 3, sound, merchantable, crop 2005; Test weight: min 78 kg/hl; Protein: min 12.5 pct (Dry matter N 5.7); Moisture: max 14 pct; Wet Gluten: min 24 pct; Foreign matter: max 2 pct; Grain matter: max 3 pct; Falling number: min 250 sec (Hagberg); Insect damage: max 1.5; IDK: max 85


When quality is unobservable to the buyer Danger of “Market for Lemons” (Akerlof 1970) Subject to consideration of cost, it is

advantageous for all to define and enforce minimum quality standards (letting individual producers, who so wish, to choose higher quality)

A system of grades, ratings, and certification may supplement standards

Facilitate transactions by minimizing information asymmetry between parties

Government plays an important role in quality standards although there are plenty of private quality standards also


Useful or necessary even when preferences of transacting parties are not monotonic in attributes

Example: shape of unified thread standard on a bolt or nut from ASME/ANSI

The reason for such standards is coordination A change in angle from 60 to 61 degrees is

unlikely to make the shape of threads better or worse for users or manufacturers

Intended to obtain a mutual fit among various actions or components for the sake of enhanced efficiency

There is no obvious way of ranking or grading products

More likely to be created in the private sector04/19/23 Jamal and Sunder, Public and Private Standards 17


Figure 2: Unified Thread Diagram

(Downloaded from http://en.wikipedia.org/wiki/Unified_Thread_Standard on February 25, 2006)

Pitch = 1 / TeethPerInch H = 0.866025 * P H1 = 0.541266 * P d2 = dimeter ? 1.082532 * P d1 = dimeter = 1.082532 * P D = d D1 = d1 D2 = d2

Toth (1996) data on Voluntary/mandatory Certification/audit service, and In-house/private development

We visited websites of 80 government agencies and able to access copies of standards in 64 agencies for Grading scales (pass/fail or multiple grades) Quality or coordination standards Economic, scientific, or social/health related


Marginally more likely to set quality standards Quality (61%), coordination (39%)

Quality standards agencies more likely to provide audit/certification (77%) than coordination standards agencies (28%)

Adoption of private sector input is common to both quality (72%) as well as coordination (56%) standards

Federal government policy directive to increase reliance on private sector

Same for the Canadian Standards Association, a government body that oversees standard setting



Quality Standards Co-Ordination Standards Voluntary

Standards Mandatory Standards

Voluntary Standards

Mandatory Standards

Overall

Audit 6/7 = .86 24/32 = .75 2/5 = .40 5/20 = .25 37/64 =.58 Private Standards

5/7 = .71 23/32 = .72 3/5 = .60 11/20 = .55 42/64 =.66

Set in private sectorHave some attributes of standards

often set in government Audit Input from private parties

Are accounting standards quality, coordination or a hybrid?


Disclosure standards often regarded as quality standards More disclosure better accounting

(questionable assumption beyond certain limits)

Measurement standards often regarded as coordination standards Justified by demand for consistency over time

and comparability across firms, industries, and economies

This classification is approximate at best04/19/23 Jamal and Sunder, Public and Private Standards 23

Quality of financial reporting not monotonic in the extent of detail or disclosure Excessive disclosure may inhibit transparency (Enron SPEs) Excessive transparency may not be good for small

shareholders due to contracting reasons Proprietary costs

Accounting practice does not quite fit the classification Measurement issues subject of great debates, research, audit,

restatement, and enforcement actions Much less so for disclosure issues Disclosure and measurement sometimes treated as

substitutes (disclosure as a poor cousin to measurement) Plenty of exceptions: lease and pension accounting debates What is the basis of determining “better” measurement in

accounting (and SEC’s claim of “higher quality” U.S. standards)?


What should the benchmark for overload? Number of accounting standards is small Comparison of FAS with the Internet Engineering

Task Force (IETF) standards FASB 159 vs. IETF 4,500 Complexity of language (Flesch-Kincaide index of the

number of years of schooling required to read the text: FASB 10.6 vs. IETF 8.5

Complexity by words per sentence: FASB 6.0 vs. IETF 5.5 Complexity by length (number of words in an average

standard): FASB 13,670 vs. IETF 8,800 It surprised us that by all three measures,

accounting standards are more complex than engineering

Should we look elsewhere to assess overload (costs?)



Standards

010002000300040005000

Years

Numb

er o

f St

anda

rds

I ETFFASB


02468

101214

1983-1987

1988-1992

1993-1997

1998-2002

2003-2007

Years

Gra

de L

evel

FASB

IETF


012345678

1983-1987

1988-1992

1993-1997

1998-2002

2003-2007

Years

Wor

ds P

er S

ente

nce

FASB

IETF


0

5000

10000

15000

20000

25000

30000

35000

1983-1987

1988-1992

1993-1997

1998-2002

2003-2007

FASB

IEFT

Wo

rds

Overlapping domains common in SSOs Comparison of FASB with four engineering standards

organizations (IETF, IEEE, ATIS, and ITU), see Table 4 in the paper

All have elaborate processes for initiating standards, engaging a diverse set of participants, quality control, and editorial processes Numbers: FASB has the smallest number of standards and

working groups (12 vs. 124 for IETF) Financing: FASB financed by tax and sale of publications;

others financed by membership dues and volunteers with text on the Internet

Adoption thresholds: 50%+1 for FASB and ATIS, 70% for ITU, 75% for IEEE, no formal voting in IETF (ascertains rough consensus)

IEEE has potential to be captured by a company by stacking membership and a five year sunset clause with automatic review or lapse


ITU is intergovernmental, IETF has no government participation, the other three have mixed involvement

Only FASB’s standards are backed by law, mandatory audit, IEEE has provision for obtaining voluntary compliance certification, other SSOs have none

FASB has government sanctions for non-compliance, others have none

Ball et al. (2003) and Bushman and Piotroski (2006) consider mandatory audit and enforcement necessary for proper functioning of financial reporting

But this is not the norm in the economy for even quality standards to be enforced through government sanctions

No evidence that compliance in financial reporting is any better than in fields where there is no mandatory audit or government enforcement


FASB is the only SSO which faces no competition and does not allow issuance of more than one standard for a particular issue

The other four all allow their standards to compete with the standards of other organizations, as well as compete with their own standards

IEEE and ATIS sponsor periodic “Olympic” competitions where the winner becomes a standard

IETF requires two independent practical operationalizations of a proposed standard before it can be adopted

FASB is the only SSO without routine field testing of standards prior to their adoption


Each industry in the U.S. is subject to standards set by multiple sets of government, domestic private, and international SSOs

Some have to deal with 100+ SSOs (e.g., construction) Multiplicity of SSOs is the norm in the economy One can argue that accounting also has many SSOs (FASB,

GASB, IASB, AICPA, PCAOB, SEC, state boards of accountancy, and national bodies in various parts of the world)

Attempts to set up one dominant accounting standard setter also finds echoes on some other industries

Imposition of a GAAP hierarchy is unique to accounting (no true and fair override permitted)

Accounting, law, and tax appear to be the only domains in the economy where a hierarchy of authoritative sources is specified in writing and enforced by law



Figure 4: Number of US and International Standards Organizations by Product Line (1996)

0 20 40 60 80 100 120 140

A coustics and Noise Contro lAerospace and Aviation

Agricu ltu reRefrigeration

Bu ildingBusiness, Finance , Insurance

CommunicationsComputers and IT

Concrete, Masonry, CeramicsConstruction

Consumer ProductsDefense

E ducationElectrical and Electronic Equipment

EnergyEnvironment

Facilities ManagementFood and Beverages

Genera lGovernment Officials

Heat ing and VentilationIndust rial Equipment

Instruments and Lab EquipmentMachinery

ManufacturingMaterials and Finishes

Medical and Health CareMed ical Devices, Equipment,

Office ProductsOptics, Ophtha lmic, Eye Protection

Packaging and PaperPhotography

P lumbingP ublic Health

Quality Assurance and TestingRecreation and Sports

Sa fety, Fire P rotect ion and Public Safet yS anitation

Social We lfa reTextiles and Clothing

TransportationWood and Wood Products

Indu

stry

No. of SS Os

U.S. Private

0 20 40 60

No. of SSOs

Internat ional

0 20 40

No. of S SOs

U.S. Government

ITU developed the PSTN (Public Switched Telephone Network) standard

It is a circuit switched network (which creates and maintains a circuit between two points for the duration of the event)

Over time, it was made more intelligent (ISDN) to provide new Internet services

Created and supported by ITU standards (H.323)

Billions of dollars spent to create a high quality reliable telephone network worldwide



Multimedia Applications, User Interface

Data Applications Media Control Terminal Control & Management

V.150 Modem

T.120*

T.38**

Audio Codecs G.711 G.723.1 G.729

RTCP RTP Control Protocol

H.225.0 RAS Gatekeeper

H.245 Control

H.225.0 Call Signaling

Video Codecs H.261 H.263 H.264

RTP Real Time Transport

Protocol

UDP TCP TCP*** /UDP

UDP- User Datagram Protocol TCP/ UDP

TCP UDP

IP (Internet Protocol)

Telephone services are rapidly migrating to the Internet using a packet switched network standard developed by an upstart organization of volunteers with no government support (IETF)

In contrast with circuit switched networks, packet switched networks neither create nor maintain a circuit path between terminals

Instead, the data transmitted is divided into small packets and each packet moves independently from origin to termination before being reassembled and presented to the recipient as an integrated message

Its Signaling Initiation Protocol (SIP) sets up the connection and gets out of the way and has no awareness of what happens during the event between the terminals until a BYE message is issued and the connection is terminated



Media Path (RPT)

Media Path (RPT)

Redirect Server

SIP Domain

A

SIP Domain

B

Proxy Server

SIP Phone

Registrar Server

Caller X

Caller Y

Registrar Server

Proxy Server

SIP Phone

SIP advantages: less cost, less complexity, less need for memory and processing capacity, and more scalability, extensibility, and modularity

IETF more nimble than ITU-T as a standard setting organization and doesn’t have a slow and deliberate process to seek complete consensus that ITU as a quasi government organization needs. IETF can focus more on technical elegance and less on politics

SIP based on a completely different (web-based) architecture; not just an extension of a circuit switch network

SIP has helped move the entire telephony industry towards the web. As the effect of legacy PSTN networks weakens with time, it is a fairly safe prediction that in the future all telephony will run on the web (or its future incarnation) and not on circuit switched networks


ITU-T: Good track record of international standards (framework, standard for each feature, integrated into a meta-standard)

Each additional feature needs adjustment of existing features and their standards

Complex but effective global standard setter, responded on timely basis to new technologies over many decades

PSTN widely regarded as reliable, good voice quality, minimal delay, and world wide coverage

Yet, a better alternative was available and not pursued by ITU-T (historical legacy, billions invested in existing technologies) and the industry would not have leapt to web-based architecture without competitive standards for new infrastructure (SIP) from IETF’s


IETF pursued Internet telephony as a matter of ideology (control at the terminals and users, not at a command center), content neutrality

No central control led to Skype, Google Talk, etc. Simplicity, scalability, better able to use

intelligent devices and deal with presence, mobility, P2P, and instant messaging

Many of these new services were not even envisioned when IETF pioneers conceived the alternative decentralized architecture

Is FASB/IASB the ITU-T or IETF of accounting considering cost, complexity, central command, and control type of standard setting model?


Most industries have competing SSOs which protect them from stagnation

What are the arguments that are special to accounting that justify a monopoly and to forego this advantage of competition?

FASB/IASB convergence project is justified using a coordination argument. The coordination demands in the industries (including financial) listed in Table 4 are hardly less severe and they seem to flourish without monopoly SSOs.

The argument that competition among standards will induce a race to the bottom does not seem to hold in these industries. What is so special about accounting?


Is monopoly a solution or a cause of the increasing complexity of financial reporting?

Competition in Internet telephony led to a much simpler and cheaper solution that is being adopted by millions around the world because they find it better

Government backed monopolies must be slow We have lost the concept of “generally accepted” in

accounting Competing standard setters have incentives to carve

out niches, and not necessarily pursue universal solutions

Just because the existing SSO is doing a satisfactory job does not mean that it would not get better under competition

Look at the Internet! We would not be where we are if IETF were trying to harmonize with ITU-T

What should we do in accounting?04/19/23 Jamal and Sunder, Public and Private Standards 43

[email protected]/faculty/sunder

karim jamal, university of alberta shyam sunder, yale university second interdisciplinary accounting...

Documents

government organizations

accounting standards

new private ssos

private standards4 slide

private standards3 slide

private standards7 slide

private standards6 slide

private standards2 slide