accounting leadership in practice, education and research

Accounting Leadership in Practice, Education and

ResearchShyam Sunder, Yale School of Management

Conference on Accounting LeadershipNational Taipei University and Taiwan Accounting

AssociationNovember 8, 2007

04/22/23 Sunder: Accounting Leadership 2

Leadership

I have three treasures. Guard them carefully:– The first is deep love; it makes one courageous.– The second is frugality; it makes one generous.– The third is not to try to be ahead of the world, it

makes one the leader of the world.

The Way of Lao-tzu (604 BC - 531 BC)


Opportunities for Leadership in Accounting: An Overview

• Practice• Education • Research


Leadership Challenges in Practice

• Developing social norms of accounting to balance reliance on written standards

• Restoring the role of accountant as a professional with self-discipline and responsibilities that extend beyond business

• Defending audits on the basis of professional judgments instead of written accounting and auditing standards


Developing Social Norms of Accounting

• Traditionally, financial reporting was largely a matter of social norms of society

• In recent years, financial accounting has shifted from social norms towards national standards, and then towards international standards

• In US, federal regulation of securities induced transition from norms towards written standards in accounting thought, practice, regulation, instruction, and research; same may happen in EU

• Generally accepted accounting principles—no longer a description in its plain English meaning of a generally accepted societal norm

• Capitalized: Generally Accepted Accounting Principles


Nature of Social Norms• Social norms of a group are shared (common

knowledge) expectations of its members about the behavior of others– Etiquette, dress, table manners, grammar, language,

customary law, private associations.• Objective of norms is observable behavior, not

unobservable beliefs• Norms need a broad consensus, not just

majority support• Dictionaries become respectable by attracting a

following, not by enforced authority


Balancing Norms and Standards

• Social norms maintained by internal and external sanctions

• Standards enforced by authority with power to punish

• Recent failures; wisdom of transition from norms to standards?

• Norms in professional, neighborhood, national, legal aspect of life

• What should be the balance between norms and standards in accounting?


Use of Social Norms in Various Walks of Life

• Family• Neighborhood• Professional• Legal• National


Example of an Accounting Norm• Revenue recognition• Inherently subjective• Complete specification of conditions both

unnecessary as well as infeasible• No authoritative source• Everybody is free to propose their own norm;

they may or may not be accepted• Authority derives from general acceptance by

the financial community and disapproval of deviations


Standards as Progress

• Profession now views standardization as a measure of progress (our rule book is thicker than yours!)

• Most research refers to standards with respect, if not approval

• Baxter analyzed the corrosive effect of authority on accounting profession half-a-century ago

• Those ideas were largely ignored• There has been little research and debate on merits and

consequences of shifting balance between standards and norms


Limits of Written Standards• Legal scholarship and practice is careful in

recognizing the limits of the efficacy of written rules

• When it is not possible to write a rule that will improve the state of affairs compared to a judgment-based system, the law leaves the judgment in place

• When a judge asks the jury to determine if the accused is guilty beyond reasonable doubt, lay jurors would want to know how much doubt is reasonable: ten percent, two percent, or one percent?


Norms in Law• Law does not attempt to codify answers to such

questions• People who write and practice law understand all too

well the consequences of clarifying such questions would be even less desirable than the consequences of leaving the answers to the best judgment, even of lay people

• The SEC and the U.S. Congress refuse to clarify the definition of insider trading beyond “trading on non-public information”

• Again, the consequences of clarification are even less desirable than the consequences of leaving such matters to judgment.


Clear Rules or Road Maps for Evasion

• A law or rule must strive for clarity and enforceability without being a road map for evasion– Documents for entering a country– Schedules and routes of border petrol– Bright line accounting standards (3% SPEs, etc.)

remove the uncertainty for financial engineers• Many clarifications facilitate financial fraud• Standard-writing agencies become unwitting

accomplices of evaders


Structural Weakness of a Standard Setting Body

• A permanent rule-making bureaucracy must make rules to justify its budget and existence– FASB (until recently) depended on revenues

from sale of its publications; IASB’s revenue model?

– Challenge to publish-or-perish very real– Inevitably, rulebook must get thicker over time


Incentives Created by Private Rule Making Institutions

• Existence of rule making institution encourages requests for “clarifications”– Lower resistance to client requests– General principles are questioned: Yes, it

says “Thou Shalt Not Steal,” but I only borrowed the car

– Competition among auditors makes it worse– After the change in auditors’ code of ethics,

partners rewarded for rainmaking, not their technical mastery or professional judgment


Effect of Rule Makers on Behavior of Auditors

• Pushed by clients to cite line and verse to support their positions

• Calls to FASB/IASB: the rule is not clear• Inability of FASB/IASB to respond in timely

fashion becomes basis for client to have his way• Absent rule making agency, the auditor would

have had to worry about the fair representation requirement under the security laws

• Existence of FASB/IASB as an unwitting supporter of the attitude: “if it is not proscribed, it must be OK”


Hide-and-Seek at the Wall Street

• Investment banker calls the FASB/IASB• Financial engineering to get around the rules• Reasonable body of rule might be devised to

deal with a given set of transactions• No rules can be devised when transactions are

continually redesigned to get around a slowly adapting body of rules

• Minimal changes to get over the bar• Wall Street/City of London calls to FASB/IASB

can have the character of the thief asking when you plan to be away from home


Rule-Making Monopolies

• Monopolies in US and EU deprive the economies and rule makers of the benefits of observation from experimentation with alternatives

• Difficulty of discovering efficient rules• Cost-of-capital consequences unclear• Self-serving arguments by constituents• Why deny ourselves the benefits of

information derived from competition


Has the pendulum of standardization has swung too far?

• Misunderstanding of the role of social norms in law

• Stress generated by popularity/promotion of stock and accounting-based compensation for senior managers

• Consequences of full-time private rule making agencies

• Has this shift gone too far? How do we know and decide?

• What should be the balance between norms and standards in accounting?


Accountant as a Professional

• What is a profession?• Is being an accountant a profession? If

not, should accountant change and become one?

• If yes, how can accountant be a better professional?


Professions

• A professional is one whose loyalties extend beyond self (business) interest to the discipline and customer/clients

• For example, a physician who pursued his business interests without regard to allegiance to his oath is not considered a professional


Traditional Hippocratic Oath• I swear by Apollo Physician and Asciepius and Hygieia and

Panaceia and all the gods and goddesses, making them my witnesses, that I will fulfill according to my ability and judgment this oath and this covenant:

• To hold him who has taught me this art as equal to my parents and to live my life in partnership with him, and if he is in need of money to give him a share of mine, and to regard his offspring as equal to my brothers in male lineage and to teach them this art—if they desire to learn it—without fee and covenant; to give a share of precepts and oral instruction and all the other learning to my sons and to the sons of him who has instructed me and to pupils who have signed the covenant and have taken an oath according to the medical law, but to no one else.

• I will apply dietetic measures for the benefit of the sick according to my ability and judgment; I will keep them from harm and injustice.


Traditional Hippocratic Oath (Contd.)

• I will neither give a deadly drug to anybody if asked for it, nor will I make a suggestion to this effect. Similarly I will not give to a woman an abortive remedy. In purity and holiness I will guard my life and my art.

• I will not use the knife, not even on sufferers from stone, but will withdraw in favor of such men as are engaged in this work.

• Whatever houses I may visit, I will come for the benefit of the sick, remaining free of all intentional injustice, of all mischief and in particular of sexual relations with both female and male persons, be they free or slaves.

• What I may see or hear in the course of the treatment or even outside of the treatment in regard to the life of men, which on no account one must spread abroad, I will keep to myself holding such things shameful to be spoken about.

• If I fulfill this oath and do not violate it, may it be granted to me to enjoy life and art, being honored with fame among all men for all time to come; if I transgress it and swear falsely, may the opposite of all this be my lot.


Yale 2003 Version of Hippocratic Oath

• In the tradition of Hippocrates and all the other great physicians who have come before me in the ancient field of medicine, I will fulfill, according to my ability and judgment, this pledge:

• I will be just and generous to those who have taught me this art, holding them in highest esteem, and will give guidance and instruction freely to all those who wish to follow in this path.

• I will strive to correct the knowledge that I have acquired and to extend its domain, while remembering that medicine is more than science, and that warmth, sympathy, and understanding may heal as well as the surgeon’s knife or the chemist’s drug.

• I will practice my art solely for the benefit of my patients, knowing that at times I must put their interests before my own. May I never see in my patient anything but a fellow human in pain. My goal will be to help, or at least to do no harm.

• I will remain free of all intentional injustice, practicing with integrity and honor, and will not exploit my privileged role in the lives of my patients. What is revealed to me in confidence, I will keep inviolably secret. I will use my skills to serve all in need, with openness of spirit and without bias.

• In the presence of my teachers, my family, and my friends, I make this pledge freely and upon my honor. I am ready for my vocation and now I turn unto my calling.


Accountants• Have struggled with their business and professional

motivations• Pressure of legal liabilities• Reluctance to accept responsibility for fraud detection• Accusations of conflict of interest• Reluctance to defend themselves on the basis of

professional judgment based on the reasonable amount of evidence that was available at the time

• Seeking protection of written accounting and auditing standards

• But written standards can go only so far• Beyond a certain level, they begin on encroach on

professionalism (box checking physician or lawyer?


Defending Judgment in Auditing• Defending audits on the basis of professional judgments

instead of written accounting and auditing standards• It is a difficult thing to do• There is great temptation to think that by writing rules to

follow in work, as long as accountants follow these rules, they shall be protected from liability

• This is highly defensive mode of thinking• It does not work, and worse• It de-professionalizes the accountants making them

appear to be hiding behind the rules• Government policies of the recent decades have not

helped


A Thumbnail Sketch of the Role of Government

• Ninety years of antitrust laws and enforcement

• These laws were not applied to the professions—including doctors, lawyers, accountants, and dentists

• They kept anticompetitive clauses in the “Code of Ethics” of their respective professions


Professional Codes of Ethics

• No advertising• No solicitation of competitors’ clients or

customers• No solicitation of employees of

competitors• Most professions justified such clauses in

their rules of membership on the basis that they are necessary for “professional” behavior


Economics of Restrictions on Professional Competition

• There were substantive economic arguments to justify restrictions of professional competition– Quality of professional services difficult to see– Customer/client depends on seller’s recommendation

about what he/she should buy– Professional must incur time/effort to find out what the

customer/client needs, must charge for it– Markets for professional services are prone to failure

under free competition– Market for lemons (Akerlof)—results would be even

worse than the consequences of insufficient competition


Theory Makes a Difference

• Economic arguments for deregulation• Stigler: robustness of competition paper• Answer to the “market for lemons”: the

reputation effect as a counter to the lemons phenomenon

• Focus on economic efficiency of the system


Status Quo Till 1977• This was the status quo of competition in

markets for various kinds of professional services in U.S. until the mid-seventies

• Then came a decision from the U.S. Supreme Court

• In 1977: U.S. Supreme Court ruling on Bates v. State Bar of Arizona, held that the restrictions on lawyer advertising violated the protections given free speech under the First Amendment to the US Constitution


Change in US Policy

• The Supreme Court decision led to a change in the U.S. government policy on professional competition

• Under pressure from the Department of Justice and the Federal Trade Commission, most professional associations, including the American Institute of CPAs deleted the anticompetitive provisions from their codes of ethics by the end of the seventies


Good Intentions, Bad Decisions• The intent behind this change in the government policy (and

the Supreme Court decision) had been to obtain for the public the presumed benefits of competition among professions

• The Court accepted the argument that, the risks of failure in the market for professional services are adequately counterbalanced by the tendency of the professionals to develop a reputation for the quality of services they provide

• Over time, customer and clients learn about the reputation of the professionals, as the basis of those they choose to patronize

• Reputation prevents market failure


Does Reputation Work?• In the case of doctors, at least the patient (or his

family) know, after the treatment, whether the patient got better (even survived)

• In the case of lawyers, at least the client knows, after the trial, whether the case was won or lost

• These ex post observations are reasonably prompt and have at least a proximate correlation with performance. They enable the doctors/lawyers to develop a more or less precise reputation with their patients/clients that serve as the basis of their own (and their acquaintances’ future decisions)


Generalizability to Auditors?• Unfortunately, this argument, applicable to

lawyers and doctors and many other professionals, does not work for auditors

• The auditors’ customers—the shareholders and other third parties—cannot tell, even after the fact, if the auditor provided quality services for three reasons:– The rate of audit failure is less than 1 percent– The customers never see the auditor do their work– Firm’s decisions on hiring the auditor are made by

managers who are the subject of the audit


The Fatal Flaw• Application of the reputation argument as the

justification for competition in the market for auditing was fatally flawed

• With very low failure rate, and absence of direct contact and observability by the customers, it is not possible for auditors to develop meaningful and accurate reputations with the shareholders in any reasonable length of time

• Under the pressure of free competition, the market for auditing broke down—a market for lemons


Audit Market Breakdown• Clients actively played audit firms against one

another to lower their audit fees• The amount and quality of the work done by

the auditors was not observable to the clients• Competition for audit services would not

sustain a price to make auditing self-supporting

• Auditors responded by a new business model to survive in this cut rate environment


Revised Business Model of Audit Firms

• Aggressive pricing of audit services• Cut labor-intensive substantive testing, and

replace it by cheaper analytical reviews• Use audit service as “foot in the clients’ door” to

sell consulting services• Share consulting revenue with audit partners• Use consulting revenue to pay for any additional

audit liability coverage arising from reduced substantive testing

• Reduce the pay for fresh graduates


Consulting: A Consequence, Not the Cause of Failure

• In the debate on consulting services over the past decade, they have often been portrayed as the cause of the failure of the audit market by depriving auditors of their independence

• Instead, auditors turned to consulting services to earn a living when they found that they could not do so from audit services


Large Liabilities• The strategy of de-emphasizing substantive

testing led to some spectacular audit failures, especially in the savings and loan banking industry in the mid-eighties

• Audit firms paid large court judgments or out-of-court settlements

• Drop in number and quality of students going into accounting majors

• Mid-course correction was needed to restore profitability


Number of Settlements of Claims Against Auditors

0

50

100

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300

1960-1964 1965-1969 1970-1974 1975-1979 1980-1984 1985-1989 1990-1995 Unknown

Time Period

Frequency by Time Period


Amounts of Settlements Against Auditors

Total Amount of Settlements

0

100,000,000

200,000,000

300,000,000

400,000,000

500,000,000

Year

Amou

nt o

f Set

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ents

Total


Joint and Several versus Proportional Liability

• The auditor liability had been joint and several; if other defendants could not pay, auditors had to pay their share

• A political strategy to change the law to proportional liability

• Financing of elections as the lawyers and doctors had done for many years to advance their interests

• Payoff: Private Securities Litigation Reform Act, 1995


Accountants’ Contributions to Political Campaigns


1995 Legislation• For auditors: switch from joint and several to

proportional liability– Reduced and less uncertain liability

• For corporate management: forward looking statements under safe harbor rule– Freedom to issue unverified (unverifiable) information

in financial statements as long as it was marked forward looking

• The only instance during Clinton’s eight year presidency when his veto was overturned by the Congress (election financing)


New Business Model• The 1995 legislation, with a 1994 Court ruling exempting

advisors from liability for aiding and abetting securities fraud, implemented a new business model for auditors– Key elements: intense competition, low audit fees to get in, fast

growing high margin consulting business for profits• Audits discarded in favor of “assurance services”• Audit partners pressured to sell consulting services

– Many old time auditors quit, instead of selling consulting• Internal reorganization of power and responsibilities

– E.g., Arthur Andersen transferred the final authority on accounting matters from headquarters specialists to the local partners


The Happy Days End• In 1999, the Securities and Exchange Commission saw the

adverse consequences, but wrongly identified consulting services as the culprit, and tried to stop consulting

• Audit industry beat back the effort with political help from the Congress (settled for disclosure of consulting fees)

• Extensive failures of corporate audits are the results of this 25-year chain of events

• Auditors became the perpetrators, the short term beneficiaries and ultimately the victims of the dot-com bubble

• The well meaning government policy to encourage competition in the industry pushed it to collapse


Perspective on Events of 2002• We can choose to view the events of 2002 as

bad behavior by some individual managers, auditors, directors, lawyers, investment bankers, bankers, politicians, etc.

• Or we can see them as a chain a related events, arising from bad policy

• We pushed competition into a market that is not able to sustain competition because of ex ante or ex post unobservability of the quality of service provided


Professional Leadership

• Restoring the role of accountant as a professional with self-discipline and responsibilities that extend beyond business

• Leadership requires us to reconsider how accountants can remain a profession, and not get reduced to a trade


Leadership Challenges in Education

• What we teach in accounting classes• Who is attracted to accounting classes• Building PhD programs as seed farms for

the future• Place of accounting programs in the

university


What We Teach

• Most, if not all, aspects of accounting have come to be dominated by standard writers– Financial reporting– Auditing– Even education (there is something called

International Accounting Education Standards Board)

• What do we (and what should we) do in our classes?


Teach Students to Think?• Present them with various scenarios and transactions

(cases)• Ask them how they think each such case should be

accounted for so as to achieve “true and fair” financial reports

• Consider and discuss the merits and weaknesses of each proposed method to help students develop their own refined judgment about how to prepare true and fair financial reports

• Help them develop a sense of professional norms of what is right and what is wrong

• Have our students leave the class with ability to back up their judgments with economic, financial, organizational and legal reasoning


Or, Teach the Rules?• Open the rule books• Teach the rules of financial reporting and

auditing• Teach them how to conform to rules so they

would not get into “troule”• One right answer to each question (to be found

in the rulebooks)• Avoid professional judgment at all costs• There are plenty of textbooks which do just that;

they compete on the basis of which edition has the latest rules issued by the authority


Who Will be Attracted to these Two Types of Accounting Classes?

• The first kind of accounting class will be attractive to those who like to think for themselves, sharpen their judgment, are willing to exert the effort to explore and understand the economic, financial, organizational and legal consequences of what they do, and apply judgment to difficult circumstances

• The second kind of class will be attractive to those who view accounting as a trade in which rote memorization of rules is the primary necessary skill

• Look at the street image of accounting and accountants and ask: what kind of people do we think we are attracting to accounting classes, and why?

• Should we the educators look at ourselves for leadership?


Quality and Number of Accounting PhD Programs

• Shortage of high caliber students willing to PhD is a problem across disciplines and countries

• Economically, it is a public good problem that requires public financing; it is expensive and does not confer direct benefits on universities who educate PhDs

• In accounting the problem is especially acute• Opportunity costs of accountants are relatively high• What kind of person is attracted to teach each of the two

kinds of accounting classes?• The street image of accounting as a trade discourages

talented students from thinking of accounting as a subject of scholarly pursuit


Accounting in University• Universities devote themselves to education and

advancement of knowledge• Many skills important to society are not

considered suitable for inclusion in university curriculum (plumbing, bricklaying, real estate sales, etc.)

• Where does accounting stand in university curriculum and why?

• How long can accounting retain its place in university as it is standardized?


Leadership Challenges in Research

• Innovation• Policy• Faculty Evaluation• International and National Journals


Innovation• Imagination, creativity, and innovation is the essence of

research• How many new ideas did we generate in accounting

research journals last year?• For some reason, the number of new ideas in accounting

research has fallen to a low level• Of course, method is important, and research has to be

properly done to be of any value, but there is no substitute for innovation in accounting research

• Academic leadership in research consists of innovation


Policy• For more than three decades, policy research in

accounting seems to have fallen out of favor• Returning to the parallel with medicine,

abandoning policy research is like abandoning research on finding a treatment for diabetes in favor of only studying who gets diabetes and why

• Of course the study of such questions is a prerequisite to finding a cure

• But no learned profession can stop at the natural or social science level, without risking its scholarly status


Faculty Evaluation

• Teaching-Research-Service formula has considerable following in B-schools

• Does this practice yield good teaching, research, and service in a desirable combination

• What are the problems associated with current practice

• What could be the alternatives?• Where do we go from here?


Another Example• Record of teaching success and productive scholarship

supported by substantial publication • Evidence of recognition by peers.• Evaluation of teaching effectiveness before scholarship

and professional service• Evaluation of record of publications, by outsiders if

necessary• Materials prepared to aid classroom teaching • Administrative and other professional services to the

University• External service (professional organizations and

community, state, and federal agencies): judgment about the educational or scholarly value of the services rendered


What We Want in Research

• Creativity, innovation and thought leadership

• Driven by curiosity about the world: How things work and why they don’t?

• Contribution to society: how they might be made to work better

• Explore new frontiers whose value and consequences may not be known for some (long?) time


How Do We Promote Research?

• Research scores weighted by journal ratings (objective?)– Citation counts– Download counts

• Criticality of external letters of review (local vs. selection bias?)

• Immediacy of assessment (power to editors and referees)


What Do We Get in Research?

• Maximization of publication counts• Journal ratings replace reading of

research• Dominance of method over substance• Citation networks


Holy Cows of Faculty Evaluation

• Judgment vs. objective measurement• History of misuse of judgment• Individual merit vs. social justice• Time horizon of evaluation and decision

– Shorter time horizon enables quick corrections of errors

– Is more error prone


International and National Journals

• Publishing in international journals: blessing or curse of scholarship?

• Many universities around the world encourage, even require, their faculty to publish their research in international journals

• It helps maintain the “high standards” of research

• It carries a stamp of unbiased distant authority behind controversial promotion and tenure decisions


Cost of the Policy• Immense costs of “publish international” policy• Talent diverted away for addressing problems of society• Wastage of scarce financial resources• Under-development of organic research cultures

– Critical thinking and discussion– Separation of scholarly critique and personal relationships– Local journals– Diversity of thought and methods– Editing and reviewing skills

• End up with research for the sake of research, instead of research for the sake of innovation


Summary• Accounting deserves and needs leadership in

– Practice (developing social norms to balance reliance on written standards, professional self-discipline)

– Education (what we teach, who is attracted to our classes, seed farms of knowledge, and place of accounting in the university)

– Research (innovation, policy research, faculty evaluation, and developing local journals and research cultures)

• I am privileged to have had this chance to discuss these challenges for accounting leadership that lie before us

• How we tackle each of these challenges will determine the future of accounting

Thank you

www.som.yale.edu/faculty/[email protected]

http://www.som.yale.edu/faculty/sunder

http://www.som.yale.edu/faculty/sunder

accounting leadership in practice, education and research

Documents

written accounting

financial accounting

accounting leadershipexample

accounting thought

accounting leadershipstandards

accounting principlesno

objective of norms

standardssocial norms