Positive Accounting Theory

2020/3/161PositiveAccountingTheory:ATenYearPerspectiveRossL.WattsandJeroldL.ZimmermanTHEACCOUNTINGREVIEWABSTRACTThispaperreviewsandcritiquesthepositiveaccountingliteraturefollowingpublicationofWattsandZimmerman(1978,1979).The1978paperhelpedgeneratethepositiveaccountingliteraturewhichoffersanexplanationofaccountingpractice,suggeststheimportanceofcontractingcosts,andhasledtothediscoveryofsomepreviouslyunknownempiricalregularities.The1979paperproducedamethodologicaldebatethathasnotbeenveryproductive.ABSTRACTThispaperattemptstoremovesomecommonmisconceptionsaboutmethodologythatsurfacedinthedebate.Italsosuggestswaystoimprovepositiveresearchinaccountingchoice.Themostimportantoftheseimprovementsistighterlinksbetweenthetheoryandtheempiricaltests.Asecondsuggestedimprovementisthedevelopmentofmodelsthatrecognizetheendogeneityamongthevariablesintheregressions.Athirdimprovementisreductioninmeasurementerrorsinboththedependentandindependentvariablesintheregressions.StructureI.EvolutionandStateofPositiveAccountingTheoryII.CriticismsofPositiveAccountingResearchIII.SummaryandConclusionsI.EvolutionandStateofPositiveAccountingTheory1.1Evolution1.2ContemporaneousPositiveAccountingTheory1.3EvidenceontheTheoryI.EvolutionandStateofPositiveAccountingTheory1.1EvolutionModernpositiveaccountingresearchbeganflourishinginthe1960swhenBallandBrown(1968),Beaver(1968).andothersintroducedempiricalfinancemethodstofinancialaccounting.Thesubsequentliteratureadoptedtheassumptionthataccountingnumberssupplyinformationforsecuritymarketinvestmentdecisionsandusedthisinformationperspectivetoinvestigatetherelationbetweenaccountingnumbersandstockprices.Theinformationperspectivehasnotprovidedhypothesestoexplainwhyentireindustriesswitchfromacceleratedtostraight-linedepreciationwithoutchangingtheirtaxdepreciationmethods.I.EvolutionandStateofPositiveAccountingTheory1.1EvolutionAnimportantreasonthattheinformationperspectivefailedtogeneratehypothesesexplainingandpredictingaccountingchoiceisthatinthefinancetheoryunderlyingtheempiricalstudies,accountingchoicepersecouldnotaffectfirmvalue.Topredictandexplainaccountingchoiceaccountingresearchershadtointroduceinformationand/ortransactionscosts.Theinitialempiricalstudiesinaccountingchoiceusedpositiveagencycostsofdebtandcompensationcontractsandpositiveinformationandlobbyingcostsinthepoliticalprocesstogeneratevalueeffectsforand,hence,hypothesesaboutaccountingchoice.Financeresearchershadintroducedcostsofdebtthatincreasewiththedebt/equityratiotoexplainhowoptimalcapitalstructurescouldvaryacrossindustries.I.EvolutionandStateofPositiveAccountingTheory1.1EvolutionTheagencycostswereofparticularinteresttoaccountantsbecauseaccountingappearedtoplayaroleinminimizingthem.Debtcontractsapparentlyaimedatreducingdysfunctionalbehavioruseaccountingnumbers.Accountingresearchersrecognizedtheimplicationsforaccountingchoiceandbeganusingtheaccountingnumbersindebtcontractstogeneratehypothesesaboutaccountingchoice.Accountingnumbersalsoareusedinmanager'scompensationcontractsanditishypothesizedthatsuchuseagainminimizesagencycosts.Thisuseofaccountingnumbersinbonusplanssuggestedthepossibilitythataccountingchoicecouldaffectwealthandsoaccountingresearchersbeganemployingthatusetoexplainaccountingchoice.I.EvolutionandStateofPositiveAccountingTheory1.1EvolutionBorrowingfromtheindustrialorganizationliteratureineconomicswhichassumespositiveinformationcostsandlobbyingcosts,accountingresearcherspostulatedthatthepoliticalprocessgeneratedcostsforfirms.Thesepoliticalcostsareafunctionofreportedprofits.Thus,incentivesarecreatedtomanagereportedaccountingnumbers.Informationandlobbyingcostsarepartofthecostsofcontractinginthepoliticalprocess.Theextentandformofthewealthtransferscreatedbythepoliticalprocess(suchasthetaxcode)areaffectedbythesecontractingcosts.I.EvolutionandStateofPositiveAccountingTheory1.1EvolutionWhiletheearlyliteratureconcentratedonusingdebtandcompensationcontractsandthepoliticalprocesstoexplainandpredictaccountingchoice,thetheoryunderlyingtheempiricalworkwasmoregeneralandhaditsfoundationinaneconomicliteratureonthetheoryofthefirm.Sincethe1970seconomistshavestrivedtodevelopatheoryofthefirmbyattemptingtoexplaintheorganizationalstructureofthefirm(e.g.,choiceofcorporateform,structureofcontracts,managementcompensation,centralization-decentralization).Theunderlyingnotionisthatcompetitionamongdifferentformsofinstitutionsleadstothesurvivalofthoseformsmostcost-effectiveinsupplyinggoodsandservices.I.EvolutionandStateofPositiveAccountingTheory1.1EvolutionItwasashortsteptosuggestthataccountingmethodsaffectthefirm'sorganizationalcostsandsotheaccountingmethodsthatsurvivearetheresultofasimilareconomicequilibrium.Accountingresearchershaverecentlyreturnedtousingthatnotionofanefficientsetofaccountingmethodstoexplainaccountingchoice.Theagencycostsassociatedwithdebtandmanagementcompensationcontractsandtheagency,information,andothercontractingcostsassociatedwiththepoliticalprocessprovidedthehypothesestestedintheearlyempiricalaccountingc