Balancing statutory and common law approaches
At least since the introduction of federal securities laws in the U.S. some eighty years ago, attempts to regulation financial reporting have become increasingly focused on writing down the rules of accounting in ever-increasing detail. This codification or statutory approach to accounting regulation has marginalized the earlier dominance of a “common law” approach to accounting in which managers, accountants, and auditors used their best judgments to decide what to report, and how to report it. “True-and-fair” was the accounting equivalent of the “guilty-beyond-reasonable-doubt” standard still used by lay juries in courts of law to make life-and-death decisions. In pursuit of faux objectivity, accounting regulators around the world, including the U.S. and the European Union, have strayed after being persuaded that writing thousands of pages of rules by bureaucracies with monopoly power will serve us better. Nothing could be farther from the truth. Continue reading ‘Improving Financial Reporting’
I first met John Dickhaut in January 1973, when I interviewed at the University of Chicago’s Graduate School of Business as a rookie faculty candidate. I noticed his unusual combination of simultaneous playfulness and intensity. Later that fall when I joined him as a colleague, he was going through a difficult personal phase. That unusual combination kept showing up often in conversations—his light-hearted comments had a serious undercurrent, and his serious remarks covered the ideas he was have fun playing with and turning over and over in his head. I once asked him about his intensity, and he told me about his training in method acting when he hurt someone with a knife on the stage, and fortunately for us all, turned from stage to scholarship.
Continue reading ‘John Wilson Dickhaut (1942-2010)’
Attempts to improve financial reporting by adding clarity to its rules and standards through issuance of interpretations and guidance also serve to furnish a better roadmap for evasion through financial engineering. Thus, paradoxically, regulation of financial reporting becomes a victim of its own pursuit of clarity. The interplay between rules written to govern preparation and auditing of financial reports on one hand, and financial engineering of securities to manage the appearance of financial reports on the other, played a significant role in the financial crisis of the recent years. Fundamental rethinking about excessive dependence of financial reporting on written rules (to the exclusion of general acceptance and social norms) may be necessary to preserve the integrity of financial reporting in its losing struggle with financial engineering.
Continue reading ‘Paradox of Writing Clear Rules: Interplay of Financial Reporting Standards and Engineering’
Let me comment first on the relationship between financial reporting and financial engineering, and then on government accounting.
For over seven decades we have worked on the assumption that writing accounting standards improves financial reporting, ignoring financial engineers who make a living out of finding ways around the written accounting standards. It may take them less than three hours to find a way around a standard that may have taken three years for standard setters to prepare. Standards affect only those who are willing to comply with them. This interplay between financial reporting and financial engineering was a fundamental issue in the creation of the financial crisis. For example, much of the securitization of sub-prime mortgages was motivated by desire to get debt off the balance sheet. Continue reading ‘Financial Reporting and Financial Engineering’
In 1897, Indiana General Assembly was persuaded to consider Bill #246 which provided a method for squaring the circle by ruler and compass (millenniums after unsuccessful search, and 15 years after Lindemann proved it to be mathematically impossible), and effectively declaring the value of pi to be rather convenient 3.2. A physician almost succeeded in getting this bill passed by arguing that the state could collect royalties from those who may use this discovery, and was stopped only by arguments of a real mathematician who just happened to be present.
Continue reading ‘Truth by Fiat: Its Accountants’ Turn’
I was asked to venture out of my ivory tower to attend a user-preparer roundtable as an invited guest in NY yesterday on the subject of insurance contract accounting proposals issued by FASB and IASB–two boards that write accounting rules in US and internationally. Some 90 people, including CFOs of major insurance firms, analysts, and institutional investors attended. A report on the proceedings by one of the attendees this morning is appended below after my own observations and reactions.
Continue reading ‘Who Do the Accounting Standards Boards Serve?’