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Abstract:
We consider accounting from an evolutionary perspective. Accounting encompasses the creation of transactional records, the summarization of records in t-accounts, and the preparation of audited financial statements. Accounting's history spans at least 10,000 years dating back to the first human settlements in ancient Mesopotamia. Our focus is on the study of accounting history in three ways: providing useful thoughts experiments valuable to researchers interested in the development of modern practices, the use of historical data to test formal hypotheses about the origins of accounting practices, and the development of theories and related empirical evidence that explain accounting based on evolution and ecological rationality. Within this third area, we describe the basis for hypotheses and empirical analyses concerning six issues: (1) the emergence of recordkeeping, (2) the effect of double-entry bookkeeping on the scale and scope of economic organization, (3) the spontaneous emergence of norms of practice in accounting, (4) the impact of law, regulation, and taxation on accounting, (5) the demand for broad principles in evaluating accounting method choices, and (6) the relation between economic crises and major discontinuities in accounting practice.

Accounting, Economic History, Economic Institutions

Abstract:
We seek to characterize the evolutionary role played by the transactional record that forms the foundation of modern accounting. We hypothesize that formal recordkeeping institutionalizes memory, which along with law and other institutions (e.g., weights and measures and money) promotes the trust necessary to secure the gains from large-scale cooperation in human societies where complex exchange occurs between strangers over time. This hypothesis yields two predictions: (1) formal recordkeeping emerges as a mnemonic device when complex exchange between strangers over time becomes more common, and (2) formal recordkeeping and other exchange-supporting institutions co-evolve and feed back to facilitate extraction of further gains from exchange and the division of labor. Several aspects of ancient Mesopotamian recordkeeping are consistent with these predictions, which we believe suggests our hypothesis is plausible. We also identify opportunities for directly testing our predictions with experiments and ethnographies as well as other implications for the co-evolution of accounting, law, cognition, and language.

intertemporal trade, verifiable history, dispute resolution, cultural selection

Abstract:
Prior research concludes that financial analysts do not process public information efficiently in generating their earnings forecasts. The OLS regression-based tests used in prior studies assume implicitly that analysts face a quadratic loss function. In contrast, we argue that analysts likely face a linear loss function, and hence, try to minimize their absolute forecast errors. We conduct and compare rational expectations tests using these two alternative loss functions. We reproduce most prior findings of forecast inefficiency with OLS regressions, but find virtually no evidence of forecast inefficiency with Least Absolute Deviation regressions, where we explicitly assume a linear loss function.

economic significance, analyst rankings, conditional median, performance evaluation, conditional skewness

Abstract:
Prior research concludes that financial analysts do not process public information efficiently in generating their earnings forecasts. The OLS regression-based tests used in prior studies assume implicitly that analysts face a quadratic loss function, or that analysts minimize their squared forecast errors. In contrast, we argue that analysts face a linear loss function, or that they minimize their absolute forecast errors. We conduct and compare rational expectations tests conditioned on these two alternative loss functions. While we replicate prior findings of inefficiency with OLS regressions, we find virtually no evidence of forecast inefficiency with Least Absolute Deviation regressions, where we explicitly assume a linear loss function.

unbiased, economic significance, analyst rankings, conditional median, performance evaluation

Abstract:
Intangibles are ideas or knowledge about the natural (physical and biological) and socio-cultural worlds that enable people to better accomplish their goals, both in primitive societies and in modern economies. Intangibles include basic research and technology improvements as well as knowledge to better organize exchange and production, and over time become inextricably embedded in improved tangible assets. Accounting intangibles are legally excludable subsets of economic intangibles, which in turn are the subsets of cultural intangibles that can be used to create tradable goods or services. Because economic intangibles are cumulative, synergistic, and frequently inseparable from other tangible assets and/or economic intangibles not owned by any single entity, it is usually futile to estimate a separate accounting value for individual intangibles. However, the income that intangibles together generate provides useful inputs for equity valuation, and voluntary non-financial disclosures could be informative for this purpose.

Moka, gift exchange, patent, trademark, fair value

Abstract:
We examine whether financial analysts rationally incorporate expected inflation in their earnings forecasts for individual stocks. We find that expected inflation proxies such as lagged inflation and forecasts from the Michigan Survey of Consumers predict future earnings growth of a portfolio long in high-SUE firms and short in low-SUE firms, but analysts do not fully adjust for this relation. Analysts' earnings forecast errors can be predicted using these expected inflation proxies. We conclude that analysts' earnings forecasts are not fully efficient with respect to earnings information in inflation, and that this evidence is consistent with analysts' suffering from inflation illusion.

inflation illusion, analysts, earnings forecasts

Abstract:
We develop the hypothesis that culturally evolved accounting principles (e.g., Objectivity) have their roots in how the biologically evolved human brain evaluates the desirability of reciprocal exchange. Our analysis is communicated in two related parts. In this first essay, Part I, we provide background on the structure and evolution of the brain, the measurement of brain activity during economic decision-making using neuroscientific methods, and the brain's central role in building economic institutions. In the second essay, Part II, we describe the emergence of modern accounting principles and review the neuroscientific evidence suggesting a mapping from brain function to the principles of modern accounting. Our analysis of NeuroAccounting is important because it extends Basu and Waymire (2006) to provide a new way to scientifically view accounting, which can prove useful for evaluating the desirability of implementing new policies that run contrary to long-established accounting principles.

Accounting principles, economic exchange, neuroeconomics, primate brain

Abstract:
We develop the hypothesis that culturally evolved accounting principles are ultimately explained by their consilience with how the human brain has biologically evolved to evaluate opportunities for exchange. The primary function of accounting in evaluating exchange is providing information on the net benefits of past exchanges. Accounting's comparative advantage arises because it provides information based on reliable quantified data that is well suited to multi-period settings where reputation and trust are of first-order importance. We review evidence documented by neuroscientists that is consistent with the hypothesis that longstanding accounting principles such as Revenue Realization, Expense Matching, Objectivity, Historical Cost, Going Concern and Conservatism have distinct parallels in brain behaviors. We conclude that NeuroAccounting has important implications for how we think about accounting principles and the ultimate forces behind their emergence and persistence.

Accounting principles, economic exchange, neuroeconomics, primate brain

Abstract:
Adam Smith hypothesized that impersonal exchange was necessary for a society to develop specialized division of labor and create wealth. Douglass North and Vernon Smith argue that successful developed economies are the result of institutions. We hypothesize and provide evidence from ethnographic data that the basic accounting technology of recording transactions is associated with more extensive impersonal exchange and increased specialization in the division of labor. Our intuition is that extensive impersonal exchange requires reliable memory of trading partners’ past behavior to sustain trust and encourage reciprocity when a group expands beyond the size of traditional hunter-gatherer groups. Our findings are consistent with the hypothesis that transaction records are necessary for the emergence of complex economies as suggested by the archaeological evidence of recordkeeping in Mesopotamian societies 10,000 years ago.

Recordkeeping, accounting history, economic development and institutions

Abstract:
We experimentally demonstrate a causal link between recordkeeping and reciprocal exchange. Recordkeeping improves memory of past interactions in a complex exchange environment, which promotes reputation formation and decision coordination. Economies with recordkeeping exhibit a beneficially altered economic history where the risks of exchanging with strangers are substantially lessened. Our findings are consistent with prior assertions that complex and extensive reciprocity requires sophisticated memory to store information on past transactions. We offer fresh insights on this research by scientifically demonstrating that reciprocity can be facilitated by information storage external to the brain. This is consistent with the archaeological record, which suggests that pre-historic transaction records and the invention of writing for recordkeeping were linked to increased complexity in human interaction.

accounting, economic institutions, trust, memory, image score

Abstract:
We experimentally demonstrate a causal link between recordkeeping and reciprocal exchange. Recordkeeping improves memory of past interactions in a complex exchange environment, which promotes reputation formation and decision coordination. Economies with recordkeeping exhibit a beneficially altered economic history where the risks of exchanging with strangers are substantially lessened. Our findings are consistent with prior assertions that complex and extensive reciprocity requires sophisticated memory to store information on past transactions. We offer fresh insights on this research because we scientifically demonstrate that reciprocity can be extended by information storage external to the brain. This is consistent with the hypothesis suggested by the archaeological record that pre-historic transaction records and the invention of writing for recordkeeping facilitated increased scale and complexity in human interaction.

Reciprocity, accounting, recordkeeping

Abstract:
This paper identifies segment characteristics that made industry segment reporting more useful in equity valuation. Those characteristics are the difference in segments' growth potential, the relative size of segments, and the magnitude of correlation in segment earnings. Usefulness is measured by examining the percentage increase in R2 and the incremental coefficient of earnings in regressions of stock returns on disaggregate segment earnings relative to aggregate earnings.

Abstract:
Conservatism is interpreted to mean that accountants more frequently report current "bad news" about future cash flows in contemporaneous earnings than current "good news." Thus, earnings reported under GAAP should be more timely in reporting "bad news" about future cash flows than "good news." This paper, using the firm's stock return as a measure of news, shows that the contemporaneous association between earnings and negative returns is two to five times as large as the contemporaneous association between earnings and positive returns. It is also shown that the greater timeliness of earnings relative to cash flow measures is largely due to a greater sensitivity to concurrent negative returns. This result is consistent with accountants recording accruals conservatively. Another implication of conservatism is that negative earnings surprises are likely to be less persistent than positive earnings surprises, because earnings reports more bad news concurrently than good news, with the latter being spread over several periods. This is shown to be true empirically. It is predicted and found that earnings response coefficients are higher for positive earnings changes than for negative earnings changes, which is consistent with the market correcting for the difference in persistence in conservatively determined earnings. It is also found that the sensitivity of earnings to negative returns has more than quadrupled since 1980, while the sensitivity of earnings to negative returns has declined by two-thirds, suggesting that earnings measurement has become more conservative. Increases in accounting conservatism are found to be correlated with increases in auditor liability, but no causal inferences are drawn.

Abstract:
We examine the extent to which financial statement ratios in the pre-SEC era were associated with Moody's securities ratings. A lack of association in this unregulated era would be consistent with subsequent accounting regulation improving the informativeness of financial reporting, whereas significant associations in predicted directions would indicate a need to quantify the incremental benefit, if any, of accounting and securities regulation. Because Moody's reported ratings components in addition to the overall ratings during our time period, we are also able to explore the structure underlying overall ratings. In particular, we examine the weights given to the components in the overall rating, as well as the accounting, contractual and market variables that determine each component. Our analysis indicates that bond ratings exhibit a significant positive association between income statement (ROE) and balance sheet (Current Ratio) ratios and overall Moody's bond ratings. Additional findings suggest that income statement and balance sheet ratios link structurally to the overall rating through differing components, as predicted. ROE is positively related to Moody's bond Safety rating (a measure of fixed charge coverage) while the Current Ratio links to Moody's bond Security rating (a measure of asset backing). Moody's third bond rating component, Salability, reflects the ease with which the bond can be readily sold. As predicted, we document that accounting ratios exert less influence over Salability compared to Safety and Security. However, unlike for Safety and Security, we document a significant positive between Salability and a measure of the extent of disclosure by the firm. Several of these findings extend to Moody's ratings of preferred and common stocks.