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Abstract:
Prediction markets are markets for contracts that yield payments based on the outcome of an uncertain future event, such as a presidential election. Using these markets as forecasting tools could substantially improve decision making in the private and public sectors.

We argue that U.S. regulators should lower barriers to the creation and design of prediction markets by creating a safe harbor for certain types of small stakes markets. We believe our proposed change has the potential to stimulate innovation in the design and use of prediction markets throughout the economy, and in the process to provide information that will benefit the private sector and government alike.

prediction markets, public policy, forecasting, regulation

Abstract:
Failures in corporate governance of many major US corporations in 2002 suggest that it may be useful to fundamentally rethink the structure of institutions of accounting, auditing, corporate governance and executive compensation. Replacement of the system of authoritative standards by a competitive, common law approach to accounting principles and rules may help shift the focus of financial reporting from form to substance. Following some key Supreme Court rulings, the quality of auditing declined under the governmental push to increase competition in that industry beginning with the late seventies, pushing audit firms to peddle consulting services to their clients for economic survival. Restoring the high quality of audit may require radical reorganization of the audit function, such as bundling it with insurance. The protection of minority interest by the board of directors and the control of runaway executive compensation are two other problems whose solution may require structural, not just procedural, changes.

Abstract:
Failures in corporate governance of many major US corporations in 2002 suggest that it may be useful to fundamentally rethink the structure of institutions of accounting, auditing, corporate governance and executive compensation. Replacement of the system of authoritative standards by a competitive, common law approach to accounting principles and rules may help shift the focus of financial reporting from form to substance. Following some key Supreme Court rulings, the quality of auditing declined under the governmental push to increase competition in that industry beginning with the late seventies, pushing audit firms to peddle consulting services to their clients for economic survival. Restoring the high quality of audit may require radical reorganization of the audit function, such as bundling it with insurance. The protection of minority interest by the board of directors and the control of runaway executive compensation are two other problems whose solution may require structural, not just procedural, changes.

Accounting, Auditing, Regulation, Institutional Reform

Abstract:
The concept of common knowledge concerning higher orders of knowledge has seen exciting new developments in the fields of philosophy, game theory, statistics, economics and cognitive science in the recent decades. Even though information lies at the heart of accounting and capital markets research, these new developments have remained at the periphery of these fields. Common knowledge thinking may significantly advance our understanding of financial reporting, analysis, securities valuation, managerial control, auditing and information systems. Such accounting and business applications will also make important contributions in the form of concrete, real-life examples and applications to the basic fields where the idea of common knowledge originated. This paper is an overview of common knowledge and its actual and potential applications to accounting and capital markets research.

Common Knowledge, Accounting, Capital Markets, Beliefs About Others' Beliefs

Abstract:
The concept of common knowledge concerning higher orders of knowledge has seen exciting new developments in the fields of philosophy, game theory, statistics, economics and cognitive science in the recent decades. Even though information lies at the heart of accounting and capital markets research, these new developments have had only a faint echo in these fields. Common knowledge thinking may significantly advance our understanding of financial reporting, analysis, securities valuation, managerial control, auditing and information systems. Such accounting and business applications will also make important contributions in the form of concrete real life examples and applications to the basic fields where the idea of common knowledge originated. This paper is an overview of common knowledge and its actual and potential applications to accounting and capital markets research.

Common Knowledge, Accounting, Capital Markets, Beliefs About Others' Beliefs

Abstract:
Growth of online auctions and other forms of e-commerce has been hampered by concerns about the privacy, integrity, and security of online transactions. To earn the trust of their participants, new e-commerce organizations, like traditional organizations, have to reach the state of expectations equilibrium or control - a state where the actual behavior of participants corresponds to what others expect them to do. Since e-commerce companies provide electronic platforms where buyers and sellers interact directly with each other (as well as with the platform operator), establishing control in e-commerce enterprises requires broadening of the traditional definition of "internal control" to encompass the activities of "outsiders" such as customers, and suppliers.

This paper presents a framework for analyzing the control environment of online auctions and identifies privacy and denial of service attacks as two new classes of risks faced by e-commerce companies. Using the control policies and practices of a leading consumer online auction company (eBay) as an illustrative example, we suggest possible ways of controlling these risks. This analysis identifies the demand for new kinds of assurance services for e-commerce to support privacy, integrity and security of online transactions. E-commerce assurance services available at the end of year 2000 (e.g. WebTrust) fall short of what is needed to establish expectations equilibrium or control in online auction firms. The merits of developing proprietary (e.g., PWC privacy standards) versus industry standards (e.g. WebTrust) for e-commerce assurance services are also discussed.

E-commerce, Online auctions, Control, Assurance, Privacy, Integrity, Security

Abstract:
This paper discusses arguments for and against introducing competition into the accounting standard-setting process in the U.S. by allowing individual corporations to issue financial reports prepared in accordance with either FASB or IASB rules. The paper examines several arguments supporting the status quo, including (1) the FASB's experience and world leadership in making accounting rules; (2) the increased risk of a "race to the bottom" under regulatory competition; (3) the inability of most users of financial reports to understand the complex technical issues underlying accounting standards; (4) the possibility that IASB's standards will be diluted to gain international acceptance, allowing additional opportunities for earnings management; (5) the risks of the IASB being deadlocked or captured by interests hostile to business; (6) the costs of experimentation in standard-setting; and (7) economies from network externalities. Arguments examined on the other side include how competition will (1) help meet the needs of globalized businesses; (2) increase the likelihood that the accounting standards will be efficient; (3) help protect standard-setters from undue pressure from interest groups; (4) allow different standards to develop for different corporate clienteles; (5) allow corporations to send more informative signals by their choice of accounting standards; (6) protect corporations against capture of regulatory body by narrow interests; and (7) not affect network externalities at national or global scales.

Accounting standards; Regulatory competition; International

Abstract:
This paper articulates the arguments for and against introducing competition into the accounting standard-setting process in the U.S. by allowing individual corporations to issue financial reports prepared in accordance with either FASB or IASB rules. The paper examines several arguments supporting the status quo, including (1) the FASB's experience and world leadership in making accounting rules, (2) the increased risk of a "race to the bottom" under regulatory competition, (3) the inability of most users of financial reports to understand the complex technical issues underlying accounting standards, (4) the possibility that IASB's standards will be diluted to gain international acceptance, allowing additional opportunities for earnings management, (5) the risks of the IASB being deadlocked or captured by interests hostile to business, (6) the costs of experimentation in standard-setting, and (7) economies from network externalities. Argument examined on the other side include how competition will (1) help meet the needs of globalized businesses, (2) increase the likelihood that the accounting standards will be efficient, (3) help protect standard-setters from undue pressure from interest groups, (4) allow different standards to develop for different corporate clienteles, (5) allow corporations to send more informative signals through their choice among accounting standards, (6) protect corporations against capture of regulatory body by narrow interests, and (7) not affect network externalities at national or global scales.

Accounting Standards, Regulatory Competition, International

Abstract:
We report on a panel discussion at the 2001 CMU Accounting Mini-conference under the title "Intellectual Foundations of Accounting." We provide a background and the motivation for the discussion and present the remarks by the four panelists. A number of perspectives are taken. Sunder emphasizes dualities in accounting. Demski stresses the endogeneity of accounting measurement activities. Fellingham examines the core and superstructure of accounting. Ijiri observes the microcosmos in accounting and its philosophical connection. We also argue that accounting's intellectual foundations are far from settled and an on-going discussion is likely to help reinvigorate accounting scholarship.

intellectual foundations, accounting

Abstract:
We report on a panel discussion at the 2001 CMU Accounting Mini-conference under the title "Intellectual Foundations of Accounting." We provide a background and the motivation for the discussion and present the remarks by the four panelists. A number of perspectives are taken. Sunder emphasizes dualities in accounting. Demski stresses the endogeneity of accounting measurement activities. Fellingham examines the core and superstructure of accounting. Ijiri observes the microcosmos in accounting and its philosophical connection. We also argue that accounting's intellectual foundations are far from settled and an on-going discussion is likely to help reinvigorate accounting scholarship.

intellectual foundations, accounting

Abstract:
Control in organizations can be defined as expectational equilibrium, or correspondence between how the members of an organization behave and how others expect them to behave. Using a contract model of organizations as the base, we use human expectations, common knowledge, and culture to propose a theory of control. Changes in factor and product market conditions tend to disrupt control in organizations. Strategic management consists of continual monitoring and anticipation of market conditions, and redesign, negotiation, and implementation of contracts to restore and maintain the expectational equilibrium.

Management Control, Expectations, Common Knowledge, Culture, Organization

Abstract:
Control in organizations can be defined as expectational equilibrium, or correspondence between how the members of an organization behave, and how they are expected to behave by others. Using contract model of organizations as the base, we build a theory of control with the help of human expectations, common knowledge, and culture. Changes in factor and product market conditions tend to disrupt control in organizations. Strategic management consists of continual monitoring of the market conditions, and redesign of contracts, to restore and maintain the expectational equilibrium.

Management Control, Expectations, Common Knowledge, Culture, Organization

Abstract:
The push for increased transparency in financial reporting and corporate governance serves shareholders only up to a point. The problem of assessing the value of transparency to shareholders is subtle because both the level and pattern of earnings can convey information. Even when earnings management conceals information, it can be beneficial to shareholders. Distinguishing between "ex ante" and "ex post" efficiency underscores the advantages of achieving a balance between transparency and privacy in corporations.

Earnings Management

Abstract:
The push for increased transparency in financial reporting and corporate governance serves shareholders only up to a limit. The problem of assessing the value of transparency to shareholders is subtle because both the level and pattern of earnings can convey information. Even when earnings management conceals information, it can be beneficial to shareholders. Distinguishing between ex ante and ex post efficiency underscores the advantages of achieving a balance between transparency and privacy in corporations.

Earnings Management

Abstract:
We experimentally explore how investor decision horizons influence the formation of stock prices. We find that in long-horizon sessions, where investors collect dividends till maturity, prices converge to the fundamental levels derived from dividends through backward induction. In short-horizon sessions, where investors exit the market by receiving the price (not dividends), prices levels and paths become indeterminate and lose dividend anchors; investors tend to form their expectations of future prices by forward, not backward, induction. These laboratory results suggest that investors' short horizons and the consequent difficulty of backward induction are important contributors to the emergence of price bubbles.

stock price bubbles, short-term investors, backward induction, market experiments

Abstract:
Most financial reporting jurisdictions across the world allow a local monopoly in financial reporting standards for publicly held corporations. In the U.S., for example, the statutory authority over these standards is vested in the Securities and Exchange Commission (SEC), who delegates the task of writing standards to the Financial Accounting Standards Board, retaining an oversight function for itself. In some countries these standards are specified through statutes in varying levels of detail. Few countries permit their corporations to choose among two or more sets of competing standards; monopoly is the reigning norm.

This paper examines regulatory competition as a model for writing and implementing corporate financial standards. Under this model, two or more approved standard setting bodies are allowed to compete for the allegiance of the reporting entities. Each corporation can choose which of the two or more sets of competing standards it wishes to use in preparing its financial reports. Corporations must choose an entire set of standards in toto, and clearly mark the reports with the set of standards used to prepare them. We examine the consequences of such regulatory competition for the quality and efficiency of standards, quality of information provided to shareholders and other interested parties, and the efficiency of corporate governance and managerial actions. A debate on the merits of monopoly versus competitive standards may help direct the formation of national and international regimes for setting accounting standards.

Accounting Standards, Regulatory Competition, International

Abstract:
In the neoclassical model of the firm, value surplus of the firm is assumed to accrue to its owner. Contract model suggests a distribution of the surplus among various agents depending on the imperfections of the markets in which they transact with the firm. If the share of the surplus to an agent declines with the perfection of the market in which he transacts, shareholders should be expected to get only a small piece of the pie, violating the neoclassical assumption. The paper explores an extensive value concept and its measurement for firms. It also examines the implications of extensive value for what we do and do not know about the consequences of corporate mergers and acquisitions.

Factor Income Distribution, Extensive Value, Surplus

Abstract:
Many accounting textbooks state that the opportunity cost of idle fixed assets is zero. A few exceptions refer to repair, overhaul, employee vacation and congestion, giving rise to positive opportunity cost. We show that in important and frequently encountered situations, idled assets have positive opportunity cost arising from extension of their useful life. We also present a simple framework to help managers identify such situations and correctly assess opportunity cost.

Abstract:
Many accounting textbooks state that the opportunity cost of idle fixed assets is zero. A few exceptions may refer to factors such as repair and overhaul, employee vacation and congestion that give rise to strictly positive opportunity cost. We show that in important and frequently encountered situations, idled assets have positive opportunity cost arising from extension of their useful life. We also present a simple framework to help managers identify such situations and correctly assess opportunity costs.

Opportunity Cost, Resource Management, Time-Based Costing, Resource Granularity, Decision-Making

Abstract:
The Securities and Exchange Commission (SEC) recently issued a call for comment on a proposal to accept financial statements prepared in accordance with international financial reporting standards (IFRS) without reconciliation to U.S. GAAP. Accounting researchers have attempted to assess the quality of IFRS using different methods and criteria. While we are skeptical of drawing direct conclusions about the SEC's proposal based on this research, there is adequate evidence that both IFRS and U.S. GAAP provide useful information to investors and other users of financial statements. Moreover, we see no conclusive research evidence that financial reports prepared using U.S. GAAP are better than reports prepared using IFRS. The prudent approach when faced with alternatives with no clear difference in quality is to promote competition among them, which supports adopting the SEC's proposal to permit foreign private issuers a choice between IFRS and U.S. GAAP. Therefore, to help improve U.S. and international GAAP through standards-setting competition, we recommend that the Commission also consider extending the choice of IFRS to U.S. companies, and require all companies to indicate clearly whether they are filing under U.S. GAAP or IFRS. Finally, we recommend that the Commission and its staff investigate and seek feedback on the educational consequences of its proposed actions. This attention will help educators better prepare future professionals to implement these proposed regulatory changes.

Financial Reporting, U.S. GAAP, IFRS, SEC, Reconciliation

Abstract:
Concern about privacy, integrity, and security of online transactions hampers absorption of e-commerce technologies as a normal way of doing business. To gain acceptance and trust of their participants, all organizations much achieve control or expectations equilibrium - a state where participants choose to do what others expect of them. Establishing control in e-commerce requires us to expand the traditional view of internal control to encompass the activities of customers, suppliers, and other "outside" users of their electronic platforms. We present a framework for analyzing control in online auctions. Privacy, authentication, and denial-of-service attacks are three classes of risk especially prevalent in e-commerce. Using the control practices of eBay as an illustrative example, we suggest possible ways of controlling these risks. Privacy, integrity, and security of online transactions demand new types of assurance services in e-commerce. We analyze assurance services available in 2002 and discuss challenges and opportunities facing existing services such as WebTrust. The merits of developing proprietary versus industry standards, and simple operational vertification of client-specific policies for e-commerce assurance services are also discussed.

Abstract:
Government regulation of financial reporting by publicly listed firms, coupled with a punitive regime for violation of generally accepted accounting principles (GAAP), has been in place in the United States for seven decades. Whether this regime is effective or useful is an open question, especially in the absence of data on the behavior of unregulated economies. Privacy disclosure in e-commerce is essentially an unregulated environment with some parallels to financial disclosure. A study of privacy standards, disclosures practices and demand for audits can help accountants and security regulators project the consequences of a competitive regime sans regulation for accounting standards, disclosure and audit practices, and the effectiveness of opt-out practices of 100 high-traffic e-commerce Web sites. We observe four diverse sets of privacy standards (TRUSTe, BBB Online, WebTrust, and PWC Privacy) competing in this market, attracting clienteles of their own as reflected in privacy policies and the disclosure of such policies. With a few exceptions, actual disclosure and opt-out practices correspond reasonably well to stated policies in e-commerce. There is little evidence that the prevailing competitive regime induces a race to the bottom with respect to privacy standards and disclosures. We explore the implications of these results for the consequences of a competitive regime for regulation of financial reporting.

e-commerce, Privacy, Regulatory Competition, Financial Reporting Standards

Abstract:
Government regulation of financial reporting by publicly listed firms, coupled with a punitive regime for violation of Generally Accepted Accounting Principles (GAAP) has been in place in the United States for seven decades. Whether this regime is effective or useful is an open question, especially in the absence of data on the behavior of unregulated economies. Privacy disclosure in e-commerce is essentially an unregulated environment with some parallels to financial disclosure. A study of privacy standards, disclosures practices and demand for audits can help accountants and security regulators project the consequences of a competitive regime sans regulation for accounting standards, disclosure and audit practices.

In this paper we set up a framework for such a study, gather data from the field, and analyze privacy standards, privacy disclosure practices, and the effectiveness of opt-out practices of one hundred high traffic e-commerce websites. We observe four diverse sets of privacy standards (Truste, BBB Online, WebTrust and PWC Privacy) competing in this market, attracting clienteles of their own as reflected in privacy policies and the disclosure of such policies. With a few exceptions, actual disclosure and opt-out practices correspond reasonably well to stated policies in e-commerce. There is little evidence that the prevailing competitive regime induces a race to the bottom with respect to privacy standards and disclosures. We explore the implications of these results for the consequences of a competitive regime for regulation of financial reporting.

E-commerce, Privacy, Regulatory Competition, Reporting Standards

Abstract:
Historically, norms of accounting played an important role in corporate financial reporting. Starting with the federal regulation of securities, accounting norms have been progressively replaced by written standards. While social norms are maintained through an informal process of social as well as internal sanctions, standards require more formal enforcement mechanisms, often supported by implicit or explicit power of the state to impose punishment. The spate of accounting and auditing failures of the recent years raise questions about the wisdom of this transition from norms to standards. Many aspects of family, local, professional, social, national and international behaviors continue to be governed by mechanisms in which norms play an important role. It is possible that the pendulum of standardization in accounting may have swung too far, and it may be time to allow for a greater role for social norms in the practice of corporate financial reporting.

Accounting standards, social norms, enforcement, financial reporting

Abstract:
Historically, norms of accounting played an important role in corporate financial reporting. Starting with the federal regulation of securities, accounting norms have been progressively replaced by written standards. While social norms are maintained through an informal process of social as well as international sanctions, standards require more formal enforcement mechanisms, often supported by implicit or explicit power of the state to impose punishment. The spate of accounting and auditing failures of the recent years raise questions about the wisdom of this transition from norms to standards. Many aspects of family, local, professional, social, national and international behaviors continue to be governed by mechanisms in which norms play an important role. It is possible that the pendulum of standardization in accounting may have swung too far, and it may be time to allow for a greater role for social norms in the practice of corporate financial reporting.

Abstract:
Business firms as well as each of their subunits can be thought of as a set of contracts in which participating agents seek their own goals. Participants contribute resources, expecting to receive in exchange more than the opportunity cost of their contributions. For this system to work, the expectations of each individual must be in balance with what he/she is expected to contribute. In addition, the production technology of the firm must be capable of fulfilling such expectations in aggregate. Changes in factor and product markets continually alter the expectations and actions of individuals, nudge them out of balance, and threaten the feasibility of the contract set. A strategic manager scans the relevant markets for incipient changes in environment, and redesigns and implements new contracts which balance the self-interest of individuals with their changing expectations. Redesign and renegotiation of contracts is complicated because people protect their self-interest. Many firms collapse when the managers fail to recognize and act upon the changes in business environment in a timely fashion. Some redesign efforts fail because managers do not elicit the cooperation of those who have the necessary knowledge and expertise and expect to be adversely affected by the proposed changes. The contract model of the firm provides a framework and perspective to reduce such failures.

Contract Theory of the firm, Strategic management, reengineering, organizations

Abstract:
We present data on privacy practices in e-commerce under the European Union's (EU's) formal regulatory regime prevailing in the United Kingdom (U.K.), and compare it to the data from a previous study of United States (U.S.) practices that evolved in the absence of government laws or enforcement. The codification by the EU law, and the enforcement by the U.K. government, improves neither the disclosure nor the practice of e-commerce privacy relative to the U.S. Regulation in the U.K. also appears to stifle development of a market for web assurance services. Both U.S. and U.K. consumers continue to be vulnerable to a small number of e-commerce websites who spam their customers, ignoring the latter's expressed or implied preferences. These results raise important questions about finding a balance between enforced standards and conventions in the domain of financial reporting. In the second half of the twentieth century, financial reporting has been characterized by a preference for legislated standards, and a lack of faith in its evolution as a body of social conventions. Evidence on whether this faith in standards over conventions is justified remains to be marshaled.

e-commerce, privacy, regulatory competition, and financial reporting standards

Abstract:
Conventions as well as standards influence the practice of financial reporting. Reporting standards arise as legislated rules, enforced by the power of law. Conventions evolve over time through trial and practice, and are upheld by socioeconomic rewards and sanctions. Financial reporting in the second half of the twentieth century has been characterized by a preference for legislated standards, and a lack of faith in its evolution as a body of social conventions. Evidence on whether this faith in standards over conventions is justified remains to be marshaled. We present data on privacy practices in e-commerce under the European Union's (EU's) formal regulatory regime prevailing in the United Kingdom (U.K.), and compare it to the data from a previous study of United States (U.S.) practices that evolved in the absence of government laws or enforcement. The codification by the EU law, and the enforcement by the U.K. government, improves neither the disclosure nor the practice of e-commerce privacy relative to the U.S. Regulation in the U.K. also appears to stifle development of a market for web assurance services. Both U.S. and U.K. consumers continue to be vulnerable to a small number of e-commerce websites who spam their customers, ignoring the latter's expressed or implied preferences. These results are germane to the rules versus principles debate in accounting, and raise important questions about finding a balance between enforced standards and conventions in the domain of financial reporting.

e-commerce, privacy, regulatory competition, and financial reporting standards

Abstract:
Accounting practices differ across geographic and political boundaries, across sectors of the economy within these boundaries, and across types of organizations. Globalization exerts a homogenizing force across the political and jurisdictional boundaries with mixed consequences. Development of markets for various factors of production exerts a similar integrative force across sectors of the economy, including the business, government and not-for-profit (NFP) sectors. In this paper is an overview of the sources, consequences, and limits of these forces as they relate to accounting.

Factor Markets, Accounting, Globalization

Abstract:
Accounting practices differ across geographic and political boundaries, across sectors of the economy within these boundaries, and across types of organizations. Globalization exerts a homegenizing force across the political and jurisdictional boundaries with mixed consequences. The development of markets for various factors of production exerts a similar integrative force across sectors of the economy, including business, government and not-for-profit (NFP) sectors. This paper presents an overview of the sources, consequences, and limits of these forces as they relate to accounting.

Factor Markets, Accounting, Globalization

Abstract:
The past decade has seen many changes in audit liability regimes of the US and the UK, and more may be on the way. These include LLP status for audit firms, proportional liability, and the introduction of various forms of liability caps through contract in engagement letters. These changes may affect audit quality, price and profitability, the organization of the market for audit services, as well as domestic and cross-national mechanisms for regulation of this market. What have been, or will be the consequences of these changes? Will the auditors, who advocate many of these reforms, benefit from them? Will the investors, who advocate other reforms, benefit from them? Answers to these questions are relevant to policy decisions at hand. We analyze the recent changes and the proposals for future changes on the basis of available research on the market for audit services, including some studies commissioned by regulators. We find it difficult to establish a correspondence between the self-interest of the advocates of various changes and the observed and anticipated effects of such changes. More evidence is needed to inform the debate in the corridors of power. Such evidence could be obtained by requiring audit firms to publish information about their true litigation costs. Moreover, the regulatory process might benefit from somewhat greater reliance on market forces.

Auditor liability, U.K. and U.S. comparison, International accounting

Abstract:
A broad consensus in accounting favors principles over rules to guide creation of a uniform high quality set of standards for use everywhere, and granting monopoly power to a single body for this purpose. If implemented into policy, this consensus will discourage discovery of and evolution toward better methods of financial reporting, make it difficult to conduct comparative studies of the consequences of using alternative methods of accounting, promote substitution of analysis and thinking by rote learning in accounting classes, help discourage talented youth from collegiate programs in accounting, and probably endanger the place of accounting discipline in university curricula. Because the presumed benefits in the form of increased comparability of financial reports internationally or stateside are unlikely to be realized, the wisdom of undertaking these burdens remains questionable. The paper calls for a reexamination of the accounting consensus.

accounting education, accounting standards, IFRS, uniformity

Abstract:
The accounting standardization project, kicked off by the passage of US securities laws in the 1930s, has steadily gained momentum over seven decades. Today, written standards dominate accounting thought, practice, regulation, instruction, even research. Generally accepted accounting principles - originally a mere description in its plain English meaning - have since been capitalized into a proper name - Generally Accepted Accounting Principles - and the phrase now describes rules and regulations issued by authorities with power to inflict punishment on those who do not choose to accept them. How and why did financial reporting get caught in the standardization project, replacing social norms of corporate and professional behavior by written rules and standards? What are the consequences of this transformation? What alternative courses are available to accounting and corporate governance? I argue that heavy reliance on the codification of financial reporting has been a wrong path. A shift from rules towards norms of behavior may yet help accounting and corporate governance recover a better balance.

Accounting rules, financial reporting, standards, social norms, enforcement sanctions, corporate governance

Abstract:
The accounting standardization project, kicked off by the passage of U.S. securities laws in the 1930s, has steadily gained momentum over seven decades. Today, written standards dominate accounting thought, practice, regulation, instruction, even research. Generally accepted accounting principles - originally a mere description in its plain English meaning - have since been capitalized into a proper name - Generally Accepted Accounting Principles - and now describes rules and regulations issued by authorities with power to inflict punishment on those who do not to accept them. How and why did financial reporting get caught in the standardization project, replacing norms of corporate and professional behaviour by written rules and standards? What are the consequences of this transformation? What alternative courses are available to accounting and corporate governance? I argue that heavy reliance on the codification of financial reporting has been a wrong path. A shift from rules towards norms of behaviour may yet help accounting and corporate governance recover a better balance.

Accounting rules, financial reporting, standards, social norms, enforcement sanctions, corporate governance

Abstract:
The possibility of building a mathematical theory of a system or of simulating that system does not depend on having an adequate microtheory of the natural laws that govern the system components. Such a microtheory might indeed be simply irrelevant. Herbert A. Simon, The Sciences of the Artificial, p. 19.

Three phenomena - the disparity between the assumed and observed attributes of economic man, the link between nature and artifacts, and the use of computers as a source of knowledge - fascinated Herbert A. Simon. He built a new paradigm for each field-bounded rationality to deal with the disparity, the science of the artificial as its link to nature, and artificial intelligence for creation of knowledge. In this paper we show that the sciences of the artificial and computer intelligence also hold the key to an understanding of the disparity between individual behavior and market outcomes. When seen as human artifacts, a science of markets need not be built from the science of individual behavior. We outline how, in the nineties, computer simulations enabled us to discover that allocative efficiency - a key characteristic market outcomes - is largely independent of variations in individual behavior under classical conditions. The Sciences of the Artificial suggests such independence and points to its benefits: This skyhook-skyscraper construction of science from the roof down to the yet unconstructed foundations was possible because the behavior of the system at each level depended on only a very approximate, simplified, abstracted characterization of the system at the level next beneath. This is lucky, else the safety of bridges and airplanes might depend on the correctness of the "Eightfold Way" of looking at elementary particles (Simon 1996, p. 16).

efficiency of markets, zero intelligence, decision making, bounded rationality, minimal rationality economics

Abstract:
Three phenomena-the disparity between the assumed and observed attributes of economic man, the link between nature and artifacts, and the use of computers as a source of knowledge--fascinated Herbert A. Simon. He built a new paradigm for each field—bounded rationality to deal with the disparity, the science of the artificial as its link to nature, and artificial intelligence for creation of knowledge. In this paper we show that the sciences of the artificial and computer intelligence also hold a key to an understanding of the disparity between individual behavior and market outcomes. When seen as human artifacts, a science of markets need not be built from the science of individual behavior. We outline how, in the nineties, computer simulations enabled us to discover that allocative efficiency-a key characteristic of market outcomes—is largely independent of variations in individual behavior under classical conditions. The Sciences of the Artificial suggests such independence and points to its benefits.

Efficiency of Markets, Zero Intelligence, Decision Making, Bounded Rationality, Minimal Rationality Economics

Abstract:
Joel S. Demski's work is characterized by the austere discipline of applying the economizing principle to accounting and management phenomena. In natural sciences optimization is used as a structural principle for understanding the organization of the physical universe. As social scientists applied it to our self-conscious selves, economizing acquired a behavioral interpretation, leading to unnecessary and avoidable confusion with the findings of cognitive sciences. Important aspects of aggregate level outcomes of social phenomena are structural. The use of the economizing principle for understanding social phenomena in general, and accounting in particular, has been highly productive, and it is not in conflict with cognitive limitations of human individuals. Demski's work defines the application of this powerful principle to problems of accounting.

Abstract:
Joel S. Demski's work is characterized by the austere discipline of applying the economizing principle to accounting and management phenomena. In natural sciences optimization is used as a structural principle for understanding the organization of the physical universe. As social scientists applied it to our self-conscious selves, economizing acquired a behavioral interpretation, leading to unnecessary and avoidable confusion with the findings of cognitive sciences. Important aspects of aggregate level outcomes of social phenomena are structural. The use of the economizing principle for understanding social phenomena in general, and accounting in particular, has been highly productive, and it is not in conflict with cognitive limitations of human individuals. Demski's work defines the application of this powerful principle to problems of accounting.

economizing principle, self-selection, employee stock options, integrated financial-tax accounting, audit failures

Abstract:
Junk e-mail or spam is rapidly choking off e-mail as a reliable and efficient means of communication over the Internet. Although the demand for human attention increases rapidly with the volume of information and communication, the supply of attention hardly changes. Markets are a social institution for efficiently allocating supply and demand of scarce resources. Charging a price for sending messages may help discipline senders from demanding more attention than they are willing to pay for. Price may also credibly inform recipients about the value of a message to the sender before they read it. This article examines economic approaches to the problem of spam and the results of two laboratory experiments to explore the consequences of a pricing system for electronic mail. Charging postage for e-mail causes senders to be more selective and to send fewer messages. However, recipients did not interpret the postage paid by senders as a signal of the importance of the messages. These results suggest that markets for attention have the potential for addressing the problem of spam but their design needs further development and testing.

spam, Junk, pricing e-mail, market for attention

Abstract:
Junk email or spam is rapidly choking off email as a reliable and efficient means of communication over the Internet. While the demand for human attention increases rapidly with the volume of information and communication, the supply of attention hardly changes. Markets are a social institution for efficiently allocating supply and demand of scarce resources. Charging a price for sending messages may help discipline senders from demanding more attention than they are willing to pay for. Price may also inform recipients about the value of a message they read it. This paper presents an economic model and the results of two laboratory experiments to explore the consequences of a pricing system for electronic mail. Charging postage for email causes senders to be more selective and to send fewer messages. However, the recipients did not use the postage paid by senders as a signal of message importance. These results suggest that markets for attention have potential for addressing the problem of spam, but that their design needs more work.

Abstract:
In competitive equilibrium, non-binding price controls (that is, price floors below and ceilings above the equilibrium) should not affect market outcomes, but in laboratory experiments they do. We build a simple dynamic model of double auction markets with zero-intelligence (ZI) computer traders that accounts for many, though not all, of the discrepancies between the data and the Walrasian tatonnement predictions. The success of the model in organizing the data, and in isolating various consequences of price controls, shows that the simple ZI model is a powerful tool to gain insights into the dynamics of market institutions.

Price controls, zero-intelligence, double auction dynamics, allocative efficiency

Abstract:
In competitive equilibrium, non-binding price controls (that is, price floors below and ceilings above the equilibrium) should not affect market outcomes, but in laboratory experiments they do. We build a simple dynamic model of double auction markets with "zero-intelligence" (ZI) computer traders that accounts for many, though not all, of the discrepancies between the data and the Walrasian tatonnement predictions. The success of the model in organizing the data, and in isolating various consequences of price controls, shows that the simple ZI model is a powerful tool to gain insights into the dynamics of market institutions.

Price Controls, Zero-Intelligence, Double Auction Dynamics, Allocative Efficiency

Abstract:
The Securities and Exchange Commission (SEC) issued a call for comment on a proposal to adopt a Roadmap for potential use of international financial reporting standards (IFRS) by U.S. Companies. We comment on five key issues raised by the SEC proposal. First, we propose that the need for a global regulator is overstated. A global regulator is unlikely to help achieve the stated goals of comparability and consistency of financial reporting on a global basis. We favor allowing U.S. companies to choose use of U.S. GAAP or IFRS rather than mandating one global monopoly set of standards. Second, we agree that the focus on auditing is a very relevant issue that deserves more attention from standard setters. Gains from adopting principles based accounting standards such as IFRS are likely to be realized only if auditors are also principles based. Third, while we have serious concerns about governance and financing mechanisms of IASB, we recommend that all regulatory actions cannot be held to a standstill while structural changes are made to the IASB. Fourth, we are not in favor of requiring reconciliation schedules from U.S. companies using IFRS. We view such reconciliations as being costly and unnecessary. Fifth, we recommend that the SEC pay more explicit attention to the educational and professional judgment consequences of its proposals.

This comment was developed by the Financial Accounting Standards Committee of the American Accounting Association and does not represent an official position of the American Accounting Association.

U.S. GAAP, IFRS, SEC, Reconciliation, Roadmap

Abstract:
Standard setters and most academics maintain that accounting standards ought to rest on a set of guiding principles stated explicitly in a “conceptual framework.” The FASB and IASB are currently involved in a project to refine conceptual framework documents developed earlier. At this point, it is not clear what their final product will look like; its defining characteristics as well as the substantive content can only be surmised. This paper addresses the issues that FASB and IASB face, including the question of what a conceptual framework should be all about. First, we suggest characteristics that a conceptual framework ought to exhibit. Most of these suggestions are based on our critique of the existing framework and the FASB-IASB work in progress. Second, we present a model framework that meets our criteria. We emphasize up front that this framework is quite explicit. It goes to the heart of what a framework document should do: it places specific restrictions on what constitutes admissible accounting standards. The purpose of our effort is to stimulate broad discussion of alternative approaches to foundational documents and to offer a specific example of such an alternative approach.

FASB, IASB, Conceptual Framework, Accounting Standards, Financial Reporting

Abstract:
Mandatory certification of the financial reports of publicly-held corporations by independent auditors has been a key element in U.S. regulatory framework to improve financial reporting. The economic consequences of mandatory certification remain controversial. Although each market is unique, comparative analyses of certification services across markets can yield useful insights into the value and consequences of mandatory audit of financial reports. Using a framework for analysis of certification services, we report: (1) descriptive data about certification activity for a range of private sector goods; (2) qualifications and interests of experts who provide online certification or opinion for a fee; and (3) analysis of an online market for certification of baseball card.

We find that (1) markets for certification services are ubiquitous in the economy, many with potential for conflicts of interest; (2) the grading scales vary from pass/fail to 100 points with greater use of the former by government agencies; (3) the unregulated market for baseball card certification is dominated by firms who also sell other services; (4) buyers of certification services are willing to pay more for stricter grading; and (5) the net returns to the purchase of stricter certification services are higher, i.e., there is little evidence of a race-to-the-bottom. These observations from unregulated markets for certification services raise interesting questions about several maintained assumptions about the federal regulation of certification of corporate
financial reports (e.g., the importance of independence).

Abstract:
Subgame perfect equilibrium predictions of ultimatum bargaining games correspond poorly to the data gathered from human subjects in laboratory environments. Attempts to reconcile this discrepancy have taken one or more of three routes: (1) expanding the agent foresight and scope of decisions, (2) explicit modeling of agents' initial beliefs and their dynamics, and (3) adding social arguments to agent preferences. We take the first two routes by including the probability of rejection by the responder in proposer's decision, and using experimental data to estimate a static model of agent beliefs. Data from previously reported experiments is compared to the predictions of the optimal decision rule to validate the proposer model. Models in which the probability of acceptance of a proposal declines with the amount offered to the responder are better able to organize the data about the behavior of both players. Explanation of responders' behavior remains weak.

Ultimatum Game, Experimental Economics, Parametric Modeling, Estimation

Abstract:
Subgame perfect equilibrium predictions of ultimatum bargaining games correspond poorly to the data gathered from human subjects in laboratory environments. Attempts to reconcile this discrepancy have taken one or more of three routes: (1) expanding the agent foresight and scope of decisions, (2) explicit modeling of agents' initial beliefs and their dynamics, and (3) adding social arguments to agent preferences. We take the first two routes by including the probability of rejection by the responder in proposer's decision, and using experimental data to estimate a static model of agent beliefs. Data from previously reported experiments is compared to the predictions of the optimal decision rule to validate the proposer model. Models in which the probability of acceptance of a proposal declines with the amount offered to the responder are better able to organize the data about the behavior of both players. Explanation of responders' behavior remains weak.

Ultimatum Game, Experimental Economics, Parametric Modeling, Estimation

Abstract:
Financial accounting standards in the U.S. are developed by private standard setting organizations (SSOs) that operate under the oversight of a government agency. The primary accounting SSO (FASB) has been criticized for writing too many standards (standards overload), the complexity of its standards, the processes by which its standards are set, and the absence of a competitive mechanism to help set standards. The present study seeks to assess the validity of these concerns by looking at standard setting processes in the broader economy.

The study consists of three parts. In Section 1, we present some historical data on standard setting activity and document standards set by 604 private and 80 government SSOs in the U.S. We find that there is a time trend in favour of greater reliance on private rather than government SSOs. Accounting standard setters are late entrants in the field of setting standards and appear to be relatively slow in developing new standards. However, accounting standards are relatively long and complex, thus possibly justifying complaints of standards overload. In Section 2, we propose a framework for analysis of the types of standards (quality versus co-ordination) and the processes by which standards are set (monopoly versus competition). We present some data on how standards are set by Government SSOs and provide a detailed comparison of the standard setting processes of four competing technology oriented SSOs relative to the FASB. The comparison highlights a number of features where the FASB differs from other SSOs. These include: the use of sanctions, the threshold of agreement required for standards adoption, and standards competition. In Section 3, we provide data on standards competition in the economy. This includes a case study of internet telephony where competing SSOs have fundamentally transformed the telecommunications industry. Implications for accounting standard setting are discussed.

Abstract:
Under what conditions is government regulation better at protecting market participants than private, evolving, market-driven protections? An intriguing answer to that question emerges if we examine a relatively unregulated area of market participant protection: e-commerce privacy. In the United States, the privacy of participants engaged in e-commerce is largely unregulated by government; instead, many commercial websites contract with third parties to establish privacy protection codes and certify to Web surfers that the Web sites adhere to those codes. In the United Kingdom, on the other hand, e-commerce privacy is a matter of government regulation and enforcement by an agency created for that purpose. An analysis of these two very different approaches to online privacy suggests that private protections perform as well as - and perhaps even better than - government-regulation.

Regulation, privacy, privacy protection, internet, internet privacy, internet regulation, government regulation, regulation by markets

Abstract:
Monetary unit is a basic element of accounting used to manage, report, govern and tax organizations in all sectors of the economy. Instability of monetary unit introduces noise, weakening the effectiveness of accounting in performing its important economic roles in society. We model the impact of monetary instability on the accuracy of accounting valuation and consequently on the economics of managing organizations. We also examine some empirically testable implications of the theory. Though the magnitude of this effect remains to be estimated, it may be significant enough to deserve explicit consideration in selection of monetary policy.

Stability of Monetary Unit, Corporate Financial Reports, Information

Abstract:
Monetary unit is a basic element of accounting used to manage, report, govern and tax organizations in all sectors of the economy. Instability of monetary unit introduces noise, weakening the effectiveness of accounting in performing its important economic roles in society. We model the impact of monetary instability on the accuracy of accounting valuation and consequently on the economics of managing organizations. We also examine some empirically testable implications of the theory. Though the magnitude of this effect remains to be estimated, it may be significant enough to deserve explicit consideration in selection of monetary policy.

Stability of Monetary Unit, Corporate Financial Reports, Information

Abstract:
When transactions have multiple attributes, achieving uniformity in their classification depends on whether similarities or dissimilarities are of interest; uniformity with respect to both is not possible. The pursuit of uniform written standards at the expense of social norms diminishes the effectiveness of financial reporting in stewardship and governance, and in keeping the security markets informed. A shift to written standards discourages thoughtful classroom discourse on alternatives which develop professional judgment. It also engenders "by the book" attitudes and drives talent away from accounting programs and, ultimately, from the accounting profession. Judgment and personal responsibility being the hallmarks of a learned profession, the dominance of uniform written standards weakens the claim that accounting programs belong in universities alongside architecture, dentistry, engineering, law, and medicine. Uniformity discourages research and debate in academic and practice forums and promotes increasingly detailed rule-making. It shuts the door on learning through experimentation, making it difficult to discover better ways of financial reporting through practice and comparison of alternatives. Improved financial reporting calls for a careful balance between written standards and unwritten social norms.

Accounting standards, uniformity, profession, practice, education, research

Abstract:
Balancing the needs of information distributors and their audiences has grown harder in the age of the Internet. While the demand for attention continues to increase rapidly with the volume of information and communication, the supply of human attention is relatively fixed. Markets are a social institution for efficiently balancing supply and demand of scarce resources. Charging a price for sending messages may help discipline senders from demanding more attention than they are willing to pay for. Price may also help recipients estimate the value of a message before reading it. We report the results of two laboratory experiments to explore the consequences of a pricing system for electronic mail. Charging postage for email causes senders to be more selective and send fewer messages. However, recipients did not use the postage paid by senders as a signal of importance. These studies suggest markets for attention have potential, but their design needs more work.

Computer Mediated Communication, Electronic Mail, Empirical Studies, Economics, Markets, Social Impact, Spam

Abstract:
Balancing the needs of information distributors and their audiences has grown harder in the age of the Internet. While the demand for attention continues to increase rapidly with the volume of information and communication, the supply of human attention is relatively fixed. Markets are a social institution for efficiently balancing supply and demand of scarce resources. Charging a price for sending messages may help discipline senders from demanding more attention than they are willing to pay for. Price may also help recipients estimate the value of a message before reading it. We report the results of two laboratory experiments to explore the consequences of a pricing system for electronic mail. Charging postage for email causes senders to be more selective and send fewer messages. However, recipients did not use the postage paid by senders as a signal of importance. These studies suggest markets for attention have potential, but their design needs more work.

Computer Mediated Communication, Electronic Mail, Empirical Studies, Economics, Markets, Social Impact, Spam

Abstract:
Jamal and Sunder [Journal of Economic Behavior and Organization, 32 (1966) 273] showed that the median prices in double auctions populated by zero-intelligence (ZI) traders whose trading limits are set by two biased heuristics tend to converge to the same equilibrium as if their trading limits were set by applying Bayes' rule. This note provides an analytical explanation of why the repeated use of biased heuristics approximates Bayes rule.

Aggregate Market Rationality, Bayaesian Equilibrium, Double Auction, Biased Heuristics

Abstract:
Jamal and Sunder (1996) showed that the median prices in double auctions populated by zero-intelligence (ZI) traders whose trading limits are set by two biased heuristics tend to converge to the same equilibrium as if their trading limits were set by applying Bayes' Rule. This note provides an analytical explanation of why the repeated use of biased heuristics approximates Bayes rule.

Aggregate Market Rationality, Bayesian Equilibrium, Double Auction, Biased Heuristics

Abstract:
Opportunity cost is a central concept in decision making. It is difficult to measure because it is the value associated with opportunities foregone. In this paper, we characterize three time-based dimensions of resources to help understand and estimate opportunity costs. These dimensions capture the intrinsic lumpiness of resources with respect to their acquisition (acquisition granularity), the extent to which they retain their usefulness over time (expiration granularity), and the extent to which the decision-maker has control over the consumption of these resources (consumption granularity). We illustrate how these concepts may be used in decision making. We show how the granularity framework points to a non-linear cost assignment procedure using multiple cost drivers for some resources.

Abstract:
The FASB and the IASB recently issued a joint discussion paper entitled, Preliminary Views on Revenue Recognition in Contracts with Customers. The Boards requested comments on whether their proposed model for revenue recognition would improve the usefulness of the financial statement information for financial decision makers. This paper sets forth the AAA's Financial Accounting Standards Committee's responses to several of the Boards' specific questions. In summary, we support the Boards' proposed comprehensive revenue recognition standard based on the following options: (1) the customer consideration approach (based on initial contract price measurement); (2) no recognition of revenue at contract inception (by assigning the initial contract price to performance obligations); (3) allocation of the transaction price to multiple performance obligations based on the relative stand-alone prices of each performance obligation. We also recommend that the Boards carefully consider the following clarifications as they develop the final exposure draft. The definition of a contract should include the words legally enforceable to describe the contract. A performance obligation must be verifiable. While the transfer of an asset to the customer or the acceptance of a service by the customer normally signals the recognition of revenue, we encourage the Boards to carefully consider situations (like long-term construction or mining) when the completion of intermediate performance obligations could trigger revenue recognition prior to the transfer of title. Absent special consideration of these situations, companies may be forced to re-write contracts in sub-optimal ways in an effort to recognize revenue continuously throughout a long-term construction project or in the process of mining or farming. Consider the difficulties that may arise in allocating the initial transaction price to multiple performance obligation contracts when the individual performance obligations are not normally sold on a stand-alone basis.

Financial Accounting Standards Board, International Accounting Standards Board, Revenue Recognition, Contracts

Abstract:
This paper studies the role of transfers among groups within a country as well as among countries in a two level game of international trade negotiations. We show that in order to realize the intended transfer in the presence of asymmetric information on the states of recipients (and donors), a transfer process uses up additional resources. The difficulty of making transfers renders it less likely that a nation would find it individually rational to participate as a member of an international institution. Costly transfers render the internal and international adjustment difficult, and serve as a barrier to trade liberalization. Costly international transfers harden the resistance against trade liberalization in the (potentially) recipient country and soften it in the (potentially) donor country.

International trade, tariff negotiation, asymmetric information, transfer, WTO common agency, two-level game

Abstract:
Properties of many important valuation rules can be quantified, examined and compared in a unified framework to assist policy decisions. Valuation rules can be viewed as econometric estimators of unobserved values of aggregates. Which valuation rule has minimum mean squared error (relative to the unobserved value of bundles of resources) is a matter of econometrics, not of theory or principle; it depends in a known fashion on the relative magnitudes of the parameters — price volatility and measurement errors — of the economy, industry or firm. In general, no valuation rule, fair or not, dominates the others. Given parameters of the environment, this framework can help identify efficient valuation rules.

Abstract:
Financial reporting environment of the world is dominated today by a top down push for uniform financial reporting standards. The advantages of uniformity and monopoly standards have been well-publicized compared to their disadvantages. No language, accounting included, can flourish under the protective umbrella of punitive authority of state. Like languages and dictionaries, accounting and other social phenomena develop best through bottom up processes. We do not have enough the design knowledge to set standards whose consequences cannot be undone by adjusting transactions. Elimination of alternative accounting treatments prevents credible revelation of information through financial statements. Codification of accounting diminishes the judgment-honing function of class room discourse to promote rote memorization that drives away talent from the profession. Introduction of regulatory competition among alternative sets of financial standards may help improve accounting practice.

Abstract:
Financial reporting environment of the world is dominated today by a top down push for uniform financial reporting standards. The advantages of uniformity and monopoly standards have been well-publicized compared to their disadvantages. No language, accounting included, can flourish under the protective umbrella of punitive authority of state. Like languages and dictionaries, accounting and other social phenomena develop best through bottom up processes. We do not have enough the design knowledge to set standards whose consequences cannot be undone by adjusting transactions. Elimination of alternative accounting treatments prevents credible revelation of information through financial statements. Codification of accounting diminishes the judgment-honing function of class room discourse to promote rote memorization that drives away talent from the profession. Introduction of regulatory competition among alternative sets of financial standards may help improve accounting practice.

Abstract:
Double auctions with profit-motivated human traders as well as "zero-intelligence" programmed traders have previously been shown to converge to Pareto optimal allocations in partial equilibrium settings. We show that these results remain robust in two-good general equilibrium settings and elucidate how market structure, not optimization by traders, guides efficient resource allocation.

Pareto optimal allocations, Edgeworth Box, Double auction, Zero-intelligence traders

Abstract:
The epsilon-intelligent competitive equilibrium algorithm is a decentralized alternative to Walrus' tatonnement procedure for markets to arrive at competitive equilibrium. We build on the Gode-Spear-Sunder zero-intelligent algorithm in which random generation of bids and offers from agents' welfare-enhancing opportunity sets generates Pareto optimal allocations in a pure exchange economy. We permit agents to know if they are subsidizing others at such allocations, and to veto such allocations, restricting the subsequent iterations of the algorithm only to those trades that are both Pareto-improving and provide strictly greater wealth, and ultimately utility, for such agents. In this simple institution actions of minimally intelligent agents based on local information can lead the market to approximate competitive equilibrium in a larger set of economies than the tatonnement process would allow. This helps address one of the major shortcomings of the Arrow-Debreu-McKenzie model with respect to the instability of tatonnement in an open set of economies. It also addresses the behavioral critique of mathematically derived equilibria for the inability of cognitively-limited humans to maximize. The proof of convergence of the algorithm presented here also provides a way of showing the existence of competitive equilibrium for monotonic, convex exchange economies with heterogeneous agents and many goods without application of a fixed-point theorem.

Learning Competitive Equilibrium, Minimal Rationality, Allocative Efficiency, Scarfs' Example

Abstract:
In physics, optimization is an organizing principle for natural phenomena. Entropy tends toward its maximum and marbles roll toward minimum potential energy, all without intent or purpose. Injection of this principle into economics initially followed the physicists' organizing perspective, and helped develop the powerful insights of the abstract partial and general equilibrium theory. However, humans and their institutions being their unit of analysis, it was not long before optimization in economics acquired a behavioral spin. Photons may travel along paths that minimize their travel time without intent or purpose; but economists were too human to think in a similar vein of the people buying ice cream or cars. Once optimization was posited as a behavioral principle of individual human beings, it was easy for cognitive sciences to show that it lacked descriptive validity; however, individual behavior is more complex and less predictable. The aggregate characterizations of Walrasian abstraction could not be derived starting from such complex micro-level behavior. If psychology and equilibrium theory were to be reduced into a single science, something had to give. Given the cognitive limitations humans share with all organisms, validity and relevance of the conclusions of equilibrium theory became suspect.

The marriage of economics and computers led to a serendipitous discovery: there is no contradiction between suboptimal behavior of individuals and aggregate-level outcomes derivable from assuming individual optimization. Science does not require integration of adjacent disciplines into a single logical structure. As the early twentieth century unity of science movement discovered, if we insist on reducing all sciences to a single integrated structure, we may have no science at all. In Herbert Simon's words (1996, p. 16): This skyhook-skyscraper construction of science from the roof down to the yet unconstructed foundations was possible because the behavior of the system at each level depended on only a very approximate, simplified, abstracted characterization of the system at the level next beneath. This is lucky; else the safety of bridges and airplanes might depend on the correctness of the 'Eightfold Way' of looking at elementary particles. This is the story of how we found that economists can have their cake while psychologists eat it too, including some antecedents and consequences of the discovery.

Optimization principle, individual behavior, aggregate outcomes, reductionism

Abstract:
The Financial Accounting Standards Committee of the American Accounting Association (the Committee) is charged with responding to requests for comments from standard-setters on issues related to financial reporting. The Financial Accounting Foundation (FAF) recently released for public comment, Proposed Changes to Oversight, Structure, and Operations of the FAF, FASB, and GASB (the proposal). Our commentary concerns four issues in the proposal which have the most relevance for accounting standard setting:

1. Reduce the size of the FASB from seven members to five;
2. Retain the FASB simple majority voting requirement;
3. Realign the FASB composition; and
4. Provide the FASB Chair with decision-making authority to set the FASB technical agenda.

We disagree with all four of these proposals. The current FASB is set up consistent with a political appointment model rather than a model designed to create an independent standard setting board. The four proposals put forth by the FAF increase the political nature of the FASB, further concentrate decision making power, and make it difficult to get general acceptance of accounting standards. We propose that the FAF move in the opposite direction. In particular, we recommend that the FAF not reduce the FASB size, and adopt a supermajority requirement not a simple voting requirement. If the majority cannot convince other members of the FASB about their views, how can we attain general acceptance of accounting standards in society? We also want a FASB that is open to more diverse views and more democratic. We urge the FAF to increase its engagement with the accounting community instead of becoming more elitist and further concentrating power in the hands of a powerful chairman and a small standard setting board.

FAF, FASB

Abstract:
Scholars tend to sign, uncritically and without negotiation, the copyright transfer forms received from journal publishers. Many publishers - often but not always in the for-profit sector - make these copyright transfers so inclusive (transfer of all ownership and all rights for the duration of copyright), as to hinder broad dissemination of scholarly knowledge. The transfer (or license) form received from publishers should be viewed as no more than their initial proposal, which the authors can get changed with only minor effort. Model license and transfer forms that better preserve authors' rights are available to help ease the burden of negotiations.

scholarship, copyright transfer, license, dissemination

Abstract:
Experimental economics originated as examination of the behavior of aggregate phenomena, especially markets, populated by human participants motivated by their desire to attain their goals. The past two decades have brought two newer trends. One is a gradual but steady shift in the focus of the questions sought to be addressed through human experiments towards examination of micro level phenomena - individual preferences and behavior. The second is the expansion in the role of computer simulations to examine questions about aggregate level phenomena. This shift to individual behavior has accentuated the ever-present dilemma of social sciences in trying to be a science on one hand, and to understand our own self-conscious selves - the human beings - on the other. To address this dilemma, it would be useful to recognize three streams of experimental economics: (1) macro stream to examine the properties of social structures, (2) micro stream to examine the behavior of individuals, and (3) agent stream to explore the links between the micro and macro phenomena using computer simulations. At least the structural stream can be firmly rooted in the tradition of sciences (bypassing the free-will dilemma of social sciences), while the agent stream can span the gap between the behavioral and structural streams.

Economic interaction, agent-based, aggregate outcomes, individual behavior, social sciences, humanities

Abstract:
Experimental economics originated as examination of the behavior of aggregate phenomena, especially markets, populated by human participants motivated by their desire to attain their goals. The past two decades have brought two newer trends. One is a gradual but steady shift in the focus of the questions sought to be addressed through human experiments towards examination of micro level phenomena - individual preferences and behavior. The second is the expansion in the role of computer simulations to examine questions about aggregate level phenomena. This shift to individual behavior has accentuated the ever-present dilemma of social sciences in trying to be a science on one hand, and to understand our own self-conscious selves - the human beings - on the other. To address this dilemma, it would be useful to recognize three streams of experimental economics: (1) macro stream to examine the properties of social structures, (2) micro stream to examine the behavior of individuals, and (3) agent stream to explore the links between the micro and macro phenomena using computer simulations. At least the structural stream can be firmly rooted in the tradition of sciences (bypassing the free-will dilemma of social sciences), while the agent stream can span the gap between the behavioral and structural streams.

Economic interaction, agent-based, aggregate outcomes, individual behavior, social sciences, humanities

Abstract:
Is personal currency issued by participants sufficient to operate an economy efficiently, with no outside or government money? Sahi and Yao (1989) and Sorin (1996) constructed a strategic market game to prove that this is possible. We conduct an experimental game in which each agent issues her personal IOUs, and a costless efficient clearinghouse adjusts the exchange rates among them so the markets always clear. The results suggest that if the information system and clearing are so good as to preclude moral hazard, any form of information asymmetry, and need for trust, the economy operates efficiently at any price level without government money. These conditions cannot reasonably be expected to hold in natural settings. In a second set of treatments when agents have the option of not delivering on their promises, a high enough penalty for non-delivery is necessary to ensure an efficient market; a lower penalty leads to inefficient, even collapsing, markets due to moral hazard.

Strategic market games, government and individual money, efficiency, experimental gaming

Abstract:
The Canadian Accounting Standards Board (AcSB) issued an exposure draft on a proposal to adopt a separate 'Made in Canada' GAAP for private enterprises. This new GAAP is justified as being consistent with the current FASB/IASB conceptual framework, but as being responsive to the different cost/benefit considerations facing private entities vis-à-vis public entities. We viewed this proposal as being innovative and responsive to the differential financial reporting needs of private entities. We proposed that the AcSB should develop a separate conceptual framework to guide the future evolution of this new GAAP and not rely only on cost-benefit considerations. We sketched a preliminary conceptual framework that could be used to develop and justify the type of changes proposed in this exposure draft. We then responded to the specific questions asked in the exposure draft and were very supportive of the concepts proposed. First, we support the proposed GAAP which is based on historical cost with very minimal reliance on fair values. Second, we expressed agreement with the proposal to reduce the amount of required disclosures for private enterprises given their significant economic differences from public companies. Third, we agreed with the proposal to drop provision of significant guidance and especially (ex-post) emerging issues committee interpretations (EIC’s). We are in favour of a principles based GAAP and the provision of detailed authoritative guidance is not conducive to professional judgment. We also suggested a series of transition issues that the AcSB should consider including the mechanism for financing the standard setting board, the need to ensure compatibility between accounting and auditing standards, and a process for adjusting the education system (both in Universities and professional exams) to support this new private enterprise GAAP. This comment was developed by the Financial Accounting Standards Committee of the American Accounting Association and does not represent an official position of the American Accounting Association.

accounting standards, private GAAP

Abstract:
The Financial Accounting Standards Committee of the American Accounting Association (the Committee) is charged with responding to requests for comments from standard-setters on issues related to financial reporting. The Financial Accounting Standards Board (FASB) recently requested comments on its Preliminary Views on Financial Instruments with Characteristics of Equity (PV). The committee believes that the PV introduces concepts and definitions involving financial statement elements that more properly would be considered at the conceptual framework level. Therefore, the committee respectfully requests that FASB take no further action regarding the proposed standard exposed in the Preliminary Views on Financial Instruments with Characteristics of Equity until the conceptual and definitional issues are resolved at the conceptual framework level.

Financial Reporting, FASB, Financial Instruments, Equity

Abstract:
We define and examine the performance of three minimal strategic market games (sell-all, buy-sell, and double auction) in laboratory relative to the predictions of theory. Unlike open or partial equilibrium settings of most other experiments, these closed exchange economies have limited amounts of cash to facilitate transactions, and include feedback. General equilibrium theory, since it abstracts away from market mechanisms and has no role for money or credit, makes no predictions about how the paths of convergence to the competitive equilibrium may differ across alternative mechanisms. Introduction of markets and money as carriers of process creates the possibility of motion. The laboratory data reveal different paths, and different levels of allocative efficiency in the three settings. The results suggest that abstracting away from all institutional details does not help understand dynamic aspects of market behavior. For example, the oligopoly effect of feedback from buying an endowed good is missed. Inclusion of mechanism differences into theory may enhance our understanding of important aspects of markets and money and help link conventional equilibrium analysis with dynamics.

Strategic market games, Laboratory experiments, Minimally intelligent agents, Adaptive learning agents, General equilibrium

Abstract:
Financial reports make significant contributions to corporate governance, capital markets, government, and the economy. US approach to financial reporting has led the way for the rest of the world, but it needs rethinking now. Over the past seven decades, a social norms based approach to financial reporting has been replaced by enforcement of written rules by authority. This approach generates endless requests for clarifications, shifts accounting education from analysis and discussion to memorization of rules, and drives talent away from the profession. Introduction of regulatory competition among sets of accounting standards, and the organizations who write them, will help simplify and improve financial reporting by permitting market feedback to enter rules, and by forcing rule-writers to make difficult trade-offs when they are asked to clarify their rules. Since regulatory competition is used in many aspects of US economy without ill-effects, the fears of race-to-the-bottom are unwarranted.

Abstract:
Two key assumptions underlying the regulation of U.S. financial reporting are the need to mandate the certification of financial statements, and to require that this certification be performed by independent auditors. Private incentives to demand (and supply) certification are thought to be insufficient, and independence is thought to be necessary for quality audit. In this study, we collect archival data on certification activity in the economy, and conduct a field experiment on an unregulated online market for certification of baseball cards to investigate the validity of these assumptions.

Our results show that: (1) Private markets for certification services are ubiquitous in the economy, many with potential for conflict of interest; (2) The grading scales used in certification reports vary from pass/fail to scales with 5-100 points with greater use of the former by government agencies; (3) the unregulated market for baseball card certification is dominated by firms who also sell other services; and (4) Certification agencies who cross sell services provide better quality audits than completely independent certification agencies. Our results suggest that the assumption that private incentives are insufficient for a well-functioning audit market may need further scrutiny. In addition, our results suggest that independence is not a necessary condition for obtaining audit quality.

Mandatory audit, independence, regulation, certification services, financial reporting, accounting

Abstract:
The Securities and Exchange Commission solicited comments on its proposed roadmap toward requiring U.S. registrants to use International Financial Reporting Standards (IFRS) in preparing their financial reports. The proposal is based on “consideration of the role a single set of high quality accounting standards plays in investor protection and the efficiency and effectiveness of capital formation and allocation.” These comments question the validity of this assumption and point to the disadvantages of a monopoly set of standards. Shifting from the monopoly of the Financial Accounting Standards Board to the International Accounting Standards Board is dominated by a competitive regime in which two or more regulator-approved standard setters compete for royalty revenues from registrants who choose the standards used to report to their stakeholders. Regulatory competition will allow experimentation, comparison, and learning and therefore lead to better financial reporting over time.

Accounting standards, internationa, IFRS, Securities and Exchange Commission

Abstract:
Science, engineering, and all other learned disciplines, as well as our socio-political-economic organizations are also artifacts because they are the results of our imagination. Modern corporation - a marvel of organizational engineering - would not be possible without imagination. To run organizations, in the face of the centrifugal forces of divergent self-interest and inherently dispersed information, we need accounting. Accounting, too, is an artifact that arose from human imagination, as a precursor of, or contemporaneously with, mathematics, writing and the civilization itself. We explore the case for imagination in our discipline with respect to its environment, scholarship and instruction. Specifically, accounting scholarship includes examination not only of the way things were and are, but also of how they might be. Why should we imagine alternate scenarios, instead of simply waiting for changes to occur, or being forced upon us? We must do so, because imagination is necessary to bring about innovation in practice and in institutions, so our children might live in a better world.

Abstract:
Organization can be seen as an alliance among various people, each of whom pursues his or her self interest. Culture of an organization can be seen as the shared expectations of the behaviour of one another held by its participants. Good governance is achieved when there is a balance or match between the shared culture (mutual expectations) and self-interest of the participants. Good governance is supposed to make everybody in the society better off. The elements of good governance are the balance among regulation, market forces, and social norms. Threats to good governance include changes in environment, markets, and the self-interest of participants. Organizations require strategic management to anticipate and address those threats. From the point of view of the society as a whole an organization can be evaluated by the sum of surplus received by all participants. Finally, there is no Holy Grail: good governance is a constant struggle to maintain this balance under ever-changing conditions.

Good governance, balance, self-interest, incentives, environment, value of the firm

Abstract:
Double auctions with profit-motivated human traders as well as "zero-intelligence" programmed traders have previously been shown to converge to Pareto optimal allocations in partial equilibrium settings. We show that these results remain robust in two-good general equilibrium settings and elucidate how market structure, not optimization by traders, guides efficient resource allocation.

Pareto optimal allocations, Edgeworth Box, Double auction, Zero-intelligence traders

Abstract:
In physics, optimization is an organizing principle for natural phenomena. Entropy tends toward its maximum and marbles roll toward minimum potential energy, all without intent or purpose. Injection of this principle into economics initially followed the physicists' organizing perspective and helped develop the powerful insights of the abstract equilibrium theory. However, humans and their institutions being the unit of analysis, economists could not long resist the temptation to give optimization a behavioral spin. Photons may travel along paths that minimize their travel time without intention or purpose; but economists were all too human to think in a similar vein of the people buying ice cream or cars. Once optimization was posited as a behavioral principle of individual human beings, it was easy for cognitive sciences to show that it lacked descriptive validity. Individual behavior is more complex and less predictable. The aggregate characterizations of Walrasian abstraction could not be derived starting from such complex micro-level behavior. If psychology and equilibrium theory were to be reduced into a single science, something had to give. Given the cognitive limitations humans share with all organisms, validity and relevance of the conclusions of equilibrium theory became suspect.

The marriage of economics and computers led to a serendipitous discovery: there is no internal contradiction in suboptimal behavior of individuals yielding aggregate-level outcomes derivable from assuming individual optimization. Individual behavior and aggregate outcomes are related but distinct phenomena. Science does not require integration of adjacent disciplines into a single logical structure. As the early-twentieth-century unity of science movement discovered, if we insist on reducing all sciences to a single integrated structure, we may have no science at all. In Herbert Simon's (1996, 16) words: This skyhook-skyscraper construction of science from the roof down to the yet unconstructed foundations was possible because the behavior of the system at each level depended on only a very approximate, simplified, abstracted characterization of the system at the level next beneath. This is lucky; else the safety of bridges and airplanes might depend on the correctness of the 'Eightfold Way' of looking at elementary particles.

This is the story of how we found that economists can have their cake while psychologists eat it too. Willingness to abandon the reductionist agenda in social sciences - something natural sciences did in the early twentieth century - reveals that the predictive validity of Marshallian supply and demand theory need not depend on the theory's assumptions being literally descriptive of cognitively bounded human agents. The next section discusses the role computers have played in the design and operation of markets, and in modeling and facilitating the decisions of market participants. These developments, combined with the growth of experimental tradition in economics research and the use of such experiments for classroom instruction, set the stage for the discovery that structural properties of markets can be isolated from the behavioral patterns of their participants. The final section explores the scientific antecedents and consequences of this finding.

Optimization principle, individual behavior, aggregate outcomes, reductionism

Abstract:
The seven papers presented at the 2008 Kobe Forum report important and interesting results from Japanese research on accounting and management. In Japan, the focus of accounting on helping management operate the firm efficiently has yielded great economies. The single-minded focus of the IFRS, based on investor and security market orientation of U.S.-U.K. accounting does not serve the Japanese economy well. The dysfunctional consequences of the attempts to force convergence of Japanese financial reporting to IFRS can be seen in the weaknesses of the so-called fair value accounting and in accounting for business combinations. Probabilistic purchase method of accounting for business combinations holds a promising alternative. Measurement of performance of corporations can be advantageously expanded beyond the concerns of shareholder to include the interests of other stakeholders in the corporation. The technological success of Japanese manufacturers in the recent decades has been accompanied by strong focus on value creation but inadequate attention to capturing the value for the shareholders. Finally, experimental research on laboratory games with Japanese subjects tends to debunk the theories about national traits so popular in armchair analyses of economic performance and behavior.

Japanese accounting research, IFRS, Japanese management

Abstract:
Why people accept intrinsically worthless fiat money in exchange for real goods and services has been a longstanding puzzle in economics. Attempts to explain the broad acceptance of fiat money have relied on either assuming that someone will exchange the fiat money for real consumption at the end of the horizon, or on pushing the puzzle of fiat money into infinite future in overlapping generations settings. We examine an alternative route that can explain the value of fiat money through a debt instrument which allows consumption to be moved backward in time. In this paper, we present empirical evidence that the theoretical predictions about the behavior of such economies work reasonably well in a laboratory experiment. The invention of fiat money and related debt instruments allow society to replace expensive commodities by costless paper and cut the dead weight loss associated with the former.

Experimental Gaming, Bank, Fiat money

Abstract:
Agent-based economics, and more generally agent-based social sciences, have been around in various forms for over 30 years. The advent of higher speed computing and new tools for the computational learning fields led to a major increase in activity in the early 1990s through today. Research activity continues to increase at the current time, but the field still remains somewhat of a "niche field" inside economics. Certain conferences and certain regions (such as Europe) are well populated with agent-based activity. However, at mainstream conferences inside the US one would have a hard time in finding agent-based researchers.

Abstract:
Experience with the 75 years of development of, and increasing reliance on, written standards of corporate financial reporting suggests that balancing them with community’s social norms may be a better option. “True and fair” override of written standards could serve as the moral compass of financial reporting

True and fair, financial reporting, standards, ethics, social norms

Abstract:
In the neoclassical model of the firm, value surplus of the firm is assumed to accrue to its owners. Contract model suggests a distribution of the surplus among various agents depending on the imperfections of the markets in which they transact with the firm. If the share of the surplus to an agent declines with the perfection of the market in which he transacts, shareholders should be expected to get only a small piece of the pie, violating the neoclassical assumption. The paper explores an extensive value concept and its measurement for firms. It also examines the implications of extensive value for what we do and do not know about the consequences of corporate mergers and acquisitions.

factor income distribution, extensive value, surplus

Abstract:
We report results of a field investigation of the process by which clients and prospective auditors acquire information about each other and enter an engagement. Often we assume that knowledge required for contracting is readily known by contracting agents, while in fact it must be acquired through a complex courtship process by agents with private and conflicting incentives. To examine this important aspect of the market for audit services, we obtain documents and conduct interviews on requests for audit proposal (RFPs) issued by a publicly traded Canadian company, as well as a Canadian government organization. We observed: (1) significant management control in selection of the external auditor; (2) asymmetry of transparency, whereby the client gathers detailed information about prospective auditors from multiple sources, but the auditors are reluctant to press prospective clients for information; (3) a selection process that requires the auditor to provide references from senior officers of current and past clients, and repeatedly demonstrate responsiveness and commitment to the prospective client’s management; and (4) extensive price competition, where one audit firm offered a bid materially below the previous year’s audit fee, and another firm offered three fee levels for different bundles of services. Implications of these observations for opacity of audit quality, auditor risk management, expertise differentiation, and auditor rotation are discussed.

Auditor-Client engagement, auditor rotation, independence, field study