The Demand for and Supply of Accounting Theories: The Market for Excuses

Table of Content

1. Introduction

Ross L. Watts and Jerold L. Zimmerman are two of the most influential and controversial contributors to accounting literature of the past decades based on their substantial individual and cooperative contributions. As pioneers, they devoted themselves to creating a positive accounting theory, and further described accounting theories as supplying excuses in their paper of 1979, which provided a chance to reflect on the significant growth in the accounting research and broadened the view ‘‘towards a more formal and deductive concern with hypothesis testing and quantitative methods’’ (Whitley, 1988). The aim of this paper is to critically review the paper by Watts and Zimmerman (1979) based on some selected criteria.

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The remainder of this paper is organised as follows. Next section provides a summary of the 1979 paper. Section three evaluates the paper based on the selected criteria. Section four gives the conclusion.

2. Summary of the Original Paper

Recognising the conclusion that ‘‘financial accounting theory has had little substantive and direct impact on accounting practice or policy formulation’’, Watts and Zimmerman (1979) tried to build a positive theory of determinants of accounting theory. To demonstrate their positive theory of the determinant role that governments played in the development of accounting theory, they analysed accounting theories using an economic framework of demand and supply.

The basic structure of the paper is shown in the below diagram.


Section I:

The demand for accounting theories

Section II:

In a regulated economy

In an unregulated economy

The supply of accounting theories

Section III:

The empirical examples

Section IV:


Section V:

Section II analysed the demand side in two different situations, namely the unregulated economy, which is without government intervention and the regulated economy, which includes government intervention. In the unregulated economy, based on the assumption of the existence of the agency cost and of the close relationship between agency costs and accounting procedures, three main functions of accounting theories were identified, namely pedagogic demand, information demand and justification demand. In the regulated economy, after analysing both the direct and indirect impact that political process had on the contents of financial statements, the paper argued that the justification demand from government, who needed to justify that their political action was in the public interest, was hugely increased based on the core assumption of the self-interest individuals and high political cost.

Section III analysed the supply side. It was suggested that, based on the existence of substitute suppliers of theories and the powerful incentive provided by the consumer (Vested Group), the accounting theory mainly served as excuses for different policies.

Section IV examined three empirical examples to prove the close relationship between government intervention and accounting theory.

3. Evaluation

3.1 The Criteria Used In Evaluation

The critical review of a paper involves making a judgement about whether or not it reaches some selected criteria. In evaluating the article of Watts and Zimmerman in 1979, six criteria are considered to be the most significant and relevant. Firstly, the framework on which the whole paper is based should be valid and applied appropriately. Secondly, under the framework, certain assumptions are established. As the basis of the logical reasoning of the propositions, they are expected to be valid and stated clearly and completely. Thirdly, to defend the theory of the paper, evidence presented should be convincing. Fourthly, an objective view of the author towards both their theory and their competing theories is also considered to be indispensable. Fifthly, a valuable paper is supposed to make innovative contribution to its research area. Finally, the degree of originality should also be taken into account in evaluating the paper as a whole. The above six criteria are used to judge the value of this paper as follows.

3.2 The Aspects Which Fail the Criteria

3.2.1 The Validity of Framework

The theoretical framework is a structure under which a collection of interrelated concepts and variables are systematically organised to support a theory of a research problem. The framework used in the paper by Watts and Zimmerman (1979) was based on the economic model of demand and supply. The validity of this economic framework is questionable, since the centre of the paper was to discuss the accounting policy-making processes, which concerned the discipline of politics. As Lowe et al. (1983) stated, using framework from a different discipline needs justification, since different frameworks have different assumptions and limitations, which might lead to the exclusivity of valid explanations for the same phenomena from another framework with more explanatory power. Booth and Cocks (1990) also justified the inappropriateness of the use of the economic framework for explaining political process by pointing out its inadequacy in addressing the key issue of power and conflicts involved in policy-making process, and provided a richer framework, namely power framework, which included important non-economic factors such as ‘‘interaction of social action, modes of rationality and hegemonic domination’’.

3.2.2 The Validity of Assumptions

The theory was demonstrated in Watts and Zimmerman’s study in 1979 as follows:

‘‘The government regulation creates incentives for individuals to lobby on proposed accounting procedures, and accounting theories are useful justifications in the political lobbying.’’

This theory was accomplished by the critical assumption that individuals are driven merely by their own interests and the attribution of their interests depends on their specific position in a social structure. However, this assumption is not necessarily valid. In the view of Rokeach(1973), instead of being driven only by self-interests, people have values and beliefs which come first. According to Meyer (1986), the assertion that individuals’ actions are based on their membership in a certain social group overlooks their knowledge and assessments, and this renders their choices redundant, which is a form of structural determinism. Moreover, as Robson (1993) stated, there is another problem in the assumption, which concerns the circular relationship between individuals’ self-interest and their actions. As indicated in the paper of Watts and Zimmerman (1979), individuals’ self-interest is the driving force of their lobbying actions, and their interests can only be revealed by their lobbying of accounting standards. However, according to Hindess(1982,1986), in such a way, the possibility of any mistaken calculations of interests and unintended results is ignored.

3.2.3 The Appropriateness of Evidence

In order to examine and support their study, Watts and Zimmerman selected three types of legislation which they believed impose a remarkable influence on the demand for and supply of accounting theories: the railroads legislation, income tax acts and securities acts. There are at least two problems with their evidence. Firstly, in the three examples, the authors focused their attention on either the U.S or the U.K rather than on a more general basis. Therefore, a suspect reasonably arises that their theory could be held only in a limited domain, not applicable universally. Secondly, in the first piece of evidence-the railroads legislation, Watts and Zimmerman stated that the accounting research articles on the nature of the depreciation started to appear from 1841 in the U.K. and from 1850 in the U.S. at latest. Meanwhile, when the authors elaborated the researchers’ relation to the vested interests’ demand of accounting theories, they implied that researchers were motivated by the rewarding system of universities to supply theories to meet vested interests’ needs. However, the accounting researchers were only seen in universities of the U.K and the U.S from the end of the nineteenth century, which rendered the authors’ first piece of evidence highly invalid (Lowe, 1983).

3.2.4 The Objectivity of Author’s View

The objectivity of author’s view towards their own theory and the competing theory influences the degree of the paper’s openness to discussion. Watts and Zimmerman (1979) showed a strongly biased view against competing theories, namely normative theory, and conservative attitude to the possible refutation of their theory. The following passages are proof of this:

‘‘The literature we commonly call financial accounting theory is predominantly prescriptive…Often the lack of impact is attributed to basic methodological weakness in the research.’’

‘‘One or two papers discussing a topic prior to the time the topic becomes politically active is not sufficient to reject our theory’’.

‘‘No other theory, no normative theory currently in the current accounting literature, can explain or will be used to justify all accounting standards’’.

As Whittington (1987) stated, the main controversy about the work of Watts and Zimmerman is their strident advocacy of the methodology of positive accounting. They should have been more objective and not as biased towards their own theory, since many research papers (Tinker, 1982; Christenson, 1983; and Lowe, 1983) are indeed seen to discuss the topic about normative and positive accounting theory, with the main conclusion that the positive theory, which originates from normative theory, has very limited predictive ability and is scientifically dubious.

3.3 The Aspects Which Reach the Criteria

Apart from the aforementioned weakness, the paper has its strengths. To some extent, it is one of the most typical accounting literatures for positive accounting research and has a great innovation on the development of accounting theory (Whittington, 1987). It is also considered to make a high degree of original contribution.

3.3.1 The Degree of Innovation

Watts and Zimmerman won the Notable Contribution to the Accounting Theory Award according to this 1979 paper (Tinker et. al, 1995). They innovatively used economic angle to investigate deeply the demand for and supply of accounting theories, especially under government intervention, which greatly broadened the views and adjusted the directions for the academic professionals. Furthermore, it closely linked theory with the empirical tests, which emphasised the importance of agency cost (Watts and Zimmerman, 1990). In their paper, Watts and Zimmerman (1979) investigated and analysed the different levels of influence in terms of the law regulating railroads, the income tax laws, and the securities acts between the UK and U.S. to verify their hypothesis, which further showed the pronounced and notable contribution they made to open another view in contrast with previous theories.

3.3.2 The Degree of Original Contribution

Watts and Zimmerman have introduced a revolutionary idea of positive accounting theory. For decades, accounting research was always based on the normative accounting theory, which prescribed “What accounting practices should be” and described “what”-type problems. Whereas, positive accounting theory predicted “what are accounting practices” and explained “why”-type questions (Zimmerman, 1980; Sterling, 1990; Sinha, 2008). Consequently, positive accounting theory has promoted the translation of accounting objectives from idealistic to reality.

Because of its predictability, positive accounting theories have offered novelty and vigour. The prediction function led explanations to unobserved accounting phenomenon and practices as well as observed ones which haven’t been certified by systematic figures and evidence. As Demski (1988) stated, comparing the prediction with empirical instances provides further verification or denegation of positive accounting theories.

In general, positive accounting theory has made a high degree of original contribution to both the theoretical development of accounting and the practice. For instance, in China, the restrictions and waste of accounting resources led to a negative impact on the development of accounting theory before the 1990s. However, with further understanding of international accounting theory by Chinese scholars and under the advantage of the development of domestic Stock Exchanges, positive accounting theory has made a substantial breakthrough in the accounting field of research in China since 1997. It was highly advantageous to improve the Chinese accounting theoretical system and strengthen international academic communication, which has served better for China’s reform and opening up policy (Chen, 2004).

4. Conclusion

This paper evaluated the paper by Watts and Zimmerman (1979) based on the criteria selected such as the validity of framework and assumption, the appropriateness of evidence, the objectivity of author’s view, and the degree of innovation and original contribution. It is found that, out of the six criteria selected, their paper failed four of them and only reached the other two. Based on this finding, although there’s no denying that the paper is widely cited as a pioneer work to initiate positive accounting research, it is considered to have serious weak points, which significantly reduce its value. Thus, the paper should be used with a high degree of caution.


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