Americanism and financial accounting theory – Part 3: Adam Smith,the rise and fall of socialism,and Irving Fisher's theory of accounting

A previous paper (Part 1) rejected the conventional wisdom that America was ‘born capitalist’ and the historians’ consensus that it had become capitalist by the early-19th century; another (Part 2) rejected Chandler's thesis that the ‘modern business enterprise’ brought a ‘new form of capitalism’ to America from the 1840s. The accounting evidence suggests that America began to make the transition to capitalism around 1900 in a period of intense conflict between ‘capital and labour’ generated by ‘big business’ from the 1880s, a process not completed until the 1920s. This paper (Part 3) examines the consequences for America's political ideology and financial accounting theory. America's exceptional transition, it argues, explains the history of its political ideology, and this history explains Irving Fisher's theory of accounting. Section A argues that America lagged behind Britain because it started from a society of simple commodity producers and semi-capitalists, which created an exceptional ideological problem for its ruling elite. Big business generated hostility from workers, farmers and small employers – expressed in labour movements, ‘populism’, socialism, and ‘progressivism’ – and created an ideological problem by contradicting the ‘independent producer’ ideology of workers and farmers, and the ‘individual liberalism’ of small manufacturers and merchants, both underwritten by Adam Smith's Wealth of Nations. The paper argues that Smith's theory of price articulates as semi-capitalist accounting, which explains his popularity in America until the appearance of big business in the 1880s. Socialism and progressivism became political forces in America from 1900 to around 1920. Progressivism produced ‘corporate liberalism’, the ideological counter to socialism that corporations could be made ‘socially responsible’ by government regulation and ‘publicity’ to ensure they earned only ‘fair’ returns, but this left two problems. First, socialists argued that no profit was ‘fair’, and second, fear of the ‘labour danger’ made American financial reports secretive and conservative. Section B argues that Irving Fisher responded to these problems with a theory of accounting, which he developed as a refutation of Marx and the American brand of socialism advocated by Eugene Debs, the threateningly successful presidential candidate of the Socialist Party of America. An important but neglected reason for socialism's abrupt collapse around 1920, it argues, was that the socialists lost the intellectual argument with the middle classes, and that Fisher's theory played an important role in this defeat. Fisher was a vigorous self-publicist, strongly influenced the teaching of economics and accounting in the universities and, the paper argues, changed the language of American accounting. Fisher claimed that accounting practice supported his theory of ‘capital’ and ‘income’, but the paper shows he did not understand double-entry bookkeeping or the accountants’ ‘cost theory of value’, and therefore divorced accounting from the reality of business transactions. As his theory underlies the FASB's framework, the paper concludes that Fisher's legacy to the world is a pathological theory of financial accounting.     

A theory and contractual framework of Islamic micro-financial institutions’ operations

Microfinance is seen as a ‘new paradigm’ for bringing about development and eradicating poverty. Many studies prove that the provision of small amounts of credit to the poor is crucial in this new paradigm. However, these studies mainly focus on the conventional microfinance institutions (MFIs) which have already existed for a couple of decades. Their role in helping the poor to achieve higher income and higher standards of living has been well recognized. Currently, there are quite a few MFIs that are operating based on Islamic principles. Although a few studies have been conducted on this subject, the literature lacks a comprehensive theoretical framework to describe the Islamic microfinance institutions (IMFIs). This article explores the contractual framework in modelling the IMFIs, on the one hand, and discusses the role of IMFIs via various modes of financing in providing capital to micro-enterprises, on the other.     

Decision-making under uncertainty – A field study of cumulative prospect theory

The presented research tests cumulative prospect theory (CPT, [Kahneman, D., Tversky, A., 1979. Prospect theory: An analysis of decision under risk. Econometrica 47, 263–291; Tversky, A., Kahneman, D., 1981. The framing of decisions and the psychology of choice. Science 211, 453–480]) in the financial market, using US stock option data. Option prices possess information about actual investors’ preferences in such a way that an exploitation of conventional option analysis, along with theoretical relationships, makes it possible to elicit investor preferences. The option data in this study serve for estimating the two essential elements of the CPT, namely, the value function and the probability weighting function. The main part of the work focuses on the functions’ simultaneous estimation under CPT original parametric specification. The shape of the estimated functions is found to be in line with theory. Comparing to results of laboratory experiments, the estimated functions are closer to linearity and loss aversion is less pronounced.     

OK in practice – and theory

This teaching note considers the experience of introducing an extended case study and simulation into an auditing course for second or final year undergraduates. Having reviewed the reasons for adopting a different approach to the teaching of auditing, the paper provides a case for the applicability of case studies, drawing a distinction between auditing practice and auditing theory and considering the different roles case studies can play therein. After setting out the redesign of the auditing course, the paper goes on to describe the extended case study, discussing the reception of the course, the limitations of the case study and resource implications.     

Who hedges more when leverage is endogenous? A testable theory of corporate risk management under general distributional conditions

This paper develops a theory of a firm’s hedging decision with endogenous leverage. In contrast to previous models in the literature, our framework is based on less restrictive distributional assumptions and allows a closed-form analytical solution to the joint optimization problem. Using anecdotal evidence of greater benefits of risk management for firms selling “credence goods” or products that involve long-term relationships, we prove that those optimally leveraged firms, which face more convex indirect bankruptcy cost functions, will choose higher hedge ratios. Moreover, we suggest a new approach to test this relationship empirically.

Bank lending ‘manias’ in theory and history

A popular view of banking crises sees them as consequences of prior bank lending manias. Such manias are supposed to be especially likely in legally unrestricted banking systems, where banks can issue notes and are not subject to statutory reserve requirements. Here it is argued that the bank lending mania hypothesis (1) exaggerates the role of subjective factors, including bankers' confidence or optimism, as a stimulus to bank lending, and (2) is not supported by evidence from past, legally unrestricted banking systems.     

New analytical option pricing models with Weyl–Titchmarsh theory

Abstract

In this paper we consider the valuation of Bermudan callable derivatives with multiple exercise rights. We present in this context a new primal–dual linear Monte Carlo algorithm that allows for efficient simulation of the lower and upper price bounds without using nested simulations (hence the terminology). The algorithm is essentially an extension of the primal–dual Monte Carlo algorithm for standard Bermudan options proposed by Schoenmakers et al. [SIAM J. Finance Math., 2013, 4, 86–116] to the case of multiple exercise rights. In particular, the algorithm constructs upwardly a system of dual martingales to be plugged into the dual representation of Schoenmakers. At each level, the respective martingale is constructed via a backward regression procedure starting at the last exercise date. The thus constructed martingales are finally used to compute an upper price bound. The algorithm also provides approximate continuation functions that may be used to construct a price lower bound. The algorithm is applied to the pricing of flexible caps in a Hull and White model setup. The simple model choice allows for comparison of the computed price bounds with the exact price obtained by means of a trinomial tree implementation. As a result, we obtain tight price bounds for the considered application. Moreover, the algorithm is generically designed for multi-dimensional problems and is tractable to implement.     

Is earnings management opportunistic or beneficial? An agency theory perspective

Earnings management has been cast into negative light due to the recent corporate scandals and, therefore, is viewed as detrimental to the firm. Enron and Worldcom represent two of the most egregious cases of opportunistic earnings management that led to the largest bankruptcies in U.S. history. However, some argue that earnings management may be beneficial because it improves the information value of earnings by conveying private information to the stockholders and the public. We offer agency theory as a tool to distinguish between the opportunistic and beneficial uses of earnings management. The empirical evidence suggests that firms where earnings management occurs to a larger (less) extent suffer less (more) agency costs. Moreover, a positive relation is documented between firm value and the extent of earnings management. Taken together, the results reveal that earnings management is, on average, not detrimental.     

‘It's the tip of the iceberg’: the hidden tensions between theory,policy and practice in the management of Freedom of Information in English local government bodies—evidence from a regional study

This article examines a major UK value-for-money study by Sir Roy McNulty in the context of the neoliberal public policy environment. This environment favoured rail's privatization, and subsequent reform attempts, which maintained the privatization model, have done little to address rail's fundamental problems. McNulty's proposals are examined in terms of their likely effects on the infrastructure authority and the train companies. The article concludes that, although McNulty correctly identified fragmentation as a key cause of rail's cost escalation, and noted the less fragmented nature of other European railways, its neoliberal focus meant that it missed the opportunity to reverse the process.     

First steps towards an equilibrium theory for Lévy financial markets

For a continuous-time financial market with a single agent, we establish equilibrium pricing formulae under the assumption that the dividends follow an exponential Lévy process. The agent is allowed to consume a lump at the terminal date; before that, only flow consumption is allowed. The agent’s utility function is assumed to be additive, defined via strictly increasing, strictly concave smooth felicity functions which are bounded below (thus, many CRRA and CARA utility functions are included). For technical reasons we require for our equilibrium existence result that only pathwise continuous trading strategies are permitted in the demand set. The resulting equilibrium asset price processes depend on the agent’s risk aversion (through the felicity functions). Even in our simple, straightforward economy, the equilibrium asset price processes will essentially only be (stochastic) exponential Lévy processes when they are already geometric Brownian motions. Our equilibrium asset pricing formulae can also be modified to obtain explicit equilibrium derivative pricing formulae.     

How accurate are modern Value-at-Risk estimators derived from extreme value theory?

In this study, we compare the out-of-sample forecasting performance of several modern Value-at-Risk (VaR) estimators derived from extreme value theory (EVT). Specifically, in a multi-asset study covering 30 years of stock, bond, commodity and currency market data, we analyse the accuracy of the classic generalised Pareto peak over threshold approach and three recently proposed methods based on the Box–Cox transformation, L-moment estimation and the Johnson system of distributions. We find that, in their unconditional form, some of the estimators may be acceptable under current regulatory assessment rules but none of them can continuously pass more advanced tests of forecasting accuracy. In their conditional forms, forecasting power is significantly increased and the Box–Cox method proves to be the most promising estimator. However, it is also important to stress that the traditional historical simulation approach, which is currently the most frequently used VaR estimator in commercial banks, can not only keep up with the EVT-based methods but occasionally even outperforms them (depending on the setting: unconditional versus conditional). Thus, recent claims to generally replace this simple method by theoretically more advanced EVT-based methods may be premature.     

Do high interest rates deter speculative attacks? – Evidence and some theory

This paper presents the first empirical evidence on the efficacy of raising interest rates ex ante as a deterrent to speculative attacks. Using a dataset that covers 54 countries from March 1964 through December 2005, we find strong evidence that raising interest rates in advance has significantly different impacts in different country groups. It significantly reduces the probability of attacks in countries that have a de facto hard peg but increases it in de facto soft-pegging countries. This finding is robust to alternative measure of monetary policy and to different specifications and samples. We then present a simple two-stage signaling model to offer a theoretical explanation for our empirical findings.     

Consumers’ collision insurance decisions: a mental models approach to theory evaluation

Using interviews with 74 drivers, we elicit and analyze how people think about collision insurance coverage and decide whether to buy coverage, and if so, what deductible level to carry. We compare respondents’ judgments and behaviors to predictions of three models: baseline expected utility (EU) theory, which predicts that insurance is an inferior good, meaning more wealthy people buy less; a modified EU model, which incorporates income constraints and suggests that property insurance is a normal good, meaning more wealthy people buy more; and a mental accounting model which predicts that consumers budget income across consumption categories. The results suggest they purchase insurance as a normal good, guided by a cognitive model that emphasizes budget constraints. Verbal reports reveal a desire to balance two conflicting goals in deductible decisions: keeping premiums ‘affordable’ and keeping deductible level ‘affordable.’ Thus, wealth does not distinguish people by risk aversion, but by ability to pay. In other words, the behavior of less wealthy people is not driven by greater risk aversion, but by their lesser ability to pay, both now and later. We find that a simple heuristic using only vehicle value accounts for most decisions of whether to purchase optional collision coverage: out of 45 respondents who did not have loans on their vehicles, 90% of those with vehicles worth more than $1000 carried collision coverage, while less than 30% of those with lower‐valued vehicles did.     

Are structural VARs with long-run restrictions useful in developing business cycle theory?

No, unless technology shocks account for virtually all of the fluctuations in output.     

Back to the future: New potential for structuration theory in management accounting research?

For three decades, the use of structuration theory has made a distinctive contribution to management accounting research. A recent development of the theory by Stones [Stones, 2005. Structuration Theory. Palgrave Macmillan, Basingstoke] advocates a move away from the relatively abstract concepts evident in the work of Giddens, towards providing more concrete constructs that give epistemological and methodological guidance to researchers in the field. In order to achieve this, he recommends deployment of the concept of position–practices, combined with use of a quadripartite model of structuration. The main purpose of this paper is to examine the potential of this development for management accounting research. We do so by setting it within our own skeletal model of the structuration process, and then using it to analyse a case study of management accounting practices in a privatised utility company. We conclude that investigation of position–practices focuses attention on the strategic conduct of agents, the importance of power in social interaction, and a plurality of structures and theories of action. But, whilst the quadripartite model highlights the phenomenology, hermeneutics and practices of agents, we note that it provides few direct insights into the processes of reproduction, learning and change in management accounting. We suggest this limitation can be overcome by using structuration theory in a flexible manner, drawing inspiration from other theoretical perspectives which ascribe central roles to path dependency, contradiction and praxis.