Efficient contracting and accounting

This paper examines the role of accounting in an efficient contracting perspective of the firm. The firm is an alternative to the market when the costs of using the market become excessive. When a firm replaces the market, authority substitutes for the price mechanism in determining how decisions are made. This paper examines accounting's role in controlling the firm to ensure resources are put to their highest-value use. Accounting, together with employment contracts, compensation arrangements, debt contracts, internal and external auditors, and the board of directors including its audit and compensation committees comprise a package of mechanisms that have evolved to govern the firm. These institutional devices become the firm's efficient contracting technology. As accounting is part of that contracting technology, the accounting controls and systems that evolve and get implemented are efficient and the accounting methods that are used in calculating the numbers that form part of the firm's contractual arrangements are, likewise, efficient.