Michael G Alles
Rutgers, The State University of New Jersey
Srikant S Datar
Harvard University
Abstract: The recent series of corporate scandals have resulted in an unprecedented crisis in accounting. Investors have lost faith in financial statements on the assumption that cooking the books has become a routine practice in corporate America. Restoring the credibility of financial reporting is clearly an urgent priority as indicated by the passage of the Sarbanes/Oxley Act that mandates that CEOs personally certify to the accuracy of their firms financial statements. The approach being contemplated by the accounting profession itself is a shift away from the rules-based approach to financial accounting standards used by GAAP towards the principles-based approach of International Accounting Standards. Both these initiatives draw attention to the fact that accounting standards are only useful and effective if they are actually implemented by firms in the way they were intended to be by the standard setter. The need to ensure implementation of accounting standards by managers who have an incentive to beat analysts earnings forecasts means that accounting standards have a management control component to them. In this paper we posit an ex-post perspective on accounting standard implementation that places the problem clearly within the domain of control theory. In turn, that implies that standard setters can make use of the powerful tools that control theory provides to ensure compliance by management, the four levers of control: belief, boundary, diagnostic and interactive control systems. Our control perspective provides new insights into accounting standards setting, including the need for both belief and boundary controls rather than the reliance on one alone. A critical examination of principles based accounting standards is particularly important in light of the ongoing study of the issue mandated by the Sarbanes/Oxley Act.
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