Legitimation crisis in accounting and beyond

In the wake of a seemingly endless wave of corporate accounting scandals, many people are beginning to realize accounting practices have important social consequences. Recent layoffs and vanishing stock portfolios demonstrate that it is false and even dangerous to view financial reports as nothing but passive and objective representations of companies’ financial results.

Accounting practices arbitrate social conflicts, mask social antagonisms and reproduce social contradictions. Given what is at stake, it is important to understand that the accounting scandals are the products of real people acting in the social, political and economic institutions we and others before us created.

I am proud to be an accounting professor, but it greatly disturbs me that accounting and other business practices sometimes violate their own norms, and in some cases turn into their opposites.

Enron, WorldCom and other corporate tragedies illustrate how shareholder wealth maximization can become shareholder bankruptcy, how principles of fair exchange can become social injustice, how some analysts have turned the maintenance of market efficiency into legalized insider trading and how trust can evolve into mistrust. Our problems might be caused by just a few bad apples, but we should not lose sight of the fact the companies involved are bigger than ever. When something bad happens, thousands of people can lose their jobs and thousands of shareholders can lose their investments.

These troubling times suggest that in order to improve corporate social responsibility, we must find ways to improve our accountability systems. Accountability and related principles of justice are based on the simple premise that people should be held responsible for the consequences of their actions. In principle, accountability systems can be designed to facilitate ongoing relationships among interdependent parties.

For example, an effective accountability system for corporate financial reporting establishes and enforces relationships among accountants, company executives, employees, shareholders and consumers. Our accounting and auditing standards, executive stewardship and fiduciary responsibilities, and legal systems are supposed to provide reasonable assurance that violations will not occur and that any violators will be caught and punished.

Of course, the real world is a lot messier. One large public accounting firm recently has been convicted and handed a virtual death sentence, but so far the company executives, lawyers, directors, investment bankers, stock analysts and other highly paid professional groups who actively participated in the scandals have not been held accountable. Unfortunately, some of our most important accountability systems are designed to resolve contested social spaces in favor of privileged parties, and thereby fail to enforce the norms they are supposed to protect.

Recent federal legislation promises to overhaul accounting practices by prohibiting a range of consulting services accountants can provide to publicly traded companies, establishing an oversight panel to set and enforce auditing standards and providing stiffer penalties for corporate wrongdoers.

I am not very excited about this legislation because I fear it does not go far enough to prevent and detect wrongdoing. In June, the Securities Exchange Commission issued a new rule requiring CEOs and CFOs to personally certify in writing and under oath that their most recent reports filed with the SEC are complete and accurate. I am disturbed that we have reached the point where such extreme measures are necessary, given that the Foreign Corrupt Practices Act of 1977 already required SEC registrants under the Securities Exchange Act of 1934 to maintain reasonably complete and accurate records and an adequate system of internal controls.

But in reality, it has been extremely difficult to convict company executives on criminal charges. It is too difficult to explain financial wrongdoing to juries, and even more difficult to prove intent. Until the new SEC rule is tested in the courts, we will not know whether it effectively erodes the “hear-no-evil-see-no evil, I sincerely tried to do the right thing, I am not a lawyer, I am not an accountant” finger-pointing legal defenses that so far have insulated most high-profile executives from accountability. In addition to the new SEC rule, I believe that meaningful financial reporting reform will require compensation committees to tie executive compensation to the accuracy of companies’ financial reports.

The erosion of accountability has created a legitimation crisis in corporate America. When seeking an appropriate public response, it is important to recognize that the recent scandals are not the inevitable consequences of capitalist system evolution. Our problematic accountability and governance systems are socially constructed – i.e., the products of historical conditions, human interests, values and institutions.

Accordingly, to better understand accounting practices and the ethical problems confronting the accounting profession, we must critically examine the institutional and social conditions in which accountants and company managers live and work. But these are not just mere technical accounting problems, for our accounting institutions and practices are situated within, and limited by, their broader socio-political context.


Brian Shapiro is an accounting professor in the Carlson School of Management. Send comments to [email protected]