Positive accounting theory (PAT) is a general term for any theory that provides descriptive information regarding the behavior of accountants. The title has been used by Watts and Zimmerman and this is largely an expansion of previous studies carried out firstly by Fama and later by Ball & Brown in the 1960’s. In looking at the apparent acceptance by politicians, firms and wide publication in academic journals PAT could easily be mistaken as being a success. A deeper analysis of the premises of PAT, its questionable scientific status, and the groups upon whom this theory has appealed to would suggest that it is flawed on many levels and is little more than an argument for deregulation and ...view middle of the document...
Watts and Zimmerman used this research in developing PAT to illustrate that because there was a reaction in capital markets when accounting information showing abnormal results was released this information was useful and those who wanted to change the present system of measurement failed to appreciate the incumbents usefulness. They claimed that capital markets could see through changes in accounting policy and see the bigger picture of firms, therefore rendering them impervious to misleading accounting methods (Watts & Zimmerman 1986).
This was then used to form and anti regulatory stance. As capital markets could ‘see through’ the accounting methods being used, regulation was considered little more than an inefficiency that interfered with the function of free markets and was costly to firms. These firms could determine the best ways to report for themselves and it is believed under this theory that auditing will also occur without regulation because users of information will demand audited information so as to give it some value (Mouck 1992).
The question still existed however, that if managers didn’t change accounting methods in order to affect share prices then why did they do it? This is the question that Watts and Zimmerman attempted to answer and this was done with assistance from the concept of ‘agency theory’.
Agency is defined as
“A contract under which one or more (principals) engage another person (the agent) to perform some service on their behalf which involves delegating some decision-making authority to the agent”
- Jensen & Meckling (1976, p.308)
This means (in a nutshell) that firms are a nexus where various self motivated utility maximizes met to generate as much wealth as possible for their own selfish selves. This means that the owners of firms must align their goals with those of the ‘drivers’ of firms in order to minimize the associated costs of the separation of ownership and management (eg laziness). This will mean tying bonuses to goal achievement and this then produces the need for accounting information with which to measure goal achievement.
It is from this theory that the three main parts of Watts and Zimmerman’s PAT come into existence; the debt hypothesis, the political cost hypothesis and the bonus plan hypothesis. For example, the bonus plan hypothesis states that management will change their accounting policies (to the extent that is reasonably allowed) in order to maximize reported income if their bonuses are dependant on the level of reported income due to their self interest. This notion of self interest can also be applied to the other PAT hypothesis put forward by Watts and Zimmerman.
Therefore, the premises of Positive Accounting Theory can be summarized as: empiricism and scientific research; the economic theory of perfect markets, The Efficient Market Hypothesis, (which is reliant upon the above economic theory) and agency theory
and its arguments of self interested agents. The broader new...