Exemplars 10

Keeping Them Honest

Opus College of Business

Brian Shapiro takes a hard look at accounting standards and practices.

I earned a B.A. in ancient Near Eastern studies and a B.A. in Latin from the University of Minnesota. My original plans were to earn a Ph.D. in ancient N. Eastern studies with an emphasis on cuneiform studies, and I wanted to conduct research on the sociocultural origins of the stories in the book of Genesis, but at the time those academic departments were shrinking at universities. My interest in languages and theoretical systems eventually led me to my graduate studies at the University of Minnesota, where I earned a Ph.D. in business administration with a concentration in accounting and a minor in cognitive psychology.

During my nearly 27 years of teaching at the Universities of Arizona, Minnesota, and St. Thomas, I have taught undergraduate financial accounting, undergraduate auditing, and graduate accounting information systems. At the University of St. Thomas I also co-teach a senior undergraduate capstone course in theology with Dr. Michael Naughton on the interface between faith and the management professions. The theology course draws from my undergraduate studies, my research on social theory and accounting, my Reform Jewish upbringing, and my experience as a Buddhist monk in training at a monastery in Bangkok, Thailand when I was 17.

As a graduate student at the University of Minnesota I learned how to design, conduct and analyze the results of psychology experiments on human subjects. My first few published research papers investigated the psychology of causal reasoning and the psychology of decisionmaking. This behavioral decision research paradigm investigates the social and psychological determinants of how people make decisions, and beginning in the early 1980s it challenged the prevailing neoclassical economic theories of rational behavior and efficient markets. My own research contributed to a growing body of literature on how different ways of framing or describing the same underlying situation can significantly influence people’s decisions, contrary to the predictions of the prevailing economic theories. Critics of the behavioral
research paradigm claimed that if only we gave our human subjects the proper incentives, they would have conformed to the predictions of economic theory, but eventually Daniel Kahneman (a leader in the behavioral paradigm) won the Nobel Prize in Economics. More recently, the global financial crisis has further demonstrated the limitations of
financial economic theories of human incentives and capital market behavior. The important lesson here is that market-based theories of human behavior are not just intellectual games; they can be seriously mistaken, and when they are implemented dogmatically in actual organizations they can have very significant (and sometimes disastrous) human consequences.   

My Ph.D. thesis and some of my subsequent research investigated the psychology of auditors’ judgments. The rationale for this research was that once we have a more complete understanding of the cognitive mistakes auditors make, we can prescribe decision aids to improve their performance. After completing my graduate studies I joined the faculty at the University of Arizona. I lost interest in studying the psychology of auditor judgment when I realized that many of the widely publicized audit failures at the time were not so much
attributable to auditors’ unconscious cognitive limitations, but rather had more to do with auditors’ conscious decisions to reduce audit costs or with their lack of  economic independence from clients. Although most auditors and most companies adhere to high professional standards and high quality financial reporting, former companies such as WorldCom and Enron illustrate that even just a few bad apples can have a major adverse impact on the financial markets.

While teaching undergraduate Intermediate Financial Accounting at the University of Arizona I grew further disillusioned when I realized that financial accounting standards on such topics as leases, pensions, post-retirement health care obligations, and executive compensation violated what is commonly referred to as the Conceptual Framework of Financial Reporting. The flaws in many of those accounting standards were not attributable to how reasonable people will disagree about how to best implement financial accounting and reporting; instead, powerful business lobbies pressured the Securities and Exchange Commission and members of Congress to support standards that were not conceptually or theoretically sound but instead benefited their constituents’ interests.

At the University of Arizona I published two papers critiquing the financial accounting standard-setting process. I used theories of discourse ethics from linguistics, sociology and philosophy to document how political power and economic interest rather than the force of the better argument can shape the evolution of financial accounting standards. Among other topics, I critiqued the Business Roundtable’s opposition to proposals to expense the cost of executive stock options on the income statement and to recognize liability for promises to pay employee retirement health costs.
Both accounting proposals would have more accurately reported corporate financial results, but they also would have materially reduced companies’ reported profits and consequently could have significantly reduced the size of executive compensation packages. Major debacles from Enron to AIG and Lehman Brothers have vividly demonstrated the consequences of our highly politicized financial accounting standard-setting process. It will be interesting to see whether the implementation of international financial reporting standards under the auspices of an international standard-setting body within a few years will reduce the pressure that U.S. business lobbies can exert on the future evolution of corporate accounting standards.

In addition, while at the University of Arizona, my colleagues and I used experimental economics methods to test an economic game theory of auditor independence and ethical behavior in a multiperson setting. One of our studies yielded counterintuitive evidence that people who score higher on a widely used measure of moral reasoning were more likely to misreport financial results in order to make more money. We speculated that people who score higher on measures of moral reasoning may sometimes more easily establish trust and collude with other like-minded individuals. That paper received the University of Oklahoma McLaughlin Prize for Research in Accounting Ethics in 2003.

After spending six years at the University of Arizona I returned to the University of Minnesota Carlson School of Management, where I continued to critique accounting and business practices. One paper critiqued public accountants’ failed attempt to provide meaningful Web privacy assurance. At that time, a company could in principle receive a clean seal of approval even if its privacy practices violated most norms of expected behavior, so long as the company accurately disclosed its practices in fine print. It bothered me that the American Institute of Certified Public Accountants did not exercise its leadership to actively promote more consumer-friendly corporate privacy practices. Privacy assurance practices and disclosures have since improved significantly during the past decade, but new privacy concerns continue to evolve and surface in social media circles, medical care and other arenas.

Another of my studies investigated curtailment of post-retirement health benefits. Most of the employer promises to pay the benefits to retired employees were not legally binding, even though they gave their employees oral assurances that they would continue to pay the benefits. The previous financial accounting standards did not require companies to report the associated liabilities and fund the promises. Many of the companies eventually faced financial difficulty and subsequently reduced or eliminated the retirement health benefits. I used theories of discourse ethics from linguistics and sociology to analyze and morally evaluate the impact of false oral assurances on employee beliefs. The study also documents the adverse human and social consequences of faulty accounting standards. A haunting parallel exists today in the arena of public pensions, where state and local governments have significantly underreported and underfunded their past promises. 

After spending more than six years at the University of Minnesota, in 2004 I joined the faculty at the University of St. Thomas Opus College of Business. My recently published research (with Professor Diane Matson) provides a critical history of corporate resistance to internal control reporting, from the Foreign Corrupt Practices Act of 1977 through Sarbanes-Oxley (2002). Another paper critiques the failure of scientific accounting research to proactively investigate and critique flaws in corporate governance and executive compensation. In my view, at least until recently, mainstream accounting research published in the so-called top accounting journals in North America during the 1990-2003 period (before Sarbanes-Oxley) placed too much weight on flawed empirical studies and abstract mathematical theories in financial economics. Many of those studies erroneously concluded that executive compensation packages were designed in a manner that was socially optimal even though not perfect. Recent market experience has since tempered enthusiasm for the standard financial economic theories, and many of the elite business schools now recognize the descriptive validity and scientific rigor of the alternative behavioral finance and behavior economics research programs.

My current research investigates how narrative traditions, spiritual traditions, and other cultural bases of accountability norms shape the policies and practices of some business organizations. During my fall 2011 sabbatical I plan to use the Committee of Sponsoring Organizations (COSO) Enterprise Risk Management Framework to systematically investigate how some business organizations translate their corporate mission statements and other abstract principles of responsible business practices into actual organizational policies, procedures and activities. This line of research has clearly been shaped by my active involvement with the University of St. Thomas Center for Catholic Studies, and I appreciate the financial and logistic support from our UST Opus College of Business Center for Ethical Business Cultures.

Brian Shapiro
“Even just a few bad apples can have a major adverse impact on the financial markets.”