Paper for the Conference of National Standard Setters (NSS) April 2010 meeting in Seoul, Korea
The Global Financial Crisis – Accounting for Systematic Risk – Cultural Perspectives
Brief:
The paper considers the role of cultural factors in the generation of the Global Financial Crisis. It identifies constructs that may make accounting standards that require “marking to market” pro-cyclical i.e. they may accentuate booms and worsen downturns. As the International Accounting Standards Board (IASB) struggles to develop a response to the crisis of confidence, its efforts may prove, ultimately, to be in vain. It may be that no accounting standard – at least in the current paradigm – can deal with a problem that is inherently systemic. Indeed, it may not be an accounting problem at all, but may be an auditing problem. Current auditing focuses on individual company accounts. The challenge may be to evolve an audit process that includes the assessment of risks that affect the wider systems within which companies operate.
Omodele R. N. Jones
July 2011
Original NSS Paper:
Financial crises are typically preceded by hyper-inflation of asset prices. When we experience consumer price hyper-inflation, we normally react quickly, spurred by concern for its adverse effects on society: it robs the poor and reinforces the rich, and can over time lead to serious social instability.
In what way are the effects of hyper-inflation of asset prices – typified by the common distinction between the financial markets and the “real” economy - different? If they are not different, how can hyper-inflation be detected in asset prices? What is the impact of current and proposed accounting treatments of financial assets on hyper-inflationary tendencies?
Current accounting valuations require marking to market. The dominant economic theory that has supported the development of the financial markets over the last thirty years assumes that markets are efficient i.e. all relevant known information is reflected in the asset price. They belong to the rational choice school of neo-classical economics that depend on the actions of “economic man” who is assumed rational with perfect information and seeking of self-interest in a gentlemanly way. With economic man at play, the markets are said to provide a mechanism for smoothly managing market disequilibria with actions that lead to new stable and good equilibria.
But markets have long been known to be prone to failures, some unexpected, others predictable. The Global Financial Crisis of 2008 and the recession of 2009 is but one. What insights can 2009 Nobel Economics Laureate Oliver Williamson’s path breaking 1970s work on transaction cost economics (TCE) offer into our understanding of the appropriateness of the mark to market orthodoxy? In particular, what are the implications of his TCE presentations on bounded rationality and on the economics of opportunism or moral hazard?
TCE pairs the concept of bounded rationality with an assumption of human self-interest seeking that “makes allowance for guile”. This allows for the disclosure of information relevant to a transaction in a selective and distorted manner. Pre-meditated efforts to “mislead, disguise, obfuscate and confuse” are anticipated. Williamson thus distinguishes between the traditional concept of the gentlemanly “economic man” and his new concept of “contracting man” (also known by Hardt as “organisational man”) who is “given to a self interest of a deeper and more troublesome kind than his economic man predecessor”. Williamson argued in a 1989 article that this new concept addresses the reality of “man as he is”.
If economic man does not dominate a market, and is instead replaced by “organisational man”, it can be shown that marking to market can actually reinforce asset price bubbles.
Can asset bubbles be shown to possess self sustaining forces of a “perverse equilibrium”? What insights can be gained from game theoretic Prisoners’ dilemmas in this vicious cycle?
“The universal fascination with this game is due to its representing, in very stark and transparent form, the bitter fact that when individuals act for their own benefit, the result may well be disaster for all.” Robert J. Aumann cited in Walsh (1994: 402)
What are the links between these insights and the actions of Williamson’s “organisational man”?
Is there a market for personal values i.e. “a broad preference for one state of affairs over others” (Hofstede)? Pierre Bourdieu spoke of the inseparable link between “social exchange” and “economic exchange” i.e. all personal and societal relationships have economic outcomes “at the root of their effects”. If this is so, can a “social market” for values be subject to the adverse effects of Nobel Economics Laureate George Akerlof’s market for lemons? If so, adapting his analysis, we can see that “bad values” may drive out “good values” of a social market.
Would the dominance of “organisational man” in a market lead to a lemon market for values? Is this how “Greed is Good” creeds are borne? Are these a part of an asset price bubble mechanism having worked their way from social exchange into economic exchange? Does marking to market, in this context become part of the problem? Once a new, bad/perverse, equilibrium is established, can we detect behaviours akin to Nash equilibria (where a change in strategy by any player would lead that player to earn less than if he remained with the current strategy) that sustain bad habits until the inevitable crash sweeps all away?
How susceptible are differing cultures to these forces? Is there evidence of one culture being better at managing these threats than others? Why?
Should accountants develop a standard for accounting for hyper-inflation in asset prices? How would hyper-inflation be detected and how would adjustments be made to asset prices in financial statements? Is it the role of the accountant to dutifully report on the real effects of economic activity, or are we to acquiesce in the roller coaster of asset booms and busts? Who are we responsible to anyway? Society and the greater good of all? Or are we really responsible to our bosses, the “organisational men”?
Omodele Jones is Chair of CSAAG Sierra Leone
The paper represents his personal views and do not necessarily represent the views of CSAAG. He is in the final stage of a part time Doctorate in Business Administration at Edinburgh Business School, Heriot Watt University, Scotland. The issues above arise from his research topic: “Countries and Companies do not compete, Cultures Do! The role of social, cultural and symbolic capital in generating national competitive position in Sierra Leone”
