Positive Accounting Theory Essay

1195 Words Sep 6th, 2010 5 Pages
WHY SHOULD WE BELIEVE THE PAT STORY?
Watts and Zimmerman have been very successful in their dissemination of the PAT story. As Whittington notes, they are "two of the most widely discussed contributors to the accounting literature of the past decade" (1989, p. 327). They are also the joint founder-editors of The Journal of Accounting and Economics, a journal devoted to positive accounting research, which has achieved an international reputation. So their story, while admittedly controversial, has achieved credibility among a significant number of accounting researchers. But what accounts for that credibility?
According to Watts and Zimmerman's (1986) view of science, a theory's credibility will ultimately be a function of explanatory
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208).
Debt/equity hypothesis. Ceteris paribus, the larger a firm's debt/equity ratio, the more likely the firm's manager is to select accounting procedures that shift reported earnings from future periods to the current period (p. 216).
Size hypothesis. Ceteris paribus, the larger the firm, the more likely the manager is to choose accounting procedures that defer reported earning's from current to future periods (p. 235).
These hypotheses, by the way, are not uniquely consistent with the remainder of positive accounting theory (the assumptions and definitions woven together in the theories of the contracting process, the political process and the role of auditing). For instance, a theory assuming that politicians and regulators act only for the public interest could be just as consistent with the size hypothesis as is Watts and Zimmerman's theory which assumes that they act only in their self-interest. Managers of large firms would presumably choose accounting procedures to report lower earnings and avoid political scrutiny regardless of the assumed motivation of politicians. That is, politicians may scrutinize firms reporting unusually large earnings in an effort to promote their (the politicians) own interest, as in the PAT story, or politicians may scrutinize such firms because they genuinely believe that large concentrations of power (as manifested by large earnings) may be contrary to the