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Volume 15, Number 11
November 2009

Back to the future

Mitchell Stein finds that accounting history challenges the idea of a perfect corporate governance model

When Enron and WorldCom collapsed amidst financial scandal, there was a huge public outcry for higher corporate governance and accounting standards. One response was the Sarbanes-Oxley Act, designed to protect shareholders and the public from accounting errors and fraudulent practices. Although the Act has been praised for its stringent measures, Ivey professor Mitchell Stein says it’s a mistake to think that the underlying problems have been solved.

Stein’s research interests include the analysis of accounting practices in terms of corporate governance reforms from both a contemporary and historical perspective. He is also undertaking an examination of how transparency is understood and used within the business press in relation to accounting practices.

In his current research Stein looks at corporate governance and financial accounting through a unique historical lens. Recently a growing group of scholars have come to feel that an historical perspective is essential to our understanding of the modern corporation. Although the emerging corporation has been studied from economic, legal, and political aspects, the accounting side has been largely overlooked. “I’m trying to understand from an historical basis how our current accounting practices have formed and influenced corporate governance models and thinking,” he says.

Stein’s study focuses on the United States, primarily New Jersey, one of the first states to allow the formation of holding companies. He has examined archival materials, legislative reports, speeches, and accounting journals relating to the late 1800s and early 1900s. Perhaps surprisingly, he has come across accounts of corporate governance issues that sound very similar to those being discussed today. For example, at the turn of the century there was a move to require senior officers to sign off on financial statements, which is now required by Sarbanes-Oxley.

At that time there was also a sense of both the possibilities and the limitations of accounting. “There was a general feeling, similar to our own, that if they could only make accounting more sophisticated and develop accounting-specific standards, they could resolve all sorts of issues,” says Stein. At the same time there were strong doubts expressed about how much audited statements could really say about the future of a company.

Another issue debated in the early 1900s was the idea of audits and how to conduct them. Today an audit is a formal affair that companies plan for months ahead. But in the early 1900s many financial people, in discussing the need for audits, had misgivings about giving companies the time to prepare. “They believed that to be effective an audit should be totally unannounced,” says Stein. “They suggested the accountant just show up and see what was going on.”

As companies developed in the United States their ownership became diffuse and widespread, unlike Europe, where the corporate model tended toward block holdings. Many people feel that accounting standards in the U.S. developed in order to protect shareholders, but Stein says that’s not entirely the case. His review of the historical record shows that early accounting was in many ways a response to the development of large trusts. “The issue was really around disclosing information that could lead to the control or break-up of these trusts, because it was felt they were prone to charge high prices that were unfair to consumers.”

Stein believes, however, that the availability of this financial information may have led to the creation of a shareholder class. “When people saw this information they started to think, ‘hey, I could be a shareholder of a company.’”

The history of accounting is important, says Stein, because it shows that efforts to change or reform standards sometimes lead to unexpected and unintended consequences. A recent example is the issue of stock options, which became popular in the 1990s but are now being reassessed. The idea behind the creation of stock options was a good one: to align the interests of shareholders and managers. No-one anticipated the danger of stock price manipulation because of the belief that market efficiency would ensure that stocks trade at appropriate prices.
Stein believes that the results of his research challenge the assumption that corporate governance can be optimized. “The same fraudulent schemes went on a hundred years ago,” he says. “Now we claim to have all these sophisticated systems, yet one may argue that very little has changed. The only difference is that before it was millions and now it’s billions – just add a few zeros.”

Although corporate governance and accounting standards are important, Stein says there’s a danger in relying on them too much and thinking they can keep you out of trouble. He also emphasizes the importance of good management and common-sense vigilance in simply dealing with problems that crop up. “Why spend so much time trying to figure out the perfect standard to resolve these corporate governance problems when there might not be one,” he says. “Maybe we should sometimes think of these issues more in terms of just muddling through.”

Professor Stein's Homepage