*Economics / 14. Economics Theory

BABALOLA, Yisau Abiodun

Accounting and Auditing Department

Volodymyr Dahl East Ukrainian National University, Lugansk, Ukraine

AGENCY THEORY, TRANSACTIONS COST ECONOMICS AND RESEARCH IN ACCOUNTING EDUCATION

The context of the development and dissemination of social science theories, the agency model presents a particular problem and this model is arguably the most popular model in use by accounting researchers today as evidenced by the body of extant accounting literature (Almer et al., 2005; Harrell and Harrison, 1993 etc) cited by Jaffrey Cohen. The model assumes a separation of ownership and control, information asymmetry arising from that separation, the availability of incentives and rewards, and most significantly, narrowly self- interested behavior on the part of the contracting parties (Noreen, 1988). Its basic propositions are easy to understand, intuitively appealing, and empirically tractable but its popularity rests upon these features which in turn, rest upon the set of simplifying assumptions that underlie the model. The assumption of self- interested behavior is the driving force behind the agency problem is the element that the theory says is ideally resolved; one can argue that ethical concerns could be subsumed in agency theory under the rubric of non pecuniary benefits. However, the way agency theory is often presented in accounting texts led to emphasize the items that can be quantified, thereby paying less attention to ethical concerns. Almer et al. (2005) argue agency theory models focus too heavily on pecuniary benefits and neglect the professional responsibility public accountants have to serve the public good, a responsibility that is an important motivator for at least some public accountants.

Agency theory, which is based on utility theory, posits rationality as a key assumption of economic agents. As Noreen (1988) notes, however, rationality has become conflated with narrowly defined self- interest and is now seen as promoting an agenda that emphasizes economic payoffs at the expense of all other outcomes. Hence, the theoretical inclusion of “self interest” in agency theory as a vehicle that narrowly advances the interest of the individual is at best debatable and, at worse, dubious.

But the primacy of self- interest is also an empirical claim. If this assumption is not true, the external validity of the agency model is threatened. Testing this assumption would seem, therefore, to be a primary consideration of researchers who are interested in using the model. Direct testing of this assumption is notably absent in our literature, even though existing literature in accounting and elsewhere indirectly raises significant questions about the validity of the assumption of strictly self- interested behavior (Almer at al., 2005). Rather, managerial self- interest may be constrained by ethical conditions, which casts much doubt on the agency theory assumption that behavior is motivated solely by self- interest. Successful markets occur when people make assumptions about other people behaving in ways that are not prescribed or described in agency theory (i.e., they do not seek only their own narrowly defined self- interest) (Noreen, 1988).

Given the domination in accounting education and research of models based on self- interested behavior, is there any chance of ever succeeding in inculcating in our students the value of acting in the public interest? The emphasis on modeling is tied up with a belief that accounting information does not imply or promote any given value system. However, by its very nature accounting information puts precedence on numbers and promotes decisions based on a narrow subset of available information. Information that is relevant but difficult to quantify is systematically excluded and thus de-valued.

The reluctance of accounting educators to talk about values and moral imperatives has promoted a complete tilting of the curriculum exclusively toward consideration of equity stakeholders (Gaa and Thorne, 2004). The interests of other stakeholders – creditors, communities, employees – are nearly disregarded in the accounting curriculum, despite the key importance of these stakeholders to the pursuit and growth of the business as well as to promoting actions that are in the public interest.

Agency models, like any model that has been simplified for tractability, offer a thin support for students who rely on their education to prepare them for dealing with the “real world.” As may be commonly understood by any individual who has experience as a member of a business organization, the decision- making process neither reduces to a question of asymmetries and pecuniary incentives, nor does it reduce to a simple question of shareholder value. These theories, such as an agency model perspective, are too spare, leaving our students unprepared for a messy, politicized environment ridden with messy organizational cultures, ethical dilemmas, and personal value conflicts. A serious consideration of multiple stakeholders is essential for accounting students, if these students are going to give more than lip service to a public interest perspective.

The agency model and related economic theories, such as transactions cost economics, have been institutionalized not only in research, but in textbooks and courses offered to both undergraduate and graduate students as well as accounting students (Richardson and O’Malley, 1995). To the extent that governance choices are an important determinant of firm performance, managers would be well-advised to heed those rules and to factor transaction-cost concerns into their decision-making calculus. Economic models in textbooks focus almost exclusively on the maximizing of equity shareholder value, and offer limited adaptability to the concerns of other stakeholders, or to the explicit incorporation of ethical concerns.

To the extent that the importation of “scientific” approaches into research and teaching has resulted in attempts to strip accounting and finance of their moral and ethical contexts, it is possible that the drive for rigor has played an indirect role in the development of a rash of accounting scandals.

REFERENCES

Almer, E. D., J. L. Higgs and K. L. Hooks. 2005. A theoretical framework of the

relationship between public accounting firms and their auditors. Behavioral

Research in Accounting (17): 1-22.

Gaa. J. C. and L. Thorne. 2004. An introduction to the special issue on ethics and

Professionalism in accounting education. Issues in Accounting Education

(February): 1-6.

Jaffrey Cohen; rethinking the influence of Agency Theory in Accounting

Academy; 4282 Grainger hall, University Ave, Madison.

Noreen, E. 1988. The economics of ethics: A new perspective on agency theory.

Accounting, Organizations and Society, 13(4): 359-370.

Richardson, G. D. and P. L. O’Malley. 1995. Ethics and Positive Accounting

Theory. Centre for Accounting and Ethics, University of Waterloo, Ontario.