Accounting Organizations and Society, Vol. 13, No. 6, pp. 623-629, 1988. 0361-3682/88 $3.00+.

00
Printed in Great Britain Pergamon Press plc

POSITIVE ACCOUNTING THEORY: A REVIEW*

JOEL S. DEMSKI
School o f O r g a n i z a t i o n a n d Management, Yale University

Abstract

watts and Zimmerman's Positive Accounting Theory provides a refreshing, controversial and important
contribution to accounting thought. It is important because of its vigorous emphasis on the entity's actual
choice of financial accounting technique (or, more broadly, financial reporting activity). It is controversial
because the theory and empirical techniques it conveys are not fully developed. It is refreshing because it
challenges us to expand our thinking about the nature of accounting institutions.
In this essay, I try to document these claims about the content and significance of Positive Accounting
Theory. The first section presents my interpretation of the work. The next section lists some concerns
which I feel are important in consuming the work and in providing directions for continued labor. The third
section discusses some unusual strengths in the work, while the final one provides some speculation about
where accounting thought might next venture.
Before proceeding, though, a caveat emptor warning must be issued. This essay presents both aspects
which I learned about and also those which I worried about while consumingPositiveAccounting Theory.
It is an experiential report.

AN INTERPRETATION In turn, theory is u s e d b o t h to g u i d e us in t h e

The c e n t r a l t h e m e in Positive A c c o u n t i n g
Theory is c h o i c e o f a c c o u n t i n g m e t h o d . Empiri-
cally, t h e w o r k f o c u s e s o n financial a c c o u n t i n g
m e t h o d as a d e p e n d e n t variable. T h e o r e t i c a l l y ,
t h e w o r k stresses t h e i d e n t i f i c a t i o n o f t h e cir-
cumstances which p r o d u c e a particular choice
o f financial a c c o u n t i n g m e t h o d . T o illustrate, w e
w a n t to p r e d i c t c h o i c e o f i n v e n t o r y m e t h o d
t h r o u g h t i m e in t h e e m p i r i c a l d o m a i n ; and w e
s e e k t h e o r y t o g u i d e this e m p i r i c a l quest. M o r e
broadly, w e w o r r y a b o u t t h e e n t i r e d o m a i n o f
financial r e p o r t i n g activities, r a n g in g f r o m
c h o i c e o f m e t h o d t h r o u g h time, to audit arrange-
ments, to p o l i t i ca l activities.
This a m o u n t s to a r e v e a l e d p r e f e r e n c e ap-
pr o ach . T h e basic data c o n s i s t o f e n t i t y c h o i c e
a n d c i r c u m s t a n c e . F r o m t h e s e data w e h o p e to
infer t h e forces, e c o n o m i c in this p a r t i c u l a r
paradigm, that p r o d u c e d t h e o b s e r v e d c h o i c e s .
s e a r c h for i n d e p e n d e n t variables an d to f o cu s
t h e i n f e r e n c e task so that it c a n b e a c c o m p l i s h e d
o r r a t i o n a l i z e d w i t h an a p p r o p r i a t e c o s t - b e n e f i t
calculus.
This line o f e n q u i r y has a l o n g t r a d i t i o n in
e c o n o m i c s . C o n s i d e r a simplistic s e t t i n g w h e r e
an individual sel ect s q u a n t i t i e s o f t h r e e g o o d s
s u b j e c t to a b u d g e t constraint. T h e p r i c e v e c t o r
is d e n o t e d p = ( P I , P 2 , P 3 ) an d t h e q u a n t i t y vec-
t o r q = ( q l , q2, q3). C o n s u m p t i o n o f v e c t o r q,
t h e r e f o r e r e q u i r e s e x p e n d i t u r e of p . q = P l q l +
P2q2 + P3q3. The e m p i r i c a l d o m a i n o f neoclassi-
cal e c o n o m i c s consists o f p r i c e s and quantities.
T h e r e v e a l e d p r e f e r e n c e q u e s t i o n is w h e n can
an e x t e r n a l o b s e r v e r n o t e p and q and m a k e in-
f e r e n c e s a b o u t t h e individual's p r e f e r e n c e s ? T h e
e c o n o m i s t , o f co u r se, typically e x p l o i t s rational
b e h a v i o r ; rational in t h e sen se that it is suffi-
c i e n t l y c o n s i s t e n t to b e r e p r e s e n t e d b y a utility
m e a s u r e . This f o c u s e s t h e o b s e r v a t i o n q u e s t i o n

*The helpful comments of Rick Antle, Anthony Hopwood, Steve Ryan, Mark Wolfson, and Jerry Zimmerman and the financial
support of the National Science Foundation are gratefully acknowledged.

623
624 JOEL S. DEMSKI

e v e n further, to t h e p o i n t o f asking w h e n p r i c e w e a l t h a n d p r i c e s ) . T h e i n d u c e d p r e f e r e n c e for

a n d q u a n t i t y o b s e r v a t i o n s c a n b e u s e d to con-
s t r u c t t h e i n d i v i d u a l ' s utility function.
For our purposes, there are three aspects of
this e x e r c i s e to k e e p in mind. First, t h e observa-
bles are p r i c e s a n d quantities. T h e d i r e c t a n a l o g y
to a c c o u n t i n g w o u l d h a v e us o b s e r v e a c c o u n t -
ing m e t h o d p r i c e s a n d t h e a c c o u n t i n g m e t h o d s
actually c h o s e n b y t h e entity. Second, t h e infer-
e n c e e x e r c i s e is s u b j e c t to a r e g u l a r i t y c o n d i t i o n
that t h e o b s e r v e d p r i c e s and q u a n t i t i e s b e suffi-
c i e n t l y c o n s i s t e n t that t h e y c a n b e r e p r e s e n t e d
b y s o m e utility function. T h e d i r e c t a n a l o g y to
a c c o u n t i n g w o u l d have a c o n s i s t e n c y c o n d i t i o n
that t h e o b s e r v a t i o n s b e c o n s i s t e n t w i t h s o m e
cost--benefit calculus. Finally, t h e individual's
tastes are t a k e n as a primitive. T h e d i r e c t a n a l o g y
to a c c o u n t i n g w o u l d h a v e us r e g a r d t h e e n t i t y ' s
tastes for a c c o u n t i n g m e t h o d as a p r i m i t i v e in
t h e o b s e r v a t i o n and i n f e r e n c e p r o c e s s .
T h e a n a l o g y is s t r a i n e d b e c a u s e o b s e r v a t i o n
a n d c h o i c e in t h e a c c o u n t i n g d o m a i n are n o t
clear-cut, a n d this s h e d s light o n t h e d e l i c a c y o f
r e v e a l e d p r e f e r e n c e e x p e r i m e n t a t i o n in ac-
c o u n t i n g . W e o b s e r v e , m o r e o r less, t h e e n t i t y ' s
c h o i c e o f financial r e p o r t i n g m e t h o d , a l o n g w i t h
t h e c o n t e m p o r a n e o u s s p e c i f i c a t i o n o f GAAP.
P r i c e s a r e a n o t h e r matter. Likewise, t h e r e is a
s e n s e in w h i c h t h e entity's tastes are n o t primi-
tive. z M o r e b r o a d l y , w e v i e w t h e firm as select-
ing an "optimal" m i x o f i n p u t s a n d o u t p u t s , in-
cluding contracting arrangements. Accounting
is b u t o n e factor o f p r o d u c t i o n in this larger
p r o b l e m . T h e e n t i t y ' s tastes for a c c o u n t i n g ,
then, d e p e n d o n t h e p r i c e s o f o t h e r factors.
Thus, t h e n o t i o n o f p r e f e r e n c e for a c c o u n t i n g
m e t h o d is a m o t i o n o f i n d u c e d p r e f e r e n c e . T o
illustrate, let us r e t u r n to t h e s i m p l e setting w i t h
t h r e e c o m m o d i t i e s . W e s p e a k o f p r e f e r e n c e for
t h e first two, b y associating w i t h e a c h p a i r o f ql
a n d q2 t h e c o n d i t i o n a l l y b e s t q3 ( d e p e n d i n g o n
t h e first two, in o t h e r w o r d s , d e p e n d s o n m a r k e t
c i r c u m s t a n c e s a n d taste for all three. In this way,
w e r e c o g n i z e that focus o n an e n t i t y ' s c h o i c e
f r o m GAAP is an i n d u c e d p r e f e r e n c e e x e r c i s e
w h e r e w e m a t c h e a c h r e p o r t i n g m e t h o d w i t h its
c o n d i t i o n a l l y b e s t m i x o f o t h e r factors. Cross-
sectionally, then, w e w o u l d like to c o n t r o l for
this m o v e m e n t to i n d u c e d p r e f e r e n c e b y
a c k n o w l e d g i n g t h e m i x o f o t h e r factors in t h e
e x p e r i m e n t . Similarly, in a t i m e series e x p e r i -
m e n t w e w o u l d like to a c k n o w l e d g e t h e t i m e
series n a t u r e o f GAAP, as w e l l as o f t h e e n t i t y ' s
p r o d u c t i o n f u n c t i o n a n d c o n d i t i o n a l l y "optimal"
m i x o f o t h e r factors.
It is also useful to n o t i c e that t h e r e v e a l e d pre-
f e r e n c e t h e m e has, in various forms, a l o n g his-
t o r y in t h e a c c o u n t i n g literature. This t h e m e , for
e x a m p l e , is a p p a r e n t in t h e h u m a n i n f o r m a t i o n
p r o c e s s i n g l i t e r a t u r e (e.g. Libby, 1981, in par-
ticular, o r K a h n e m a n e t a L , 1982, m o r e g e n e r -
ally). B r o a d l y c o n s t r u e d , w e offer t h e s u b j e c t
some information processing opportunities and
ask h i m o r h e r to r e s p o n d w i t h a " c h o i c e " o f pro-
cessing. As t h e data b a s e o f c h o i c e s builds, w e
b e g i n to s e e patterns. E x a m p l e s are c o n s e r v a t i v e
i n f o r m a t i o n p r o c e s s i n g o r a n c h o r i n g ( r e l a t i v e to
Bayesian p r o c e s s i n g ) . T h e basic data, in o t h e r
w o r d s , a r e t h e s u b j e c t s ' actual choices. C o n t r a r y
to t h e e c o n o m i s t ' s r a t i o n a l i t y focus, h o w e v e r , ra-
t i o n a l i t y (as d e f i n e d b y Bayesian r e v i s i o n a n d a
c o n s i s t e n t a p p r o a c h to risk a v e r s i o n ) is n o t
d o c u m e n t e d o r inferred. Rather, t h e focus is o n
d o c u m e n t a t i o n o f s y s t e m a t i c t e n d e n c i e s rela-
tive to this n o r m .
T h e r e v e a l e d p r e f e r e n c e t h e m e is also appa-
r e n t in field s t u d i e s (e.g. H o p w o o d , 1972; Brow-
nell, 1986; Banker & Datar, 1 9 8 7 ) w h e r e w e
s t u d y b u d g e t m e c h a n i s m s in t h e i r natural envi-
r o n m e n t . H e r e w e e n v i s i o n a b r o a d set o f b u d g e t
devices, i n c l u d i n g s u c h things as h o w to mea-

~The standard consistency condition is the strong axiom of revealed preference. Casually, this states that ifcommodity bundle
q0 = (q l, q2, q~) is revealed preferred to bundle ql ..., is revealed preferred to bundle q~, then ~ must also be revealed prefer-
red to q~. See Henderson & Quandt ( 1971 ), Varian ( 1971 ) and Chipman et al. ( 1971 ).
ZIn particular, l speak of the "entity's choice" or the "organization's goals" in this essay. But a deeper understanding would
allow us to treat the entity's tastes as endogenous. Recognize, therefore, that when I speak of the entity's choice I am sidestep-
ping basic questions of how this entity forms and operates.
 POSITIVE ACCOUNTING THEORY 625

sure performance, what non-financial informa-
tion to use and evaluation "style". Links to the en-
tity's environment and mix of productive factors
are sought in turn, so as to make some inference
about the taste for (or appropriateness of) the
procedures and infrastructure that are observed.
In m y view, then, Positive Accounting Theory
is an exercise in revealed preference. We have
some experience with this art form, especially in
the human information processing and intra-
organization reporting settings. The novelty of
Positive Accounting Theory is its emphasis on
economic constructs in the financial reporting
domain. Studies of this genre include Hepworth
(1953), Archibald ( 1 9 6 7 ) and Gagnon (1967).
Recent work takes advantage of developments in
economic theory, and empirical techniques and
opportunities. Positive Accounting Theory
stands out for its c o h e r e n c e and broad applica-
tion, for its attempt to structure financial ac-
counting debate within a single framework of ef-
ficient organizational arrangement.3
SOME CONCERNS
This work has generated c o n c e r n in response
to the identification of its precise nature (e.g.
Christenson, 1983) or the execution of particu-
lar studies (e.g. McKee et al., 1984; Holmstrom,
1982). Maintaining the view that the work is an
exercise in revealed preference focuses m y task
of placing the work in perspective. On the one
hand, the application of revealed preference to
the financial accounting domain is novel, and we
should therefore expect a refinement in theory
and empirical application as the art form prog-
resses. On the other hand, the work has an exten-
sive pedigree, and we should therefore expect to
exploit this pedigree in developing the art form.
Some insights along this line flow from the in-
duced preference nature of the application.
Others flow from surrounding applications.
Stepping back from the specific studies,
though, I identify several c o m m o n themes
which I think are useful to keep in mind when
working through this material. My first such con-
cern is the rhetoric of perfect markets. Market
value maximization, present value and wealth
are useful constructs from the world of perfect
and complete markets. Accounting is most (or
perhaps only) interesting when markets are not
pristine. Contracting and political costs emerge
in Positive Accounting Theory as an important
acknowledgement that markets are not perfect.
What, then, would the organization's goal be-
come? Is market value maximization sufficiently
descriptive? Is present value sufficiently weU
defined in a world of significant market imper-
fections? What is wealth in a world where profes-
sional managers face significant and largely unin-
surable career risks? Limited marketability and
non-financial concerns enter here, and we are
led to search for a mechanism to rationalize the
entity's goals. Unfortunately, we have little
theory to guide us. Positive Accounting Theory
cannot be faulted for this shortage of theory; but
it is important to keep in mind that the rhetoric
of perfect markets is a substitute for inadequate
theory. 4
My second c o n c e r n is covered by the ques-
tion: what is endogenous here? Revealed prefer-
ence has its roots in individual choice and, aside
from complaints that advertising creates (a lack
of) taste, the primitive in the system is the indi-
vidual's taste. Here, however, we are worried
about a major corporation's choice of public re-
porting method at a particular time in its history.
Is it sufficient to focus the exploration of some-
thing like bonus plan characteristics or the struc-
ture of debt contracts? More generally, these
contractual relationships are endogenous.5
What characteristics of the production function,

3Broad structures are in abundance in the literature, e.g. Canning (1929). Also, it seems more correct to view P o s i t i v e
A c c o u n t i n g T h e o r y as offering a broad structure of accounting, not simply financial accounting. But the book is confined to
financial reporting experiments and I therefore carry along the financial qualifier.
4Recall my c a v e a t in note 2.
SLeftwich e t al. ( 1981 ), for example, provide a model based on exogenous supply and demand for monitoring, where demand
is driven by size, debt, preferred stock and price.
 626 JOEL S. DEMSKI
a l o n g w i t h t h e labor, capital a n d p r o d u c t mar-
kets, c o n s p i r e t o l e a d t h e o r g a n i z a t i o n to t h e s e
choices? F o r m a l a g e n c y t h e o r y (e.g. Hart &
H o l m s t r o m , 1 9 8 7 ) c o n c e r n s itself w i t h t h e link
f r o m e n v i r o n m e n t t o c o n t r a c t u a l relationships,
a n d t h e r e f o r e to i n d u c e d o r g a n i z a t i o n choices.
M o r e specifically, t h e e n t i t y ' s c h o i c e o f re-
p o r t i n g m e t h o d is o n e a m o n g c o u n t l e s s factor
choices. Most o f t h e s e c h o i c e s are d e c e n t r a l i z e d ,
and the managers and the control systems under
w h i c h t h e y l a b o r a r e e n d o g e n o u s . Linking ac-
c o u n t i n g c h o i c e t o p a r t i c u l a r c o n t r a c t u a l ar-
r a n g e m e n t s ( s u c h as a d e b t c o v e n a n t o r a formal
b o n u s p l a n ) is interesting, b u t w e w a n t a m o r e
p r i m i t i v e identification. W h a t e n v i r o n m e n t a l
factors a r e a s s o c i a t e d w i t h t h e c o m b i n e d ar-
r a n g e m e n t o f c o n t r a c t i n g and a c c o u n t i n g
c h o i c e ? 6 An e c o n o m i c a l l y d e s i g n e d o r g a n i z a t i o n
o r c h e s t r a t e s t h e b e h a v i o r o f its actors. T h e m o r e
i m p o r t a n t question, then, is n o t h o w a c c o u n t i n g
m e t h o d c h o i c e s v a r y t h r o u g h t i m e a n d cir-
c u m s t a n c e , b u t w h y t h e o r g a n i z a t i o n has b e e n
d e s i g n e d to m o t i v a t e this p a r t i c u l a r b e h a v i o r in
t h e a c c o u n t i n g d o m a i n . R e t u r n i n g to t h e t h r e e
c o m m o d i t y vignette, it is as if t h e t h i r d c o m m o d -
ity h a d d i s a p p e a r e d f r o m t h e analysis. This casts,
it seems, c o n s i d e r a b l e n o i s e ( i f n o t b i a s ) i n t o t h e
e m p i r i c a l e x p l o r a t i o n . T h e r e is a t e n d e n c y h e r e
to t r e a t t h e e n d o g e n o u s as e x o g e n o u s .
A third, a n d c l o s e l y related, c o n c e r n d e a l s
w i t h t h e level o f i n t e g r a t i o n a m o n g t h e various
c o m p o n e n t s o f t h e labor, capital, p r o d u c t , infor-
m a t i o n a n d p o l i t i c a l "markets". In b u i l d i n g a
m o d e l o r s e e k i n g an e m p i r i c a l i d e n t i f i c a t i o n w e
always e m p l o y j u d g m e n t in defining t h e b o u n d -
ary o f t h e e x e r c i s e . But it strikes m e that consid-
e r a b l e c a r e is r e q u i r e d in u n d e r s t a n d i n g w h e r e
t h e b o u n d a r i e s a p p e a r to b e d r a w n in Positive
Accounting Theory. O n e illustration o f w h e r e
this b o u n d a r y c o n c e r n a p p e a r s is in t h e focus o n
a c c o u n t i n g earnings. C o m p e t i n g s o u r c e s o f in-
f o r m a t i o n a r e always p r e s e n t . In s t u d y i n g ac-
c o u n t i n g , then, w e w a n t to r e c o g n i z e t h e exis-
t e n c e o f this o t h e r information. This d r i v e s us to
6In contrast, the intra-organization studies tend to focus on environmental explanations, but without use of(induced) econ-
omic incentives as an intervening variable.
7Aparallel comment applies to the notion that lobbying activity is useful in the political arena, or "market".
w o r r y a b o u t c o n d i t i o n a l i n s t e a d o f marginal
p r o b a b i l i t i e s in defining i n f o r m a t i o n c o n t e n t . It
also d r i v e s us to w o r r y a b o u t t h e c o m p a r a t i v e
a d v a n t a g e o f a c c o u n t i n g . Thus, it w o u l d s e e m
that t h e i n f o r m a t i o n c o n t e n t o f actual tech-
n i q u e s g i v e n that w e a l r e a d y k n o w t h e informa-
t i o n c o n v e y e d b y t h e cash o u t c o m e w o u l d b e a
useful w a y t o s t r u c t u r e t h e d e b a t e . Similarly,
s e a r c h i n g for c o r r e l a t i o n b e t w e e n t h e " p e r f o r m -
a n c e i n d e x ( e a r n i n g s ) ... [and] t h e effect o f t h e
m a n a g e r ' s a c t i o n s o n t h e value o f t h e firm" (p.
2 0 6 ) misses t h e i m p o r t a n c e o f o t h e r informa-
tion. T h e c o r r e l a t i o n s h o u l d b e a partial correla-
tion, r e c o g n i z i n g t h e e x i s t e n c e o f t h e o t h e r in-
f o r m a t i o n (e.g. cash). In e a c h i n s t a n c e w e w a n t
to ask w h a t w e are learning, g i v e n w h a t w e h a v e
a l r e a d y l e a r n e d f r o m o t h e r sources. D r a w i n g t h e
b o u n d a r y a little less tightly w o u l d c a r r y a l o n g
t h e i d e a that w e m u s t b e e v e r c o g n i z a n t o f t h e
o t h e r s o u r c e s o f information.
A n o t h e r illustration o f this b o u n d a r y c o n c e r n
arises in t h e p o l i t i c a l s e c t o r o f t h e a r g u m e n t .
Political activities a r e i m p o r t a n t in u n d e r s t a n d -
ing r e g u l a t o r y p h e n o m e n a . F o r m a l e c o n o m i c
m o d e l i n g o f m u l t i p e r s o n p h e n o m e n a uses t h e
n o t i o n o f e q u i l i b r i u m behavior. Here, b y con-
trast, w e s e e e x t e n s i v e u s e o f b e h a v i o r a l con-
s t r u c t s i n s t e a d o f f o r m a l e q u i l i b r i u m analysis.
F o r e x a m p l e , a c o m m o n t h e m e is that p o l i t i c a l l y
sensitive firms s e e k t o m i n i m i z e s h o r t - r u n re-
p o r t e d i n c o m e ( t h o u g h a p p a r e n t l y n o t in t h e ob-
vious fashion o f d e s i g n i n g a n d p r o d u c i n g unsala-
b l e p r o d u c t s ) . Yet this activity is successful in
the political arena because of "information
costs". This strikes m e as an u n u s u a l e q u i l i b r i u m ,
b u t I h a v e n o formal m o d e l to offer o r cite. 7
A n o t h e r e x a m p l e is t h e u s e o f political c o s t s
( w h i c h are t h e n m e a s u r e d b y s i z e ) in t h e argu-
m e n t . A g o o d a n a l o g y h e r e is t h e s t o c k o u t c o s t in
a c o n v e n t i o n a l i n v e n t o r y m o d e l . W e p o s i t par-
ticular o r d e r i n g a n d h o l d i n g costs, a n d t h e n
round out the model with some generic cost
n u m b e r to link t h e analysis to t h e b a c k o r d e r i n g ,
r e s c h e d u l i n g and d e m a n d shift activities that a r e
 POSITIVEACCOUNTINGTHEORY 627

likely to a c c o m p a n y a s t o c k o u t . I liken this t o m o r e t h a n c h a n g e t h e list o f regulations. It con-

asking for a c o s t n u m b e r t o s u r r o g a t e for t h a t
p a r t o f t h e analysis t o o difficult to f o r m a l i z e ( a n d
this is likely t o b e p a r t a n d p a r c e l o f an efficient
d e c i s i o n analysis t e c h n i q u e ) . W h e n r e a d i n g
Positive Accounting Theory w e w a n t t o a c k n o w -
l e d g e t h e i m p o r t a n c e o f p o l i t i c a l a c t i v i t y in t h e
r e v e a l e d p r e f e r e n c e analysis. But w e d o this b y
e n v i s i o n i n g a p o l i t i c a l c o s t t e r m w i t h o u t exa-
m i n i n g ( e q u i l i b r i u m ? ) b e h a v i o r in a l a r g e r
m o d e l . O n c e this is r e c o g n i z e d , w e b e g i n t o un-
d e r s t a n d that p o l i t i c a l c o s t is an e q u i l i b r i u m no-
t i o n that is vital t o i n t e g r a t i n g t h e a r g u m e n t . At
this p o i n t w e h a v e a label for this i m p o r t a n t link;
b u t its t h e o r e t i c a l a n d e m p i r i c a l n a t u r e r e m a i n a
m y s t e r y . Positive Accounting Theory is c a n d i d
about the under-development of the political
c o s t n o t i o n . M y s u g g e s t i o n is that it is usefully
t h o u g h t o f as an e q u i l i b r i u m n o t i o n , l i n k e d t o
w h e r e w e c i r c u m s c r i b e t h e a r g u m e n t . [More-
over, t h e e q u i l i b r i u m b e h a v i o r w e a r e t r y i n g to
intuit m a y b e c o u n t e r intuitive. F o r e x a m p l e , in
e q u i l i b r i u m a t i g h t e n i n g u p o f GAAP t o m o r e in-
formative disclosure mechanisms may reduce
t h e a m o u n t o f d i s c l o s u r e , as in D y e ( 1 9 8 5 ) . ] s
A final c o n c e r n is o n e o f e m p i r i c a l aggressive-
ness. To a r g u e b y analogy, w e d o n o t s e e indus-
trial o r g a n i z a t i o n e c o n o m i s t s e x a m i n i n g t h e set-
tings o n s c r e w m a c h i n e s in t h e i r e m p i r i c a l w o r k ;
t h e y t e n d to b e m o r e m a c r o , c o n c e r n i n g t h e m -
selves w i t h s u c h things as c o s t c u r v e e s t i m a t i o n
o r d o c u m e n t i n g a g g r e g a t e r e g u l a t o r y effects.
T h e q u e s t i o n is, at w h a t p o i n t d o w e o u t s t r i p t h e
e m p i r i c a l t e c h n o l o g y in this d o m a i n ? ( I h a v e n o
a n s w e r . ) O n e e x a m p l e is a focus o n s w i t c h i n g
phenomena. With a larger model of the account-
ing m e t h o d c h o i c e p r o b l e m , it s e e m s that t h e
s w i t c h e r s at a n y p a r t i c u l a r p o i n t w o u l d b e t h o s e
w h o a r e c l o s e r to t h e margin. D o e s this suggest
u n u s u a l e m p i r i c a l n o i s e in t h e quasi e x p e r i -
ment? Another example stems from regulatory
activities. A r e g u l a t o r y a n n o u n c e m e n t d o e s
veys that n o w w a s an o p p o r t u n e t i m e to c h a n g e
t h e list o f regulations, a n d t h u s m a y c o n v e y
something about future regulatory manoeuvres.
P r e s e r v a t i o n o f t h e c u r r e n t list o f r e g u l a t i o n s has
a similar i n t e r p r e t a t i o n . W h a t c o n t r o l variables
c a n w e a c c e s s t o a c k n o w l e d g e that h o w t h e
g a m e is p l a y e d m a y b e a s o u r c e o f i n f o r m a t i o n t o
the game's participants?
A n o t h e r e x a m p l e is t h e i m p o r t a n c e o f o t h e r
s o u r c e s o f information. Again u s i n g t h e t h r e e
c o m m o d i t y vignette, c h o i c e o f q2 a n d q3 will
g e n e r a l l y d e p e n d o n t h e p r i c e s o f all t h r e e c o m -
modities. Ignoring other sources of information
(as w e l l as s u b s t i t u t e s for l a c k o f i n f o r m a t i o n )
a m o u n t s t o i g n o r i n g t h e first p r i c e in this illustra-
tion. At p r e s e n t w e h a v e l i m i t e d insight i n t o t h e
i m p o r t a n c e o f this m y o p i a . P r e s u m a b l y , field
studies, w i t h an e m p h a s i s o n d o c u m e n t i n g t h e
a c t u a l r e p o r t i n g c h o i c e s a l o n g w i t h an e n o r m -
o u s a m o u n t o f d e t a i l a b o u t o t h e r s o u r c e s o f in-
formation and the local environment, can be
f o c u s e d o n this q u e s t i o n . 9
SOME UNUSUAL STRENGTHS
T w o f e a t u r e s o f Positive Accounting Theory
are, in m y mind, sufficiently i m p o r t a n t to war-
rant e m u l a t i o n . T h e first is s h e e r novelty. Re-
v e a l e d p r e f e r e n c e w o r k has b e e n a familiar
activity in s o m e areas o f o u r literature. M o v i n g it
i n t o t h e financial r e p o r t i n g s p h e r e in a v i g o r o u s
fashion is a m a j o r i m p r o v e m e n t in o u r literature.
In fact, it f o r c e s m e to t h i n k in m o r e e x p a n s i v e
w a y s a b o u t a c c o u n t i n g , a n d t o b e m o r e judi-
c i o u s in a t t e m p t i n g t o link t h e v a r i o u s s t r a n d s o f
o u r literature.
T h e s e c o n d i m p o r t a n t f e a t u r e is risk taking be-
havior. N o v e l t y is n o t in a b u n d a n c e in o u r litera-
ture, p e r h a p s b e c a u s e p r o d u c i n g n o v e l lines o f
t h o u g h t is a risky business. T h e w o r k in Positive

8Notice how far we have moved from the single person specification of the usual revealed preference experiment. Strategic
behavior is now a possibility, thus raising additional concern over how widely the experimental net should be cast.
9Yet another example concerns the choice among indifferent alternatives. From a preference perspective, we regard the
exercise as well structured up to the identificationof equivalence classes. Yet the array ofinformationallyequivalent account-
ing choices, especiallywhen other sources of information are present, may be large. See Antle & Demski ( 1988 ).
628 JOEL S. DEMSKI
Accounting Theory r e s u l t e d f r o m a w i l l i n g e s s to
take r e s e a r c h risks. T h e b e t w a s an u n d e r de-
veloped theory coupled with under-developed
e m p i r i c a l t e c h n i q u e s c o u l d b e c o m b i n e d to
t e a c h us s o m e t h i n g . O n t h e surface, it is n o t ap-
p a r e n t that this is a w i s e b e t ( t h o u g h it has s u r e l y
b e e n r e v e a l e d to b e so). Even at this j u n c t u r e ,
w e a r e n o t y e t a s s u r e d that this p a r t i c u l a r line o f
activity will c o n t i n u e t o o c c u p y a m a j o r p o r t i o n
o f t h e literature. That d e p e n d s o n t h e s u c c e s s o f
t h e n e x t g e n e r a t i o n o f studies. H o w e v e r , at this
t i m e in o u r literature, it is c l e a r that Positive Ac-
counting Theory has c a t a l y z e d c o n s i d e r a b l e
thought. Risk taking b e h a v i o r p r o d u c e d this
catalyst. W h e r e a r e t h e n e w risk takers? t°
SOME SPECULATION
A s s u m i n g that Positive Accounting Theory is
t h e state-of-the-art in r e v e a l e d p r e f e r e n c e w o r k
at this level, w h a t m i g h t w e s p e c u l a t e to b e t h e
n e x t d i r e c t i o n that this line o f t h o u g h t will take?
Williamson's (1985) notion of governance
strikes m e as a likely c a n d i d a t e . T h e m o s t haunt-
ing t h o u g h t that o c c u r s w h e n s t u d y i n g this liter-
a t u r e is h o w little it tells us a b o u t a c c o u n t i n g .
W e h a v e an u n u s u a l m i x t u r e o f m a n d a t e d , dele-
g a t e d a n d r e g u l a t e d r e p o r t i n g - - all in an envi-
ronment of political oversight and occasional
political onslaught. W h y d o w e a l l o w m a n a g e r s
f r e e d o m , o f a sort, t o s e l e c t a r e p o r t i n g m e t h o d ?
W h y d o w e e n t r u s t d y n a m i c a d j u s t m e n t o f GAAP
to t h e FASB a l o n g w i t h d y n a m i c a d j u s t m e n t o f
GAAS to t h e AICPA? ( W h y d o w e h a v e s e p a r a t e
e n t i t i e s for g o v e r n m e n t a l r e p o r t i n g , n o t to m e n -
BIBLIOGRAPHY
Antle, R. & Demski, J., Revenue Recognition (unpublished manuscript).
Archibald, T. R., The Return to Straight-line Depreciation: an Analysis of a Change in Accounting Method,
Journal of AccountingResearchSupplement ( 1967 ).
Banker, R. & Datar, S., Accounting for Labor Productivity in Manufacturing Operations: an Application, in
Bruns, W. and Kaplan, R. (eds)Accounting and Management:FieldStudyPerspectives (Harvard Busi-
ness School Press, 1987).
t~vrhismay tell us something about the infrastructure of our scholarly enterprise.
t i o n railroads?) W h a t e x p l a i n s t h e g o v e r n a n c e
s t r u c t u r e b e f o r e us? W h a t is it a b o u t financial re-
p o r t i n g that c r e a t e s a d e m a n d for s u c h an elabor-
ate g o v e r n a n c e s t r u c t u r e ? D e m a n d for gover-
nance, it s e e m s to me, is n e e d e d to r o u n d o u t t h e
t h e o r y a n d e m p i r i c a l w o r k . W e h a v e an u n u s u a l
institutional s t r u c t u r e in a c c o u n t i n g , c o m p l e t e
w i t h an u n u s u a l g o v e r n a n c e s t r u c t u r e . A c c o u n t -
ing r e s e a r c h will, o n e h o p e s , a d d r e s s this land-
scape.
CONCLUSIONS
T h e test a p p l i e d to Positive Accounting
Theory in this essay is utilitarian: g i v e n t h e state
o f o u r literature, d o e s this a d d i t i o n c o n t r i b u t e to
o u r s t o c k o f k n o w l e d g e ? To me, t h e a n s w e r is
affirmative. Positive Accounting Theory offers
n o v e l t y a n d vigor. Many q u e s t i o n s r e m a i n
b e c a u s e t h e t h e o r y is scant a n d b e c a u s e t h e em-
p i r i c a l t e c h n i q u e s are at t h e early stages o f de-
v e l o p m e n t . T h e s h o r t - r u n s u c c e s s o f this re-
s e a r c h activity is a s s u r e d b y t h e q u e s t i o n s p o s e d .
T h e l o n g - r u n s u c c e s s is l i n k e d to p r o g r e s s in
d e a l i n g w i t h t h e s e questions.
R e f i n e m e n t s in t h e o r y a n d e m p i r i c a l tech-
n i q u e c a n b e a n t i c i p a t e d o n this score, as c a n
g r a d u a l e x p a n s i o n to i n c l u d e t h e issue o f gover-
nance. Scholarship, though, is an i n t e r a c t i v e p r o -
cess. R e v e a l e d p r e f e r e n c e is a w e l l - p r a c t i c e d art
f o r m in o t h e r settings, a n d it s e e m s that Positive
Accounting Theory has s o m e t h i n g to l e a r n f r o m
t h e s e c o m p l e m e n t a r y e n t e r p r i s e s , just as t h e y
h a v e s o m e t h i n g to l e a r n f r o m Positive Account-
ing Theory.
 POSITIVE ACCOUNTING THEORY 629

Canning, J., The Economics o f Accountancy ( New York: Ronald Press, 1929).
Chipman, J., et aL, Preferences, Utility, and Demand (St. Petersburg, EL: Harcourt, 1971 ).
Christenson, C., The Methodology of Positive Accounting, Accounting Review (January 1983).
Dye, R., Strategic Accounting Choice and the Effects of Alternative Financial Reporting Requirements Jour-
nal o f Accounting Research (Autumn 1985).
Gagnon,J., Purchase Versus Pooling of Interests: the Search for a Predictor J o u r n a l o f Accounting Research
Supplement ( 1967 ).
Hart, O. & Holmstrom, B., The Theory of Contracts, in Bewley, T. (ed.)Advances inEconomic Theory, Fifth
World Congress (Cambridge: Cambridge University Press, 1987).
Henderson, J. & Quandt, R., Mieroeconomic Theory: a MathematicalApproach (New York: McGraw-Hill,
1971).
Hepworth, S., Smoothing Periodic Income, Accounting Review (January 1953).
Holmstrom, B., Managerial Incentive Problems - - a Dynamic Perspective, Essays in Economics andMan-
agement in Honor ofLars Wahlbeck (Stockholm: Swedish School of Economics, 1982).
Kahneman, D., Slovic, P. & Tversky, A.,Judgment Under Uncertainty: Heuristics and Biases ( Cambridge:
Cambridge University Press, 1982).
Leftwich, R., Watts, R. & Zimmerman, J., Voluntary Corporate Disclosure: the Case of Interim Reporting,
Journal o f Accounting Research Supplement ( 1981 ).
Libby, R., Accounting and H u m a n Information Processing: Theory and Applications (Englewood Cliffs,
NJ: Prentice-Hall, 1981 ).
McKee, A., Bell, T. & Boatsman, J., Management Preferences over Accounting Standards: a Replication and
Additional Tests, Accounting Review ( October 1984).
Varian, H., MicroeconomicAnalysis (New York: Norton, 1978).
Watts, R. & Zimmerman, J., Positive Accounting Theory (Engiewood Cliffs, NJ: Prentice-Hall, 1986).
Williamson, O., The Economic Institutions o f Capitalism (New York: Free Press, 1985 ).