Description
Accounting practices are deeply implicated in the current financial crisis and in proposals
for recapitalizing financial institutions and restoring stability to the global financial system.
This essay discusses the methodological and theoretical gaps in accounting research that
explain our failure to anticipate the crisis and limit our ability to analyze and respond to it.
Global ?nancial crisis: The challenge to accounting research
Patricia J. Arnold
Sheldon B. Lubar School of Business, University of Wisconsin-Milwaukee, P.O. Box 742, Milwaukee, WI 53201, USA
a r t i c l e i n f o a b s t r a c t
Accounting practices are deeply implicated in the current ?nancial crisis and in proposals
for recapitalizing ?nancial institutions and restoring stability to the global ?nancial system.
This essay discusses the methodological and theoretical gaps in accounting research that
explain our failure to anticipate the crisis and limit our ability to analyze and respond to it.
Ó 2009 Elsevier Ltd. All rights reserved.
Introduction
While it has become commonplace to blame bankers
and their bonuses for the current global ?nancial crisis,
as the economic ruin deepens and spreads more funda-
mental questions will undoubtedly be asked about our
economic system and the institutions upon which it is
founded. The academic community is one such institution.
Why did neoclassical economic thought become unques-
tioned doctrine in so much of our academic discourse?
How did business and economics departments come to
be champions of market dogma, rather than centers for
intellectual debate and social critique? In the years preced-
ing the near collapse of the US ?nancial system, why did
the looming catastrophe, inherent in a highly ?nancialized
economy that was fuelled by irresponsible lending prac-
tices, ?nancial engineering, bogus bond ratings, opaque
?nancial instruments, and the growth of a systemically
dangerous shadow banking system, escape the attention
and critique of academic researchers?
The magnitude of this ?nancial and economic crisis
calls for a fundamental reassessment of all areas of
business and economic scholarship, including accounting
research. This essay examines the reasons accounting
research largely failed to anticipate the crisis that was
ballooning in the world of accounting practice. The aim
of this self critique is to identify the gaps in our research
methodologies and theories in order to better position
ourselves to interpret the crisis and understand account-
ing’s role in ongoing attempts to ?nd a resolution to it.
Two reasons for accounting academics’ failure to anticipate
the crisis are discussed. The ?rst is methodological, namely
the persistent gap between the world of academic research
and the world of ‘‘accounting in action’’ (Hopwood, 1978).
The second is theoretical, namely our failure to understand
the linkages between micro accounting and regulatory
technologies, and the macroeconomic and political envi-
ronment in which accounting operates. The essay con-
cludes with suggestions for a research agenda aimed at
understanding accounting’s role in the ?nancial crisis.
Bridging the gap between academic research and the
world of ‘‘accounting in action’’
The world of accounting practice is implicated in the
current ?nancial crisis in a number of ways. The most obvi-
ous is through ?nancial reporting requirements governing
asset valuation and off-balance sheet entities (Ryan, 2008).
The importance of these seemingly mundane accounting
rules is underscored by the fact that the solvency and sur-
vival of our major ?nancial institutions now turns on how
accountants value bank assets and the extent to which
auditors require ?rms to consolidate off-balance sheet
entities. Fair value accounting rules, which require compa-
nies to write-down ?nancial assets to re?ect plunging mar-
ket values, have been generating intense controversy.
Critics charge that fair value accounting ?rst contributed
to excessive credit expansion and then exacerbated the
downturn by encouraging pro-cyclical risk taking (Boyer,
2007). Opponents of fair value, including many within
the banking industry, are exerting pressure on accounting
regulators to modify valuation rules, while advocates
0361-3682/$ - see front matter Ó 2009 Elsevier Ltd. All rights reserved.
doi:10.1016/j.aos.2009.04.004
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Accounting, Organizations and Society 34 (2009) 803–809
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remain vehement in defending the need for fair value
accounting in order to reveal the full extent of bank losses.
Although less in the spotlight than the fair value debate,
?nancial reporting rules governing off-balance sheet struc-
tured investment vehicles (SIVs), including rules on special
purpose entities (SPEs), quali?ed special purpose entities
(QSPEs), and variable interest entities are equally, if not
more, signi?cant. In the 1980s, US accounting standards
setters began allowing banks to move securitized loans
and related debts off their balance sheets and onto the
books of these off-balance sheet entities (Turner, 2008).
This obviously ?awed rule which enabled the creation of
the shadow banking system has been modi?ed several
times since the 1980s,
1
but never satisfactorily. The practice
of using structured investment vehicles to move banking
operations off-balance sheets in order to evade accounting
rules and regulatory capital standards, together with the po-
tential impact on capital adequacy ratios of forcing banks to
consolidate off-balance sheet vehicles remains a crucial is-
sue facing accounting and regulatory authorities (Group of
Thirty, 2009, pp. 48–49).
Financial reporting is not the only way accounting is
implicated in the crisis; the major accounting ?rms in
the US and Europe were also directly involved in the pro-
cess of securitization and structured ?nance. In their
capacity as advisors to investment banking clients, the ma-
jor ?rms performed due diligence work, offered accounting
and tax advice on off-balance sheet vehicles, and assisted
with the securitization of trillions of dollars of mortgage
back securities (MBS) and collateralized debt obligations
(CDOs). Although an evaluation of the extent of the
accounting ?rms’ role in the making of the crisis is beyond
the scope of this essay, a preliminary review of the ?rms’
marketing literature indicates that their advisory service
divisions were active participants in the securitization
industry in the years leading up to the crisis. The following
excerpts are illustrative of securitization services offered
by all of the Big Four international accounting ?rms.
Since 1985, Deloitte & Touche USA, LLP professionals
have added insight, consistency and value to more
than 14,000 securitized offerings with an aggregated
principal of more than $5 trillion. . . Serving leading
players in the MBS, ABS, CDO and CMBS markets,
domestic and global, we offer state-of-the-art prod-
ucts and expert services in ?nancial modeling, analyt-
ics, technology, operations, due diligence, accounting
and tax.
In the past year, the PwC’s and the Structured Finance
Group (SFG) have been involved in securitization
transactions totaling billions of dollars. Structured
Finance Group professionals combine a high-level of
technical expertise to provide a wide range of securiti-
zation services, such as: deal structuring, asset valua-
tion, due diligence, modeling, operational consulting,
tax and accounting analysis, tax reporting and tech-
nology development, implementation and mainte-
nance (American Securitization Forum, 2006).
Accounting research lagged behind this burgeoning
world of accounting practice. While accounting practitio-
ners were involved in the securitization schemes that ulti-
mately led to the crisis, accounting scholars were largely
unaware of their activities or the troubles brewing in the
credit markets and shadow banking system. The premier
academic accounting journals did not address the dangers
of structured investments, securitization, and off-balance
sheet entities until 2008 when the credit crisis was in full
swing. The leading journals published more articles on
these topics in 2008 alone then in the ten preceding years
(1998–2007) combined. While there were a number of re-
search studies on fair value accounting published in the
mainstream accounting literature in the mid 1990s, they
tended to assess fair value accounting narrowly in terms
of whether it provided incremental information to capital
markets rather than evaluating its macroeconomic conse-
quences.
2
With few exceptions, academic accounting re-
search generally failed to anticipate the crisis, or mount a
substantive critique of accounting’s contribution to systemic
?nancial instability and/or accounting ?rms’ involvement in
securitization and structured ?nance.
Some will argue that the shadow banking system is too
opaque for accounting researchers to penetrate since
empirical data on off-balance sheet entities, hedge fund
activities, credit default swaps and other privately traded
derivatives are unavailable. This view suggests that our re-
search agendas must necessarily be limited and ultimately
shaped by the availability of quantitative databases. The
alternative to this unacceptable proposition is to begin to
take seriously the methodological problem of ?nding ways
to engage the world of accounting practice. Arguably, some
of the most socially important aspects of accounting prac-
tice are those where the dif?culty of obtaining data has,
with few exceptions, produced a lacuna in academic re-
search. These include issues such as tax evasion, money
laundering, transfer pricing, off-balance sheet ?nancial
activities, and the politics of accounting standard setting,
to name but a few.
3
The task of bridging the gap between
accounting research and this world of accounting practice
is extremely dif?cult, but nonetheless essential. We have
seen some progress in the ?eld of managerial accounting
where strides have been made towards understanding
‘‘accounting in action’’ (Hopwood, 1983) within organiza-
tions through the use of case study and ethnographic re-
search methodologies. The need for ?nancial accounting
research to reduce its dependence on quantitative databases
and develop the methodological tools, institutional knowl-
edge, and links to practice needed to bridge the gap between
academic research and the world of ‘‘accounting in action’’ is
one of the most signi?cant challenges posed by the current
crisis to accounting research.
1
See SFAS No. 125, SFAS No. 140, and FIN 46R.
2
The critical accounting literature, by contrast, published several
critiques of fair value accounting for ?nancial instruments. For example,
see Hernández (2003), Ishikawa (2005) and Young (1996).
3
Exceptions include Mitchell, Sikka, and Willmott (1998) on the role of
accountancy ?rms in money laundering, and related work on tax avoidance,
off-shore ?nancial centers, and transfer pricing. For example, see Sikka and
Hampton (2005), Sikka (2008) and Sikka et al. (2009).
804 P.J. Arnold / Accounting, Organizations and Society 34 (2009) 803–809
Understanding accountings relationship to the macro
political economy
The previously ignored linkages between micro level
regulatory and accounting technologies and the macro
economy is likely to be another major implication of the
crisis for research and practice. In the realm of accounting
practice, this is apparent in discussions of whether fair va-
lue accounting has a pro-cyclical impact on the economy,
and in the pressures being exerted on accounting standard
setters to consider whether the objectives of ?nancial
reporting should include ?nancial stability (Financial
Accounting Standards Board, 2009). It is also evident in
Jules Muis’ (2008) proposal that accounting ?rms report
on any systemic risks they observe in the course of their
practice that might present a threat to the orderly func-
tioning of the ?nancial markets.
There is a danger that research will lag behind the
world of accounting practice in this area, as well, since
mainstream accounting research has not developed the
theoretical capability to analyze and interpret the relation-
ship between accounting and the macro political and eco-
nomic environment in which it operates. Conventional
accounting research remains bound to neoclassical eco-
nomic theory and the narrow view of accounting as a neu-
tral technology whose function is to reduce information
asymmetry and provide the transparency needed for capi-
tal markets to function ef?ciently. The current crisis chal-
lenges the credibility of market theory and along with it
the ideas on which much of accounting theory is founded.
If we acknowledge that capital markets do not price assets
ef?ciently, what then is the economic impact of fair value
accounting? If we recognize that ?nancial markets do not
allocate capital ef?ciently, what then is the role of ?nancial
reporting in the capital markets? What then is accounting’s
role in restoring ?nancial stability? Mainstream account-
ing theory has no answers to these questions and can only
cling to the defunct notion that more transparency will
somehow revive con?dence in ?nancial markets and en-
able them to function ef?ciently once again.
Political economy offers an alternative theoretical
perspective for understanding the links between the micro
world of accounting and the macro economy. In the 1980s, a
new steam of critical accounting research grounded in
theories of political economy emerged within the ?eld of
interdisciplinary accounting research. In?uenced directly
or indirectly by Marxist thought, the political economy
approach critiqued the notion that accounting is a neutral,
objective technology that functions to improve the alloca-
tive ef?ciency of markets, and emphasized instead the ways
in which accounting is a partisan practice that is implicated
in distributive transfers of wealth between social classes. In
this view, accounting both shapes and is shaped by relations
of power within the political economy in which operates.
Accounting is, thus, seen as essentially political; accounting
policies are in?uenced by ruling elites and dominant ideol-
ogies, and accounting practices, in turn, affect the distribu-
tion of income, wealth and power within society.
The literature on the political economy of accounting
studies the historical development of accounting practices
to examine the ways in which they have been implicated
in social con?icts and distributional transfers not only on
the factory ?oor, but also within capitalist societies as a
whole. In the process, it has laid the theoretical foundations
for understanding the relationship between accounting and
the development of capitalism across different historical
periods (Bryer, 1993). The literature has also drawn on state
theory to understand the role of the state in capitalist soci-
eties as a foundation for analyzing the role that accounting
plays in the interaction between state politics and market
economies (Arnold & Sikka, 2001; Tinker, 1984). And, it
has used political economy’s concept of ideology – loosely
de?ned as ideas in the service of power – to examine the
role that accounting practices and accounting research play
in legitimizing existing relations of power and distribu-
tional transfers of wealth by cloaking them in the guise
of seemingly neutral and objective techniques (Tinker,
Merino, & Neimark, 1982).
Although political economy continued as a recognized
stream of critical accounting research, its in?uence was
overshadowed in the 1990s by the rise of postmodern
and poststructuralist theories within the social sciences
and humanities (Arnold, 1998). Post-structuralism took
hold in critical accounting, in part, as a needed corrective
to the economic determinism and functionalism found in
both neoclassical and Marxian economics. It developed a
social analysis that focused on the diffuse power of micro
technologies, such as accounting practices, as opposed to
the macro political and economic structures of power. At
the same time, micro-institutional theory which empha-
sizes the ways in which accounting is socially embedded
in cultural norms, cognitive scripts, and taken-for-granted
assumptions also gained prominence within the ?eld of
critical accounting. While post-structuralism and micro-
institutionalismhave undoubtedly made signi?cant contri-
butions to the accounting literature, both schools represent
a turn away from the analysis of politics and economics in
favor of cultural explanations of accounting’s role in orga-
nizations and society. Accounting research’s failure to
anticipate the crisis or problematize the relationship be-
tween ?nancial accounting, the growth of the shadow
banking system, and macroeconomic instability can be
attributed, in part, to this cultural turn away from political
economy and its critique of capitalism.
There are several reasons for the neglect of critical re-
search grounded in political economy. These include the
dif?culty and perhaps the fear of pursing critical scholar-
ship in business school settings, particularly in the United
States, but in many other places as well. For those who
might otherwise be motivated to do critical research, doc-
toral training poses a hurdle in the United States where
accounting PhD program curricula and cultures often dis-
courage critical studies. Outside the US, where there is a
greater acceptance of alternatives to positivist thought, the-
oretical divisions within the critical accounting research
community were sometimes exaggerated by polemics and
polarizing debates that may have discouraged a broader
engagement with the ?eld. Finally, the institutional incen-
tives faced by accounting scholars, including the tenure
and promotion system and university rankings, contribute
P.J. Arnold / Accounting, Organizations and Society 34 (2009) 803–809 805
to the commodi?cation of accounting research (Puxty, Sik-
ka, & Willmott, 1994) and encourage an overemphasis on
‘‘hits’’ in prestigious journals rather than ideas (Hopwood,
2007, 2008). These incentives, likewise, encourage confor-
mity with conservative norms and militate against the risk
taking required to engage in a social critique.
The ?nancial crisis will hopefully stimulate a revival of
accounting scholarship aimed at understanding the rela-
tionship between accounting practice and the macro polit-
ical and economic environment in which it operates.
Fortunately, political economists and economic historians
such as Polanyi (1944), Brenner (2002), Harvey (2006),
and Arrighi (1994), among others, have produced a rich lit-
erature from which we can draw to understand the under-
pinnings of the ?nancial crisis. While Marx’s intellectual
contribution remains a cornerstone of political economy,
the theoretical ?eld for accounting’s engagement with
political economy can be de?ned more broadly to include
any non-neoclassical economic framework for understand-
ing the economy and accounting’s relationship to it. These
include the work of economists such as John Maynard Key-
nes and Joseph Schumpeter as well as neo-Smithian (Ar-
righi, 2007; Sen, 2009) and neo-Marxian interpretations
of classical political economy. Socio-economic frameworks
such as economic sociology (Zukin & DiMaggio, 1990) and
regulation theory (Boyer, 1990), likewise, provide a theo-
retical foundation for accounting research to draw upon
in developing an analysis of the relationship between
accounting and the macro political economy.
Towards a political economy of accounting and crisis
In his classic study of the transformation of the US econ-
omy in the last quarter of the twentieth century, Robert
Brenner (2002) traces the roots of the crisis to the down-
turn in the economy that originated in the 1970s as a result
of global overproduction and declining rates of pro?t. In re-
sponses to declining pro?ts in the real economy, the US
adopted a host of monetary, ?scal, regulatory, and trade
policies to promote the growth and global expansion of
the ?nancial sector. This shift, which gave rise to the ascent
of ?nance capital and the concentration of economic and
political power within the ?nancial sector, is commonly re-
ferred to as ‘‘?nancialization’’. In Giovanni Arrighi’s (2007,
p. 230) analysis, ?nancialization, which is characterized by
the ‘‘capacity of ?nance capital to take over and dominate,
for a while at least, all the activities of the business world’’
provided a temporary ‘‘?x’’ to the problem of overproduc-
tion. Pro?tability was restored in the mid-1990s – albeit an
unsustainable pro?tability built on ?nancial speculation
and successive ?nancial bubbles ?rst in the stock market
and later in the housing and credit markets. This transfor-
mation within the macro political economy poses several
questions for accounting research as we attempt to under-
stand accounting’s relationship to the unfolding crisis.
Three potential avenues of inquiry are discussed below.
The politics of standard setting
First, further research is needed to examine how ?nan-
cial reporting standards have shaped and been shaped by
the ?nancialization of the economy. What is the relation-
ship between ?nancial reporting rules and the rise in
power and in?uence of the ?nancial sector? Have ?nancial
accounting rules in?uenced the strategy and structure of
the ?nancial services industry? And, too what extent has
the ?nancial industry in?uenced the standard setting
agendas of the US Financial Accounting Standards Board
(FASB) and the International Accounting Standards Board
(IASB)? Does the domination of ?nance over industrial cap-
ital explain the move towards fair value accounting and
the abandonment of the income measurement model in fa-
vor of a balance sheet valuation approach to ?nancial
accounting? Why did US accounting standard setters allow
banks to move banking operations off their balance sheets
in the 1980s?
Presently, we have only a very rudimentary knowledge
of the politics of standard setting, the relationships of
power that underlie it, and the mechanisms through which
power is exercised within the accounting standard setting
process. As Hopwood (1994) notes, notwithstanding the
prevailing view that international standard setting is dri-
ven by the needs of capital markets, ?nancial statement
users are not well represented in forums of in?uence;
users’ presence in the policy-making arena is more rhetor-
ical than substantive. In practice, the audit industry and
their lobbyists exercise far more in?uence over accounting
policy than is generally recognized in descriptions of the
accounting standard setting process that focus on the pre-
sumed interests of capital markets and regulatory author-
ities (Hopwood, 1994). This discrepancy between rhetoric
and practice is indicative of a signi?cant gap in our under-
standing of the politics of standard setting.
A political economy approach prompts us to look be-
yond conventional interest group theories of politics to
examine the structure of power within society and the of-
ten subtle ways in which power operates. Does the ?nan-
cial sector exert direct in?uence over standard setting, or
does it exercise power indirectly through its control over
the state and state regulatory apparatuses? To what extend
does power operate via ideological hegemony, namely the
belief that ?nancial accounting’s raison d’être is to serve
the ?nancial markets. As Young (1996) suggests, does
‘‘institutional thinking’’, re?ected in the narrow view that
accounting’s function is to provide transparency to the
markets, explain why standard setters adopted fair value
accounting for ?nancial instruments without regard to
the macroeconomic consequences of sanctioning the pro-
liferation of complex, unregulated, and systemically dan-
gerous ?nancial products? Or, does economic power
manifest itself in the standard setting process in more di-
rect ways? Research analyzing the political histories of
?nancial reporting standards on fair value accounting and
off-balance sheet entities, and the current pressures on
standard setting bodies to revise these rules in response
to the ?nancial crisis may shed light on these questions.
The role of accounting ?rms
Second, research is needed to evaluate the role that the
major accounting ?rms played in the origins of the ?nan-
cial crisis. The ?nancialization of the economy over the
806 P.J. Arnold / Accounting, Organizations and Society 34 (2009) 803–809
past quarter century created pro?table niches not only for
investment banks and other ?nancial intermediaries, but
also for the major accounting ?rms. Over the past two dec-
ades, economic and political power within the interna-
tional accounting industry was consolidated in the hands
of a small oligopoly of ?rms based in the US and UK. As
the ‘‘Big Four’’ ?rms expanded in size and scope, they also
moved beyond traditional accounting and auditing ser-
vices to recast themselves as providers of all types of ?nan-
cial expertise. They expanded their ?nancial advisory
divisions and marketed themselves as specialists in merg-
ers and acquisitions, corporate reorganizations, tax shel-
ters
4
, and privatization consulting (Arnold & Cooper,
1999). As discussed above, the ?rms also entered the bur-
geoning business of securitization and structured invest-
ment offering a variety of securitization services to
investment banking clients.
Although the US Sarbanes-Oxley Act of 2002 and similar
independence rules in other jurisdictions prohibit account-
ing ?rms from selling certain types of consulting services
to their own audit clients, the consultancy arms of the ma-
jor ?rms continue to thrive. Tax consulting and some other
types of advisory work can still be done for audit clients,
and services to non-audit clients are not proscribed. As a
result, a small group of accounting ?rms continues to oper-
ate simultaneously as both auditors and advisors for the
banking industry. As auditors, they play a quasi-regulatory
role as a watchdog, responsible for assuring third parties
that the ?nancial statements present a true and fair picture
of the banks’ ?nancial condition. As ?nancial advisors, it
appears that the same ?rms may have assisted the ?nan-
cial services industry in designing the structured invest-
ment vehicles that enabled them to move operations off
their balance sheets, effectively ensuring that the banking
industry’s ?nancial statements did not re?ect the full ex-
tent of risk and leverage within the ?nancial system. Re-
search is needed to evaluate the extent of the accounting
?rms’ involvement in the process of securitizing toxic debt
and structuring off-balance sheet vehicles. What was the
nature of the due diligence, tax, modeling, valuation and
accounting services offered to their investment banking
clients? Were auditors aware of systemic risk within the
banking system? And, to what extent, if any, do the major
accounting ?rms share responsibility for the ?nancial crisis
as a result of their role in the securitization and structured
investment business?
Rethinking transparency
Third, research is needed to examine the ideological
roots of the notion of ‘‘transparency’’ and the role it is ex-
pected to play in governing today’s extraordinarily com-
plex and volatile ?nancial system. The idea that markets
will ef?ciently allocate capital and risk under conditions
of perfect competition and perfect information, of course,
derives from neoclassical economic theory. It follows that
?nancial accounting and auditing have an essential role
to play by ensuring that relevant and reliable information
is disclosed to investors. This is the theoretical rationale,
but what are the actual historical and political origins of
the quasi-regulatory role that ?nancial reporting and
auditing have come to play in the governance of capital
markets? In their study of the US legislation which created
the SEC and its ?nancial disclosure requirements in the
1930s, Merino and Neimark (1982) suggest that ?nancial
reporting and auditing requirements played a largely ideo-
logical role in efforts to restore the status quo after the US
stock market crash in 1929. To what extent does that con-
tinued to be the case? Was ?nancial accounting ever up to
the task of providing transparency to capital markets with-
in the hyper ?nancialized economy of the 1990s and 2000s
where the combination of uncontrolled ?nancial innova-
tion, complex ?nancial instruments, deregulation, moral
hazard, and the consolidation of economic and political
power within the ?nancial sector rendered the ?nancial
system increasingly ungovernable? And, if not, why do
we cling to the notion that improved transparency, rather
than a recon?guration of political and economic power, is
a solution to the crisis?
A ?nancialized economy is an inherently unstable econ-
omy as evident in the series of ?nancial crises that erupted
in the 1990s, including the Mexican peso crisis, the Asian
?nancial crisis, the Russian debt default, and the collapse
of the US hedge fund, Long Term Capital Management.
These events demonstrated the fragility of the interna-
tional ?nancial system and the need for capital controls
and/or a more robust regulatory framework to reign in
the ?nancial sector and reduce systemic risk. In the after-
math of the Asian crisis, proposals were made for a global
?nancial regulator, an international bankruptcy court,
international deposit insurance, a Tobin tax, and even a
global central bank. This new ‘‘international ?nancial
architecture’’ never materialized. Instead, western govern-
ments opted for a weaker governance regime, favored by
the ?nancial sector, in which ?nancial reporting and audit-
ing played a prominent role. This regime, which Robert
Wade (2007) calls the ‘‘standards-surveillance-compliance
system’’ relied upon relatively weak forms of control,
namely transparency and compliance with international
?nancial standards – including ?nancial reporting and
auditing standards – to address the problem of systemic
risk within the global ?nancial system. Further research
is needed to understand the political processes and power
relationships that precluded, and perhaps still preclude,
the creation of stronger institutional and regulatory
arrangements for governing the ?nancial sector and in-
stead relied upon private sector institutions, such as
accounting standards boards, auditing ?rms and bond rat-
ing agencies, to play a crucial quasi-regulatory role in the
governance of the ?nancial markets. Did the illusion that
?nancial reporting standards and auditing surveillance
could substitute for more stringent forms of oversight
and/or restrictions on speculative capital ?ows contribute
to the current crisis? To what extent did false con?dence
in accounting’s ability to provide transparency to self-reg-
ulating capital markets contribute to systemic instability
4
In 2009, The Guardian published a series of investigative articles on tax
avoidance that highlight the role of accounting ?rms. See ‘‘Creative
accountants’’, ‘‘Sheltering cash: the intricate schemes drawn up by KPMG’’,
and ‘‘Gilt-edged pro?ts for profession’s ‘big four’’’ (The Guardian, 7 February
2009).
P.J. Arnold / Accounting, Organizations and Society 34 (2009) 803–809 807
by providing ideological support for dangerous levels of
global ?nancial liberalization and national deregulation
in the 1990s and 2000s?
Conclusion
In the 1980s, Cooper and Sherer (1984, p. 219) argued
the case for a political economy of accounting in the pages
of this journal by advising accounting scholars to ‘‘be nor-
mative, descriptive and critical.’’ Speci?cally, they encour-
aged accounting researchers to make their normative
value judgments explicit, to describe and interpret the
world of ‘‘accounting in action’’, and to be critical in the
sense of recognizing the politically and socially contested
nature of accounting practices. On the whole, ?nancial
accounting scholarship has developed in quite different
ways. In the futile pursuit of objectivity, we have not been
explicit (or re?ective) about the value judgments that
underpin our theories and research agendas. We became
overly dependent on quantitative databases, and failed to
grasp developments within the world of accounting prac-
tice or describe the ways in which ?nancial reporting stan-
dards, accounting ?rms, and accounting ideologies were
implicated in the build up to the crisis. Our dominant the-
ories provided an insuf?cient bases for understanding the
transformations that were occurring in the international
political economy over the past quarter century or for ana-
lyzing the relationship between macro level changes, such
as the rise to power of the ?nancial sector, and the micro
level ?eld of ?nancial accounting practice. Most impor-
tantly, we did not develop a suf?ciently broad culture of
critique within our academic community.
These shortcomings not only explain our failure to
anticipate the current ?nancial crisis, they also limit our
ability to analyze, interpret, and response to the crisis as
it continues to unfold. Accounting scholars are uniquely
positioned to use our knowledge of accounting institu-
tions, the intricacies of accounting rules, and the socially
and politically contested nature of accounting practices
to identify and explain how seemingly neutral accounting
practices facilitated, and continue to facilitate, the massive
wealth transfers that mark this extraordinary ?nancial cri-
sis. The crisis, thus, challenges us to re-evaluate our re-
search agendas – and perhaps also the institutional
incentives and unexamined assumptions that drive
them – so that accounting research can contribute to a
broader social and political analysis of the ?nancial crisis.
Acknowledgements
I wish to thank Anthony Hopwood, Prem Sikka, and the
accounting research faculty at the University of Wisconsin-
Milwaukee for their thoughtful comments and
suggestions.
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doc_541596596.pdf
Accounting practices are deeply implicated in the current financial crisis and in proposals
for recapitalizing financial institutions and restoring stability to the global financial system.
This essay discusses the methodological and theoretical gaps in accounting research that
explain our failure to anticipate the crisis and limit our ability to analyze and respond to it.
Global ?nancial crisis: The challenge to accounting research
Patricia J. Arnold
Sheldon B. Lubar School of Business, University of Wisconsin-Milwaukee, P.O. Box 742, Milwaukee, WI 53201, USA
a r t i c l e i n f o a b s t r a c t
Accounting practices are deeply implicated in the current ?nancial crisis and in proposals
for recapitalizing ?nancial institutions and restoring stability to the global ?nancial system.
This essay discusses the methodological and theoretical gaps in accounting research that
explain our failure to anticipate the crisis and limit our ability to analyze and respond to it.
Ó 2009 Elsevier Ltd. All rights reserved.
Introduction
While it has become commonplace to blame bankers
and their bonuses for the current global ?nancial crisis,
as the economic ruin deepens and spreads more funda-
mental questions will undoubtedly be asked about our
economic system and the institutions upon which it is
founded. The academic community is one such institution.
Why did neoclassical economic thought become unques-
tioned doctrine in so much of our academic discourse?
How did business and economics departments come to
be champions of market dogma, rather than centers for
intellectual debate and social critique? In the years preced-
ing the near collapse of the US ?nancial system, why did
the looming catastrophe, inherent in a highly ?nancialized
economy that was fuelled by irresponsible lending prac-
tices, ?nancial engineering, bogus bond ratings, opaque
?nancial instruments, and the growth of a systemically
dangerous shadow banking system, escape the attention
and critique of academic researchers?
The magnitude of this ?nancial and economic crisis
calls for a fundamental reassessment of all areas of
business and economic scholarship, including accounting
research. This essay examines the reasons accounting
research largely failed to anticipate the crisis that was
ballooning in the world of accounting practice. The aim
of this self critique is to identify the gaps in our research
methodologies and theories in order to better position
ourselves to interpret the crisis and understand account-
ing’s role in ongoing attempts to ?nd a resolution to it.
Two reasons for accounting academics’ failure to anticipate
the crisis are discussed. The ?rst is methodological, namely
the persistent gap between the world of academic research
and the world of ‘‘accounting in action’’ (Hopwood, 1978).
The second is theoretical, namely our failure to understand
the linkages between micro accounting and regulatory
technologies, and the macroeconomic and political envi-
ronment in which accounting operates. The essay con-
cludes with suggestions for a research agenda aimed at
understanding accounting’s role in the ?nancial crisis.
Bridging the gap between academic research and the
world of ‘‘accounting in action’’
The world of accounting practice is implicated in the
current ?nancial crisis in a number of ways. The most obvi-
ous is through ?nancial reporting requirements governing
asset valuation and off-balance sheet entities (Ryan, 2008).
The importance of these seemingly mundane accounting
rules is underscored by the fact that the solvency and sur-
vival of our major ?nancial institutions now turns on how
accountants value bank assets and the extent to which
auditors require ?rms to consolidate off-balance sheet
entities. Fair value accounting rules, which require compa-
nies to write-down ?nancial assets to re?ect plunging mar-
ket values, have been generating intense controversy.
Critics charge that fair value accounting ?rst contributed
to excessive credit expansion and then exacerbated the
downturn by encouraging pro-cyclical risk taking (Boyer,
2007). Opponents of fair value, including many within
the banking industry, are exerting pressure on accounting
regulators to modify valuation rules, while advocates
0361-3682/$ - see front matter Ó 2009 Elsevier Ltd. All rights reserved.
doi:10.1016/j.aos.2009.04.004
E-mail address: [email protected]
Accounting, Organizations and Society 34 (2009) 803–809
Contents lists available at ScienceDirect
Accounting, Organizations and Society
j our nal homepage: www. el sevi er. com/ l ocat e/ aos
remain vehement in defending the need for fair value
accounting in order to reveal the full extent of bank losses.
Although less in the spotlight than the fair value debate,
?nancial reporting rules governing off-balance sheet struc-
tured investment vehicles (SIVs), including rules on special
purpose entities (SPEs), quali?ed special purpose entities
(QSPEs), and variable interest entities are equally, if not
more, signi?cant. In the 1980s, US accounting standards
setters began allowing banks to move securitized loans
and related debts off their balance sheets and onto the
books of these off-balance sheet entities (Turner, 2008).
This obviously ?awed rule which enabled the creation of
the shadow banking system has been modi?ed several
times since the 1980s,
1
but never satisfactorily. The practice
of using structured investment vehicles to move banking
operations off-balance sheets in order to evade accounting
rules and regulatory capital standards, together with the po-
tential impact on capital adequacy ratios of forcing banks to
consolidate off-balance sheet vehicles remains a crucial is-
sue facing accounting and regulatory authorities (Group of
Thirty, 2009, pp. 48–49).
Financial reporting is not the only way accounting is
implicated in the crisis; the major accounting ?rms in
the US and Europe were also directly involved in the pro-
cess of securitization and structured ?nance. In their
capacity as advisors to investment banking clients, the ma-
jor ?rms performed due diligence work, offered accounting
and tax advice on off-balance sheet vehicles, and assisted
with the securitization of trillions of dollars of mortgage
back securities (MBS) and collateralized debt obligations
(CDOs). Although an evaluation of the extent of the
accounting ?rms’ role in the making of the crisis is beyond
the scope of this essay, a preliminary review of the ?rms’
marketing literature indicates that their advisory service
divisions were active participants in the securitization
industry in the years leading up to the crisis. The following
excerpts are illustrative of securitization services offered
by all of the Big Four international accounting ?rms.
Since 1985, Deloitte & Touche USA, LLP professionals
have added insight, consistency and value to more
than 14,000 securitized offerings with an aggregated
principal of more than $5 trillion. . . Serving leading
players in the MBS, ABS, CDO and CMBS markets,
domestic and global, we offer state-of-the-art prod-
ucts and expert services in ?nancial modeling, analyt-
ics, technology, operations, due diligence, accounting
and tax.
In the past year, the PwC’s and the Structured Finance
Group (SFG) have been involved in securitization
transactions totaling billions of dollars. Structured
Finance Group professionals combine a high-level of
technical expertise to provide a wide range of securiti-
zation services, such as: deal structuring, asset valua-
tion, due diligence, modeling, operational consulting,
tax and accounting analysis, tax reporting and tech-
nology development, implementation and mainte-
nance (American Securitization Forum, 2006).
Accounting research lagged behind this burgeoning
world of accounting practice. While accounting practitio-
ners were involved in the securitization schemes that ulti-
mately led to the crisis, accounting scholars were largely
unaware of their activities or the troubles brewing in the
credit markets and shadow banking system. The premier
academic accounting journals did not address the dangers
of structured investments, securitization, and off-balance
sheet entities until 2008 when the credit crisis was in full
swing. The leading journals published more articles on
these topics in 2008 alone then in the ten preceding years
(1998–2007) combined. While there were a number of re-
search studies on fair value accounting published in the
mainstream accounting literature in the mid 1990s, they
tended to assess fair value accounting narrowly in terms
of whether it provided incremental information to capital
markets rather than evaluating its macroeconomic conse-
quences.
2
With few exceptions, academic accounting re-
search generally failed to anticipate the crisis, or mount a
substantive critique of accounting’s contribution to systemic
?nancial instability and/or accounting ?rms’ involvement in
securitization and structured ?nance.
Some will argue that the shadow banking system is too
opaque for accounting researchers to penetrate since
empirical data on off-balance sheet entities, hedge fund
activities, credit default swaps and other privately traded
derivatives are unavailable. This view suggests that our re-
search agendas must necessarily be limited and ultimately
shaped by the availability of quantitative databases. The
alternative to this unacceptable proposition is to begin to
take seriously the methodological problem of ?nding ways
to engage the world of accounting practice. Arguably, some
of the most socially important aspects of accounting prac-
tice are those where the dif?culty of obtaining data has,
with few exceptions, produced a lacuna in academic re-
search. These include issues such as tax evasion, money
laundering, transfer pricing, off-balance sheet ?nancial
activities, and the politics of accounting standard setting,
to name but a few.
3
The task of bridging the gap between
accounting research and this world of accounting practice
is extremely dif?cult, but nonetheless essential. We have
seen some progress in the ?eld of managerial accounting
where strides have been made towards understanding
‘‘accounting in action’’ (Hopwood, 1983) within organiza-
tions through the use of case study and ethnographic re-
search methodologies. The need for ?nancial accounting
research to reduce its dependence on quantitative databases
and develop the methodological tools, institutional knowl-
edge, and links to practice needed to bridge the gap between
academic research and the world of ‘‘accounting in action’’ is
one of the most signi?cant challenges posed by the current
crisis to accounting research.
1
See SFAS No. 125, SFAS No. 140, and FIN 46R.
2
The critical accounting literature, by contrast, published several
critiques of fair value accounting for ?nancial instruments. For example,
see Hernández (2003), Ishikawa (2005) and Young (1996).
3
Exceptions include Mitchell, Sikka, and Willmott (1998) on the role of
accountancy ?rms in money laundering, and related work on tax avoidance,
off-shore ?nancial centers, and transfer pricing. For example, see Sikka and
Hampton (2005), Sikka (2008) and Sikka et al. (2009).
804 P.J. Arnold / Accounting, Organizations and Society 34 (2009) 803–809
Understanding accountings relationship to the macro
political economy
The previously ignored linkages between micro level
regulatory and accounting technologies and the macro
economy is likely to be another major implication of the
crisis for research and practice. In the realm of accounting
practice, this is apparent in discussions of whether fair va-
lue accounting has a pro-cyclical impact on the economy,
and in the pressures being exerted on accounting standard
setters to consider whether the objectives of ?nancial
reporting should include ?nancial stability (Financial
Accounting Standards Board, 2009). It is also evident in
Jules Muis’ (2008) proposal that accounting ?rms report
on any systemic risks they observe in the course of their
practice that might present a threat to the orderly func-
tioning of the ?nancial markets.
There is a danger that research will lag behind the
world of accounting practice in this area, as well, since
mainstream accounting research has not developed the
theoretical capability to analyze and interpret the relation-
ship between accounting and the macro political and eco-
nomic environment in which it operates. Conventional
accounting research remains bound to neoclassical eco-
nomic theory and the narrow view of accounting as a neu-
tral technology whose function is to reduce information
asymmetry and provide the transparency needed for capi-
tal markets to function ef?ciently. The current crisis chal-
lenges the credibility of market theory and along with it
the ideas on which much of accounting theory is founded.
If we acknowledge that capital markets do not price assets
ef?ciently, what then is the economic impact of fair value
accounting? If we recognize that ?nancial markets do not
allocate capital ef?ciently, what then is the role of ?nancial
reporting in the capital markets? What then is accounting’s
role in restoring ?nancial stability? Mainstream account-
ing theory has no answers to these questions and can only
cling to the defunct notion that more transparency will
somehow revive con?dence in ?nancial markets and en-
able them to function ef?ciently once again.
Political economy offers an alternative theoretical
perspective for understanding the links between the micro
world of accounting and the macro economy. In the 1980s, a
new steam of critical accounting research grounded in
theories of political economy emerged within the ?eld of
interdisciplinary accounting research. In?uenced directly
or indirectly by Marxist thought, the political economy
approach critiqued the notion that accounting is a neutral,
objective technology that functions to improve the alloca-
tive ef?ciency of markets, and emphasized instead the ways
in which accounting is a partisan practice that is implicated
in distributive transfers of wealth between social classes. In
this view, accounting both shapes and is shaped by relations
of power within the political economy in which operates.
Accounting is, thus, seen as essentially political; accounting
policies are in?uenced by ruling elites and dominant ideol-
ogies, and accounting practices, in turn, affect the distribu-
tion of income, wealth and power within society.
The literature on the political economy of accounting
studies the historical development of accounting practices
to examine the ways in which they have been implicated
in social con?icts and distributional transfers not only on
the factory ?oor, but also within capitalist societies as a
whole. In the process, it has laid the theoretical foundations
for understanding the relationship between accounting and
the development of capitalism across different historical
periods (Bryer, 1993). The literature has also drawn on state
theory to understand the role of the state in capitalist soci-
eties as a foundation for analyzing the role that accounting
plays in the interaction between state politics and market
economies (Arnold & Sikka, 2001; Tinker, 1984). And, it
has used political economy’s concept of ideology – loosely
de?ned as ideas in the service of power – to examine the
role that accounting practices and accounting research play
in legitimizing existing relations of power and distribu-
tional transfers of wealth by cloaking them in the guise
of seemingly neutral and objective techniques (Tinker,
Merino, & Neimark, 1982).
Although political economy continued as a recognized
stream of critical accounting research, its in?uence was
overshadowed in the 1990s by the rise of postmodern
and poststructuralist theories within the social sciences
and humanities (Arnold, 1998). Post-structuralism took
hold in critical accounting, in part, as a needed corrective
to the economic determinism and functionalism found in
both neoclassical and Marxian economics. It developed a
social analysis that focused on the diffuse power of micro
technologies, such as accounting practices, as opposed to
the macro political and economic structures of power. At
the same time, micro-institutional theory which empha-
sizes the ways in which accounting is socially embedded
in cultural norms, cognitive scripts, and taken-for-granted
assumptions also gained prominence within the ?eld of
critical accounting. While post-structuralism and micro-
institutionalismhave undoubtedly made signi?cant contri-
butions to the accounting literature, both schools represent
a turn away from the analysis of politics and economics in
favor of cultural explanations of accounting’s role in orga-
nizations and society. Accounting research’s failure to
anticipate the crisis or problematize the relationship be-
tween ?nancial accounting, the growth of the shadow
banking system, and macroeconomic instability can be
attributed, in part, to this cultural turn away from political
economy and its critique of capitalism.
There are several reasons for the neglect of critical re-
search grounded in political economy. These include the
dif?culty and perhaps the fear of pursing critical scholar-
ship in business school settings, particularly in the United
States, but in many other places as well. For those who
might otherwise be motivated to do critical research, doc-
toral training poses a hurdle in the United States where
accounting PhD program curricula and cultures often dis-
courage critical studies. Outside the US, where there is a
greater acceptance of alternatives to positivist thought, the-
oretical divisions within the critical accounting research
community were sometimes exaggerated by polemics and
polarizing debates that may have discouraged a broader
engagement with the ?eld. Finally, the institutional incen-
tives faced by accounting scholars, including the tenure
and promotion system and university rankings, contribute
P.J. Arnold / Accounting, Organizations and Society 34 (2009) 803–809 805
to the commodi?cation of accounting research (Puxty, Sik-
ka, & Willmott, 1994) and encourage an overemphasis on
‘‘hits’’ in prestigious journals rather than ideas (Hopwood,
2007, 2008). These incentives, likewise, encourage confor-
mity with conservative norms and militate against the risk
taking required to engage in a social critique.
The ?nancial crisis will hopefully stimulate a revival of
accounting scholarship aimed at understanding the rela-
tionship between accounting practice and the macro polit-
ical and economic environment in which it operates.
Fortunately, political economists and economic historians
such as Polanyi (1944), Brenner (2002), Harvey (2006),
and Arrighi (1994), among others, have produced a rich lit-
erature from which we can draw to understand the under-
pinnings of the ?nancial crisis. While Marx’s intellectual
contribution remains a cornerstone of political economy,
the theoretical ?eld for accounting’s engagement with
political economy can be de?ned more broadly to include
any non-neoclassical economic framework for understand-
ing the economy and accounting’s relationship to it. These
include the work of economists such as John Maynard Key-
nes and Joseph Schumpeter as well as neo-Smithian (Ar-
righi, 2007; Sen, 2009) and neo-Marxian interpretations
of classical political economy. Socio-economic frameworks
such as economic sociology (Zukin & DiMaggio, 1990) and
regulation theory (Boyer, 1990), likewise, provide a theo-
retical foundation for accounting research to draw upon
in developing an analysis of the relationship between
accounting and the macro political economy.
Towards a political economy of accounting and crisis
In his classic study of the transformation of the US econ-
omy in the last quarter of the twentieth century, Robert
Brenner (2002) traces the roots of the crisis to the down-
turn in the economy that originated in the 1970s as a result
of global overproduction and declining rates of pro?t. In re-
sponses to declining pro?ts in the real economy, the US
adopted a host of monetary, ?scal, regulatory, and trade
policies to promote the growth and global expansion of
the ?nancial sector. This shift, which gave rise to the ascent
of ?nance capital and the concentration of economic and
political power within the ?nancial sector, is commonly re-
ferred to as ‘‘?nancialization’’. In Giovanni Arrighi’s (2007,
p. 230) analysis, ?nancialization, which is characterized by
the ‘‘capacity of ?nance capital to take over and dominate,
for a while at least, all the activities of the business world’’
provided a temporary ‘‘?x’’ to the problem of overproduc-
tion. Pro?tability was restored in the mid-1990s – albeit an
unsustainable pro?tability built on ?nancial speculation
and successive ?nancial bubbles ?rst in the stock market
and later in the housing and credit markets. This transfor-
mation within the macro political economy poses several
questions for accounting research as we attempt to under-
stand accounting’s relationship to the unfolding crisis.
Three potential avenues of inquiry are discussed below.
The politics of standard setting
First, further research is needed to examine how ?nan-
cial reporting standards have shaped and been shaped by
the ?nancialization of the economy. What is the relation-
ship between ?nancial reporting rules and the rise in
power and in?uence of the ?nancial sector? Have ?nancial
accounting rules in?uenced the strategy and structure of
the ?nancial services industry? And, too what extent has
the ?nancial industry in?uenced the standard setting
agendas of the US Financial Accounting Standards Board
(FASB) and the International Accounting Standards Board
(IASB)? Does the domination of ?nance over industrial cap-
ital explain the move towards fair value accounting and
the abandonment of the income measurement model in fa-
vor of a balance sheet valuation approach to ?nancial
accounting? Why did US accounting standard setters allow
banks to move banking operations off their balance sheets
in the 1980s?
Presently, we have only a very rudimentary knowledge
of the politics of standard setting, the relationships of
power that underlie it, and the mechanisms through which
power is exercised within the accounting standard setting
process. As Hopwood (1994) notes, notwithstanding the
prevailing view that international standard setting is dri-
ven by the needs of capital markets, ?nancial statement
users are not well represented in forums of in?uence;
users’ presence in the policy-making arena is more rhetor-
ical than substantive. In practice, the audit industry and
their lobbyists exercise far more in?uence over accounting
policy than is generally recognized in descriptions of the
accounting standard setting process that focus on the pre-
sumed interests of capital markets and regulatory author-
ities (Hopwood, 1994). This discrepancy between rhetoric
and practice is indicative of a signi?cant gap in our under-
standing of the politics of standard setting.
A political economy approach prompts us to look be-
yond conventional interest group theories of politics to
examine the structure of power within society and the of-
ten subtle ways in which power operates. Does the ?nan-
cial sector exert direct in?uence over standard setting, or
does it exercise power indirectly through its control over
the state and state regulatory apparatuses? To what extend
does power operate via ideological hegemony, namely the
belief that ?nancial accounting’s raison d’être is to serve
the ?nancial markets. As Young (1996) suggests, does
‘‘institutional thinking’’, re?ected in the narrow view that
accounting’s function is to provide transparency to the
markets, explain why standard setters adopted fair value
accounting for ?nancial instruments without regard to
the macroeconomic consequences of sanctioning the pro-
liferation of complex, unregulated, and systemically dan-
gerous ?nancial products? Or, does economic power
manifest itself in the standard setting process in more di-
rect ways? Research analyzing the political histories of
?nancial reporting standards on fair value accounting and
off-balance sheet entities, and the current pressures on
standard setting bodies to revise these rules in response
to the ?nancial crisis may shed light on these questions.
The role of accounting ?rms
Second, research is needed to evaluate the role that the
major accounting ?rms played in the origins of the ?nan-
cial crisis. The ?nancialization of the economy over the
806 P.J. Arnold / Accounting, Organizations and Society 34 (2009) 803–809
past quarter century created pro?table niches not only for
investment banks and other ?nancial intermediaries, but
also for the major accounting ?rms. Over the past two dec-
ades, economic and political power within the interna-
tional accounting industry was consolidated in the hands
of a small oligopoly of ?rms based in the US and UK. As
the ‘‘Big Four’’ ?rms expanded in size and scope, they also
moved beyond traditional accounting and auditing ser-
vices to recast themselves as providers of all types of ?nan-
cial expertise. They expanded their ?nancial advisory
divisions and marketed themselves as specialists in merg-
ers and acquisitions, corporate reorganizations, tax shel-
ters
4
, and privatization consulting (Arnold & Cooper,
1999). As discussed above, the ?rms also entered the bur-
geoning business of securitization and structured invest-
ment offering a variety of securitization services to
investment banking clients.
Although the US Sarbanes-Oxley Act of 2002 and similar
independence rules in other jurisdictions prohibit account-
ing ?rms from selling certain types of consulting services
to their own audit clients, the consultancy arms of the ma-
jor ?rms continue to thrive. Tax consulting and some other
types of advisory work can still be done for audit clients,
and services to non-audit clients are not proscribed. As a
result, a small group of accounting ?rms continues to oper-
ate simultaneously as both auditors and advisors for the
banking industry. As auditors, they play a quasi-regulatory
role as a watchdog, responsible for assuring third parties
that the ?nancial statements present a true and fair picture
of the banks’ ?nancial condition. As ?nancial advisors, it
appears that the same ?rms may have assisted the ?nan-
cial services industry in designing the structured invest-
ment vehicles that enabled them to move operations off
their balance sheets, effectively ensuring that the banking
industry’s ?nancial statements did not re?ect the full ex-
tent of risk and leverage within the ?nancial system. Re-
search is needed to evaluate the extent of the accounting
?rms’ involvement in the process of securitizing toxic debt
and structuring off-balance sheet vehicles. What was the
nature of the due diligence, tax, modeling, valuation and
accounting services offered to their investment banking
clients? Were auditors aware of systemic risk within the
banking system? And, to what extent, if any, do the major
accounting ?rms share responsibility for the ?nancial crisis
as a result of their role in the securitization and structured
investment business?
Rethinking transparency
Third, research is needed to examine the ideological
roots of the notion of ‘‘transparency’’ and the role it is ex-
pected to play in governing today’s extraordinarily com-
plex and volatile ?nancial system. The idea that markets
will ef?ciently allocate capital and risk under conditions
of perfect competition and perfect information, of course,
derives from neoclassical economic theory. It follows that
?nancial accounting and auditing have an essential role
to play by ensuring that relevant and reliable information
is disclosed to investors. This is the theoretical rationale,
but what are the actual historical and political origins of
the quasi-regulatory role that ?nancial reporting and
auditing have come to play in the governance of capital
markets? In their study of the US legislation which created
the SEC and its ?nancial disclosure requirements in the
1930s, Merino and Neimark (1982) suggest that ?nancial
reporting and auditing requirements played a largely ideo-
logical role in efforts to restore the status quo after the US
stock market crash in 1929. To what extent does that con-
tinued to be the case? Was ?nancial accounting ever up to
the task of providing transparency to capital markets with-
in the hyper ?nancialized economy of the 1990s and 2000s
where the combination of uncontrolled ?nancial innova-
tion, complex ?nancial instruments, deregulation, moral
hazard, and the consolidation of economic and political
power within the ?nancial sector rendered the ?nancial
system increasingly ungovernable? And, if not, why do
we cling to the notion that improved transparency, rather
than a recon?guration of political and economic power, is
a solution to the crisis?
A ?nancialized economy is an inherently unstable econ-
omy as evident in the series of ?nancial crises that erupted
in the 1990s, including the Mexican peso crisis, the Asian
?nancial crisis, the Russian debt default, and the collapse
of the US hedge fund, Long Term Capital Management.
These events demonstrated the fragility of the interna-
tional ?nancial system and the need for capital controls
and/or a more robust regulatory framework to reign in
the ?nancial sector and reduce systemic risk. In the after-
math of the Asian crisis, proposals were made for a global
?nancial regulator, an international bankruptcy court,
international deposit insurance, a Tobin tax, and even a
global central bank. This new ‘‘international ?nancial
architecture’’ never materialized. Instead, western govern-
ments opted for a weaker governance regime, favored by
the ?nancial sector, in which ?nancial reporting and audit-
ing played a prominent role. This regime, which Robert
Wade (2007) calls the ‘‘standards-surveillance-compliance
system’’ relied upon relatively weak forms of control,
namely transparency and compliance with international
?nancial standards – including ?nancial reporting and
auditing standards – to address the problem of systemic
risk within the global ?nancial system. Further research
is needed to understand the political processes and power
relationships that precluded, and perhaps still preclude,
the creation of stronger institutional and regulatory
arrangements for governing the ?nancial sector and in-
stead relied upon private sector institutions, such as
accounting standards boards, auditing ?rms and bond rat-
ing agencies, to play a crucial quasi-regulatory role in the
governance of the ?nancial markets. Did the illusion that
?nancial reporting standards and auditing surveillance
could substitute for more stringent forms of oversight
and/or restrictions on speculative capital ?ows contribute
to the current crisis? To what extent did false con?dence
in accounting’s ability to provide transparency to self-reg-
ulating capital markets contribute to systemic instability
4
In 2009, The Guardian published a series of investigative articles on tax
avoidance that highlight the role of accounting ?rms. See ‘‘Creative
accountants’’, ‘‘Sheltering cash: the intricate schemes drawn up by KPMG’’,
and ‘‘Gilt-edged pro?ts for profession’s ‘big four’’’ (The Guardian, 7 February
2009).
P.J. Arnold / Accounting, Organizations and Society 34 (2009) 803–809 807
by providing ideological support for dangerous levels of
global ?nancial liberalization and national deregulation
in the 1990s and 2000s?
Conclusion
In the 1980s, Cooper and Sherer (1984, p. 219) argued
the case for a political economy of accounting in the pages
of this journal by advising accounting scholars to ‘‘be nor-
mative, descriptive and critical.’’ Speci?cally, they encour-
aged accounting researchers to make their normative
value judgments explicit, to describe and interpret the
world of ‘‘accounting in action’’, and to be critical in the
sense of recognizing the politically and socially contested
nature of accounting practices. On the whole, ?nancial
accounting scholarship has developed in quite different
ways. In the futile pursuit of objectivity, we have not been
explicit (or re?ective) about the value judgments that
underpin our theories and research agendas. We became
overly dependent on quantitative databases, and failed to
grasp developments within the world of accounting prac-
tice or describe the ways in which ?nancial reporting stan-
dards, accounting ?rms, and accounting ideologies were
implicated in the build up to the crisis. Our dominant the-
ories provided an insuf?cient bases for understanding the
transformations that were occurring in the international
political economy over the past quarter century or for ana-
lyzing the relationship between macro level changes, such
as the rise to power of the ?nancial sector, and the micro
level ?eld of ?nancial accounting practice. Most impor-
tantly, we did not develop a suf?ciently broad culture of
critique within our academic community.
These shortcomings not only explain our failure to
anticipate the current ?nancial crisis, they also limit our
ability to analyze, interpret, and response to the crisis as
it continues to unfold. Accounting scholars are uniquely
positioned to use our knowledge of accounting institu-
tions, the intricacies of accounting rules, and the socially
and politically contested nature of accounting practices
to identify and explain how seemingly neutral accounting
practices facilitated, and continue to facilitate, the massive
wealth transfers that mark this extraordinary ?nancial cri-
sis. The crisis, thus, challenges us to re-evaluate our re-
search agendas – and perhaps also the institutional
incentives and unexamined assumptions that drive
them – so that accounting research can contribute to a
broader social and political analysis of the ?nancial crisis.
Acknowledgements
I wish to thank Anthony Hopwood, Prem Sikka, and the
accounting research faculty at the University of Wisconsin-
Milwaukee for their thoughtful comments and
suggestions.
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