July 26, 2005

The Economic Function of Accounting

In the fall, at Texas Tech, I'm going to be teaching ethics to accounting students. I have most of the philosophical part of the syllabus planned, but there's a bit of economic stuff I'm interested in for the intro, and I'd like specific suggestions for reading.

The question is this: What role do accounting and auditing have to play in a well-functioning capitalist system? I have an idea that it's something like this: For a market to allocate resources efficiently, there must not be too many informational asymmetries. If you don't know what you're buying, then you may wind up with something other than what you want--supply and demand then won't work as we hope them to--etc. This applies, for instance, when people are thinking of buying stock in a company, lending money to a company, or buying the company outright.

Now, the present management of a company inescapably knows more about its affairs than prospective shareholders, buyers, and lenders. Auditing, as I understand, ideally rectifies that informational asymmetry. An audit report gives people who are interacting with the company a picture of its finances without revealing its trade secrets. So they can know, perhaps, a picture of how good a credit risk it might be without industrial espionage. Ideally.

(The fact that it doesn't work this way is, I think, not unrelated to the surge in demand for ethics for accountants courses, especially in Texas.)

So that's the kind of issue I'm concerned with. I ask you: Have I got this right? Am I in the right ballpark? If I'm not, it's especially important that I get some reading on this. If I am, I'd still like some reading to assign.

The students will have no philosophical background. I'm not sure if they'll have much of an economics background, but I know I don't, so no hardcore economics either.

And I'd like the article (if this is true) to make it clear that this isn't about government reining in greedy capitalists or anything. As I think it works (as described above), auditing frees up people and corporations to act in their enlightened self-interest. It's not about interfering with the market at all.

Anyway, any suggestions for introductory reading?

Posted by Matt Weiner at July 26, 2005 02:36 PM

Krugman isn't as non-partisan as you would would like but this is how I see the benefit of acounting and auditing.

>Honesty in corporate accounting isn't a left-right issue; it's about protecting all investors from exploitation by insiders.

Bad accounting allows insiders to profit by the artificial rise of the stock price, which means somebody else is buying a stock at an inflated price.

Posted by: Joe O at July 26, 2005 03:02 PM

Yeah, I like that basic message, but I probably can't use that column. It ends up bashing Bush and the Republicans (and they seem to deserve it), and I'm afraid that if I give students something like that the pro-Bush ones will just be put off of the whole idea of ethics. Ideally I'd like something that gives the theory behind the idea that it's about protection from exploitation by insiders.

Posted by: Matt Weiner at July 27, 2005 11:00 AM

There might be something in Mill - I've mostly read him for his social issues, but he *was* an economist, he's all about the transparency and fairness, and economics creeps into all his social discussions in a non-technical manner, so there might be useful discussions in his work.

Yes, he's a bit Victorian in his style, but it isn't that hard to deal with after a bit. And although some Hegemony think tank did put him on the Enemies list, it wasn't widely reported except briefly in Blogistan, so I doubt that too many Republican-family students will have a negative prejudgment towards him. (Given that the Mises institute had to quote him severely out of context to make him seem to say the opposite of what he actually says to "discredit" him, it also seems unlikely that Mill's actual words would cause any kneejerk reaction, either.)

Posted by: bellatrys at July 30, 2005 05:59 AM