How regulators fabricate conceptual narratives to spread criticism

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In 2010, as the world reeled from the global financial crisis, the body that determines generally accepted accounting principles for listed companies in the United States abandoned the principles of reliability and auditability as necessary properties of accountability. Why did he do this? A new article offers a possible explanation.

Editor’s Note: This short article is an excerpt from a full article to be published in a dedicated issue of the journal Accounting, Economics and Law: A Convivium in early 2022.

Imagine that you are a parent concerned about your child’s low level of math achievement in school. You raise this concern with the school board. The council proposes to use a new technology, a smartphone app, supposed to improve the learning of mathematics in children. Several experts are emerging to support the school board. The application plan is launched.

As the school year progresses, it becomes evident that the app does not improve math learning outcomes. Over time, it also becomes clearer that the experts are in fact not independent; they are affiliated with the application makers. You start to worry. Has the school board been duped, or worse, co-opted, by special interests? You ask yourself. You raise this new suspicion with the school board. The board states that the goal of apps has never been to improve math learning outcomes; rather, it was about helping students adopt new technologies. This is what the app does, they note, and therefore your concern is unwarranted.

Would you be satisfied? I expect not. The position of school boards challenges basic principles of accountability. The school board arbitrarily altered its rationale for the app to avoid being held accountable for its original rationale.

Yet the above scenario is similar to what we experienced in 2010 from the Financial Accounting Standards Board (FASB), the body that determines generally accepted accounting principles (GAAP) for listed companies in America. GAAP is one of the rules that should hold companies and their managers to account for their control over our collective savings and investments in the economy.

Regulators and conceptual buckling

To guide its work, the FASB developed, shortly after its creation in the 1970s, a conceptual framework, a constitution-type document that sets out the basic principles of accounting. In 2010, the FASB revised this conceptual framework to abandon the principles of reliability and auditability as necessary properties of accounting. This change was particularly shocking, as both characteristics were long considered (long before the FASB’s own framework) as existential for accounting. After all, there are many competing channels beyond accounting for the provision of corporate information, including pro forma management disclosures: What gives GAAP numbers their comparative advantage is that they are reliable and verifiable.

In explaining its changes, the FASB argued that the term reliability has become misunderstood in practice to mean, among other things, objective measurement. The FASB asserted that its original intention had always been for reliability to be understood as a fair representation, an expression it defined in a self-referential manner as an accounting estimate that represents[s] what it claims to represent. In this sense, the FASB argued that the abandonment of reliability simply clarified the original meaning.

Some prominent watchers of the change, including a former member of its sister regulator, the International Accounting Standards Board (IASB, which sets GAAP for many non-U.S. Metrics), argued the change was more significant. They argued that the change was driven in part by the need to reconcile the conceptual framework of the FASB with the increasing use of fair value accounting. This practice involves recording assets and liabilities in the company’s books at estimates of their present value, and it represents one of the biggest changes in the nature of accounting in the past thirty years.

Since fair values ​​could not always be measured objectively, the concepts of reliability and verifiability in the constitution of the FASB have been an obstacle to the increasing use of fair value accounting in GAAP. In addition, the rise of fair value accounting may be linked to the contemporary financialization of the American economy and to the private profits of players in the financial industry. Indeed, the growth of fair value accounting is raising suspicions that the FASB is being captured by certain interests in the financial industry.

“Conceptual veiling is costly for regulators, not only because producing conceptual narratives takes time, but also because adopting a given conceptual rationale typically involves, as James Kwak notes, taking sides in a process. ideological debate. “

In a forthcoming publication, I focus on the two competing explanations for the changes to the constitution of the FASB: clarifying its original intent; and justify the rise of fair value accounting after the fact. I rely on primary archival evidence from the minutes of the FASB and IASB board meetings (both boards worked closely on these changes), internal and external documents from the personnel and communications of the main constituents of the FASB. I also rely on initial field interviews with thirteen board members, seven senior executives and seven active members of the FASB and IASB at the time. Finally, I supplement these sources with secondary data from academic and media articles on the changes.

The evidence does not exclude any explanation. A small group of senior FASB officials had long believed that the term reliability was misinterpreted in practice to mean objectivity. For those FASB insiders, the revisions to the conceptual framework actually represented a clarification of the original intention.

But for several board members and constituents, the revisions reflected the need to update the framework to be consistent with the changes in the nature of GAAP, particularly fair value accounting. As one person who sat on the board during the deliberations noted, the main thing that concerned us at the time was fair value measurement. said that, but it was pretty clear that this was one of the great things Fair value was used in over thirty places in accounting literature, maybe I didn’t have it at first [when I joined the board], but in the end it was pretty clear.

The evidence compatible with the latter explanation is remarkable because it illustrates the importance for regulators to have a conceptual narrative of their actions, even if such a narrative is constructed ex post facto. After all, the changes to the conceptual framework were made in 2010, almost twenty years after the FASB first initiated a major movement towards fair value accounting.

It is possible that regulators construct such conceptual narratives for their actions because they seek internal intellectual consistency. But, as I explain in my article, crafting and adopting a new concept story is expensive, both in terms of direct costs and opportunities. Additionally, the conceptual framework was created to guide standard setting, but the evidence here suggests that it has been altered to reflect changes in standard setting, a circularity that is both publicly observable and embarrassing. . This observation suggests that there is probably a stronger reason for revisions to the conceptual framework than the search for internal consistency.

A more plausible explanation is that conceptual narratives provide regulators with a cover against criticism. To this end, the timing of the reliability and verifiability purge can be informative. While the project was first conceived in earnest in 2004, the Boards of Directors of the FASB and the IASB voted definitively on the changes in January 2009, at the height of the global financial crisis, when the stock markets had fallen to dangerous levels and their regular functioning was disrupted. As the world reeled from a financial crisis, the boards of directors that oversaw the development of accounting rules for much of the global economy voted to eliminate reliability and auditability as necessary properties. in companies’ financial reports. I contend that they did so in part to deflect criticism of the dangers of fair value accounting, criticisms that had started to become more audible to the general public due to the global financial crisis.

These revisions are an illustration of a phenomenon that I call conceptual veiling, in which regulators fabricate or adopt conceptual justifications for their actions in order to diffuse criticism. Conceptual veil is costly for regulators not only because producing conceptual narratives takes time, but also because adopting a given conceptual rationale typically involves, as James Kwak notes, taking sides in an ideological debate. . This approach can reduce the public perception of regulatory neutrality.

Conceptual veiling is related to the phenomenon of regulator cover-up (labeled CYA or cover your a **), which, although widely recognized by journalists covering regulatory behavior, has not been well developed as an idea in the academic literature on regulation. William Safire described regulator CYA as a cultural tendency among bureaucrats to spread criticism and deflect responsibility. Conceptual shroud is similar to the CYA regulator in that both involve a manufacturing blanket against criticism. But while the CYA regulator is attributed to the regulator’s risk aversion, the conceptual veil is associated with a regulator seeking to protect itself from the scrutiny of risky (and potentially captured) regulation.

I think we can find a conceptual veil in situations where regulators are likely to be challenged, perhaps due to suspicion of capture. Conceptual haze may well occur in contexts other than accounting, as diverse as the regulation of labeling of genetically modified foods and regulatory forbearance in banking supervision.

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