Criticizing positive accounting theory

Criticizing positive accounting theory*

LAWRENCE A. BOLAND Simon Fraser University

IRENE M. GORDON Simon Fraser University

[MJethodology criticisms have failed the market test because they have had litde influenceon accounting research. . . . [To] most researches, debating methodology is a "no win"situation because each side argues from a different paradigm with different rules and nocommon ground.

Watts and Zimmerman, 1990, p. 149

Abstract. One theoretical approach recently emphasized in the accounting literattire ispositive accounting theory. Synonymous with this theoretical view are the 1978 and 1979articles published by Ross Watts and Jerold Zimmerman. These two articles promptedcriticism from three different perspectives. There are critiques that refer to technicalresearch methods problems, critiques concerned with philosophy of science issues, andcritiques centered on the limitations of economics-based accounting research. In their1990 article. Watts and Zimmerman responded to most of the published critiques. Theyspecifically claimed that methodological criticisms have failed to have any influence onaccounting research. This paper provides a critical examination and assessment of thesealleged failures by examining two types of critiques, economics-based critiques and thosebased on issues of the philosophy of science. The critiques discussed include those towhich Watts and Zimmerman responded as well as several other critiques that eitherWatts and Zimmerman failed to discuss or that were not published until after their 1990article appeared. Positive accounting theory is shown to be applied economic positivism.Tracing the historical background of positive accounting research through its economicroots shows that the "positive" aspect of the Watts and Zimmerman approach is morerhetoric than methodology. It is argued that positive accounting theory does representa problem shift toward a domain of research that is appropriate for Chicago Schooleconomics. A review of the published critiques of positive accounting theory shows thatalthougji critiques based on philosophy of science may not be very effective, economics-based critiques that emphasize the limitations of equilibrium-based economic analysisoffer a promising avenue for methodological critiques of positive accounting theory.

Resumi. Parmi les publications relatives a la comptabilite, celles qui touchent la« theorie de la comptabilite positive » attiraient recemment l'attcntion. Ross Watts et

* We wish to thank Haim Falk, James Gaa, Richard Mattessich, William Scott, Robert Sterling,Daniel Thornton, Tony Tinker, an anonymous referee, and our colleagues George Blazenko,Peter Clarkson, Moustafa Magid, Zelma Rebmann-Huber, and Chris Wright for their helpfulcriticisms and comments on earlier drafts.

Contemporary Accounting Research, Vol. 9, No. 1 (Fall 1992) pp. 142-170 ®CAAA

Criticizing Positive Accounting Theory 143

Jerold Zimmerman, dans leurs articles publics en 1978 et 1979, adoptaient l'equivalentde ce point de vue th6orique. Ces deux articles ont souleve les critiques, dans trois pers-pectives differentes. Certaines critiques portent sur le probfeme des methodes techniquesde recherche, d'autres ont trait aux questions relatives a la philosophie de la science etd'autres encore sont centr6es stir les limites de la recherche comptable qui s'appuie surl'economique. Dans leur article de 1990, Watts et Zimmerman refutaient la plupart descritiques qui avaient 6te publiees, invoquant plus precis6ment le fait que les critiquesm6thodologiques ne sont pas parvenues a influer sur la recherche comptable. Les auteursprocedent a un examen et a une evaluation critiques des lacunes que Ton impute a cettetheorie, sous forme d'analyse de deux ordres de critiques : les critiques relatives auxfondements economiques et les critiques relatives aux questions touchant la philosophiede la science. Les critiques analysees comportent celles auxquelles Watts et Zimmermanont repondu ainsi que plusieurs autres critiques que ni Watts ni Zimmerman n'avaientanalysees auparavant ou qui n'ont ete formulees qu'apr^s la publication de leur articlede 1990. Les auteurs demontrent que la theorie de la comptabilite positive equivaut aupositivisme economique applique. En retra9ant les fondements historiques de la recherchesur la comptabilite positive dans ses tacines economiques, ils demontrent que 1'aspect «positif » de l'approche de Watts et Zimmerman est plus rdthorique que methodologique.La theorie de la compatibilite positive represente toutefois le deplacement du problemevers im domaine de recherche qui convient a l'economique de l'Ecole de Chicago.L'analyse des critiques de la theorie de la comptabilite positive qui ont ete publieesdemontre que meme si les critiques se rapportant a la philosophie de la science ne sesont peut-etre pas r6v6\6es tres efficaces, les critiques se rapportant a l'economique etmettant l'accent sur les limites de l'analyse economique basee sur l'equilibre ouvrentdes horizons prometteurs aux critiques methodologiques de la th6orie de la comptabilitepositive.

Since the publication of their widely cited papers promoting what they calledpositive accounting theory, Ross Watts and Jerold Zimmerman have been con-fronted by at least a dozen published critiques and evaluations.' In a recentpaper (Watts and Zimmerman, 1990), they responded to eight of these critiques.Judging by the criterion employed by Watts and Zimmerman, all of the method-ological criticisms failed. We intend to examine this empirical question withrespect to detemdning whether the alleged failure is because all of the critiqueswere launched, as claimed, from "different" paradigms with "different mles andno common ground" or because all of the critiques are methodologically inad-equate or irrelevant. We will show that Watts and Zimmerman were partiallycorrect. Almost all the critiques are inadequate or mistaken, and the few re-maining critiques that are adequate and logically sound have been ignored inthe 1990 response of Watts and Zimmerman.

Since Watts and Zimmerman explicitly advocate a methodology that wouldfocus empirical research in accounting theory on economics-based explanationsand predictions of accounting practice and, in particular, on an empirical method-ology found in mainstream economics, we examine how this methodology ispracticed in accounting research and the avenues for criticism. This is followedby a guide to the numerous critiques of the Watts and Zimmerman version of

1 For a general survey of positive theory in accounting researeh, see Abdel-khalik, Regier, andReiter (1989).

144 L.A. Boland I.M. Gordon

positivism. The examination of what Watts and Zimmerman and their critics sayabout positive accounting theory seems to reveal confusions and fiindamentaldisagreements. To understand what Watts and Zimmerman mean by economics-based positive accounting theory, we review the dominant economics-based em-pirical methodology, namely that which is practiced under the banner of "positiveeconomics." We then examine how the Watts and Zimmerman (1978 and 1979)papers represent a problem shift away from ordinary empirical accounting re-search. In the process, we explain the irrelevance of the philosophy of scienceviews that are popular among some of the critics and as an altemative, we finishby arguing for the development of effective methodological critiques that canmeet the market test.

Positive accounting theory according to Watts and Zimmerman

Since Watts and Zimmerman define positive accounting theory as exclusivelyeconomics-based accounting theory (e.g., Zimmerman, 1978, p. 4, and Wattsand Zimmerman, 1986, pp. 1 and 13), it would be useful for us to identify theessentials of this theory.

The salient features of "economics-based accounting theory "There are two salient features of economics-based explanations: (1) method-ological individualism and (2) the neoclassical maximization hypothesis.

Methodological individualism is the commitment to explain every social phe-nomenon as being a consequence of individual decision making. In short, indi-viduals make decisions but things do not.̂ When a standard-setting committee ora board of directors makes a decision, the methodological individualist explainsthe group's decision by explaining the decision made by each member of thecommittee or board. 3

The neoclassical maximization hypothesis goes beyond this to claim thatevery individual makes such decisions, subject to given constraints, exclusivelyto maximize his or her personal utility (or indirectly maxamize his or her wealthin order to be able to maximize future utility).^

Once these two essential features are accepted, a neoclassical economics-based explanation is primarily concemed with specifying the cost constraintsfacing the individual decision maker (see Stigler and Becker, 1977). For example,to choose action A rather than action B, one has to assess not only the utilitythat would be obtained by either action but also the possibly different costs(i.e., sacrificed utility) of pursuing one action rather than the other. Thus, theindividual is presumed to choose action A only if the net utility gained is greaterthan would be obtained by choosing action B. A question one might ask is how

2 For more on methodological individualism see Agassi (1960); and for its role in neoclassicaleconomics, see Boland (1982), chap 2.

3 For example, see Watts and Zimmerman (1978, p. 113) and Zimmerman (1978, p. 4).4 For example, see Watts and Zimmerman (1986, p. 3).


one would ever know whether such an explanation is actually false. We willexamine this question later.

The reasons for developing an "economics-based accounting theory"Watts and Zimmerman have offered several different rationales to explain whyothers should join them in the development of a successful economics-basedaccounting theory. In Watts (1977) and in Watts and Zimmerman (1979), theyoffer the inductivist's pursuit of confirmable theories. In his 1978, 1979, and1980 papers Zimmerman introduces a different reason—a combination of MiltonFriedman's instmmentalism' and the positivism that has its origins in the method-ological pronouncements of Paul Samuelson.În 1986, Watts and Zimmerman of-fered a sophisticated combination of Poincare, Hemple, and Popper even thoughthe combination offered has little to do with Popper's philosophy of science.Specifically, what they offered in 1986 was nothing but the conventionalism thatPopper often criticizes.^ Let us examine these rationales in more detail since itwill help us to understand why Watts and Zimmerman shy away from explic-itly answering the methodological critics in their 1990 paper and perhaps evenunderstand why they do not find methodological discussions very useful.

In Watts and Zimmerman (1979), they begin an adventure in methodologicaldiscussion.* In their initial footnote, they state a definition of "theory" that isa relic of 17th century inductivism. Specifically, they define "theory" as "setsof hypotheses which have been confirmed." According to the inductivist's text-book tradition, a tme scientist begins with data, forms a "hjôthesis," tests thehypothesis, and if it is confirmed, it is elevated to the status of a "theory." Oldscience textbooks went even further to say that when the confirmation withstoodthe examination of the scientific community, the theory could be elevated to thestatus of a "law" (see Boland, 1982, p. 26). Why one would ever perpetuate a17th century methodological doctrine that David Hume refuted 200 years agois difficult to understand.

In their 1979 paper and in Zinmierman (1979), much is made about thepositive/normative distinction. Unfortunately, they tell us only that the theory

Specifically the notion that theories and explanations should be judged by their usefulnessrather than their realism (for more on Friedman's instrumentalism, see Boland, 1979).According to Samuelson, all that is required for an empirically meaningful theory is that it"could conceivably be refuted, if only under ideal conditions" (1947, p. 4).Conventionalism is the commonplace doctrine that asserts that all theories are never absolutelytrue (or absolutely false). Instead, we are supposed to say they are the best available accordingto the currently accepted conventions or criteria. In matters of choice between competingtheories, we are variously urged to choose the theory that is more verifiable, simpler, general,and so forth. An example is the commonplace claim that since we cannot hope to develop a"perfect theory," we should be concemed with developing a "better" theory where "better"is determined according to a set of criteria such as usefulness and error mitiimization (Wattsand Zimmerman, 1986, pp. 4-5). For a detailed explanation and criticism of this view ofmethodology, see Boland (1979 and 1989, chap. 5).To be fair it is important to recognize that Watts and Zimmerman do not claim to be profes-sional philosophers so we would not expect their adventure to be flawless.


offered is "not normative or prescriptive." As we explain below, positivists arenot always clear about what positivism is.

In his 1980 paper, Zimmerman becomes even more adventurous. Afterquoting from Friedman's quotation of John Neville Keynes, he adds that positivetheory is "a set of empirically tested hypotheses" (p. 108). Note, this appears tobe a shift of methodology from 17th century inductivism to early 20th centuryconventionalism. In 1979, hypotheses had to be confirmed to be "theory" butby 1980 they needed only to be tested. The methodological arguments movealong rapidly since next he says that a "positive theory . . . is capable of beingrefuted" (p. 108). Thus, by 1980 we seem to have progressed as far as the 1947positivism of Samuelson. On the same page, Zimmerman adds the puzzlingstatement that a "theory, if not refuted, explains." Surely, failure to refute an ex-planation is not equivalent to confirming an explanation.' A few pages later, heretreats somewhat to say "testable implications, which if empirically supported"(Zimmerman, 1980, p. Ill)—thus being tested and not refuted is not enough;we also need positive suppon.

Interestingly, in Watts' 1977 paper (which refers to the Watts and Zimmerman1979 paper as an unpublished 1977 paper). Watts offers a definition of theoriesthat goes beyond the inductivism of their 1979 paper by saying that a theory isa set of hypotheses that not only have been confirmed but have been "subjectedto formal tests" (Watts, 1977, p. 54). In 1977, he says that a theory can beboth positive and normative (p. 54). By not rejecting normative theories. Wattsalso presented a more liberal view of normative theories than the 1979 view.Watts' more liberal view agrees with other accounting researchers who supponeconomics-based research. Not all positive accounting researchers think thatnormative (i.e., welfare) implications should be ignored (see Lev, 1988; Levand Ohlson, 1982, pp. 291-292; Jensen, 1976 and 1983). By 1990, Watts andZimmerman (p. 148) together can see that positive accounting theories can havenormative implications so the separation is no longer obvious.'"

Apan from their diverse methodological pronouncements, there is a moreimponant message. Theories must explain; that is, they must answer "why"questions. We think the issue of explanation is at root a restatement of anongoing argument in the economics profession over whether wacroeconomictheories (such as Keynesian economics) can ever explain what goes on in theeconomy without explaining what is going on at the wjcroeconomic level. Ineconomics literature, this is called the problem of providing microfoundations formacroeconomics (see Phelps 1970)'^ and those economists who identify with the

9 It is easy to have a false theory that is complex enough to make refutation difficult for tech-nical econometric reasons (see Boland, 1989, chaps. 7 and 8).

10 Also by 1990, Watts and Zimmerman downplay the importance of prediction and, instead.emphasize explanation (1990, footnote 13).

11 The perception that the absence of microfoundations would constitute a problem is nothingmore than an alternative way of expressing the neoclassical commitment to methodologicalindividualism (see further Boland, 1982, chap. 5).


Chicago School find microfoundations a necessity (e.g., see Barro and Grossman,1971, and compare with Clower, 1965; Solow, 1979; or Okun, 1980). In positiveaccoimting theory, this becomes the claim that one has not explained accountingstandards until one has explained the individual rationality of the people whotry to infiuence the accounting standards-setting bodies (Zimmerman, 1978, p.4, and 1980, pp. 110-111). This claim is really the keystone of promotingeconomics-based accounting theory.

In Watts and Zinunerman (1986), more is offered to explain what they meanby positive theory beyond just saying it is not normative. In distinguishingpositive theory from the discredited "logical positivism" of the 1930s, they sayin a footnote (p. 8),

In positive or scientific theory there are no brute facts. The interpretation of facts dependson theories. ... Iwther, we cannot prove a hypothesis correct; all that is possible is todisprove a hypothesis. Hence, there is an emphasis on criticizing theories and attemptingto falsify them rather than verifying them. ...

They reference this view to both Mark Blaug (1980, pp. 1-28) and Karl Popper(1963, pp. 228-229), but their statement of the view is just Blaug's confiisedversion of Popper (see Boland, 1985).'^

A few pages later in their book. Watts and Zimmerman change to a versionof Friedman's methodology by claindng that since theories are necessarily im-perfect, we need to employ a criterion to choose between them. Theories arechosen if they provide the most useful predictions. Moreover, such a theory maybe chosen "even if it has a lot of prediction errors" (p. 12). So it would appearthat despite their references to philosophy of science literature, in the end weare back at the begimiing of Chicago School economics, namely, Friedman'sinstmmentalism.

Possibilities for criticizing "economics-based accounting theory"Given the two ingredients of economics-based explanation of social behavior,there are thus only two lines of criticism. Either there is something wrong withthe notion that people maximize their utility or there is something wrong withmethodological individualism (or possibly both).

Since the maximization assumption is just one of many assumptions requiredin a neoclassical model (others are needed to specify the constraints and par-ticular circumstances), criticizing the maximization assumption alone is usuallyquite futile (see Boland, 1981). In neoclassical economics, the issue is neverwhether people are really maximizers but whether it is possible to developmodels that include this assumption and still explain the observed behavior ofthe people in question. The only possible criticism is whether it is feasible

12 Their Popper reference is mostly out of context since on the pages referred to Popper isarguing for the sufficiency of a "critical approach." And on page 229, Popper explicitly identi-fies two groups: "positivists" and "negativists." Popper explicitly states that he is a member ofthe latter group; that is. Popper is not a posidvist!


for people to be maximizing utility. For example, some economists claim thatthe assumed process of maximization is not logically possible since it requiresknowledge beyond what is logically possible (see Shackle, 1972). Others claimthat although maximization may be logically possible, it is not practical (seeSimon, 1959).

Methodological individualism poses the larger problem. While it seems rea-sonable to assert that only individuals make decisions, it is not clear that thismeans that individuals always and only "till their own gardens" as Voltaire saidin Candide. There is nothing to preclude individuals from being concemed withthe social consequences of their own selfish actions. For example, although it iseasy to mn the red traffic light when no police officer seems to be looking, ifwe see our actions as promoting proper social behavior, then we might chooseto stop at the red light, regardless.

Hidden in the Chicago School version of methodological individualism is thenotion that what is good for the individual decision maker (at General Motors)is good for the whole society. Myron Gordon (1964) explicitiy states such an as-sumption. He says that "the private ownership and use of property in the privateinterest of its owners serves the public interest best" (p. 259). Supposedly, ifall individuals in society are maximizing, then necessarily we have reached thesocial optimum, the "best of all possible worlds." This is obviously tme when-ever public interest is thought to be the sum of all individuals' private interest(i.e., their personal utilities). If all individuals are maximizing their personalutility, then necessarily the welfare of society must also be at the maximum(see Koopmans, 1957, pp. 50-51). Implicit in this notion is the presumptionthat the whole economy is in a state of general equilibrium and, thus, there isno reason for anyone to change their choices or decisions (this is achieved onlywhen all markets are cleared and all individuals are maximizing ^^). It is notclear to us that this common equilibrium notion is consistent with the idea ofsocial standards such as GAAP. If the notion of accounting standards is actuallyto help interested parties monitor whether the behavior of a large business entityis serving the interests of the investors or, through the tax system, the societyin general, then one cannot begin with the notion that we have already achievedthe necessary equilibrium state so that what is best for any large business entityand what is best for the whole country are simultaneously obtained.

We will examine these avenues for criticism more fully below. For now, wewish to consider how others have tried to criticize positive accounting theory.

13 This coincidence of equilibrium and universal maximization is a consequence of theeconomist's definition of demand and supply curves. The quantity demanded in the marketat the going price is the sum one would get when one assumes all individual denumders aremaximizing their personal utilities at that price. Similarly, the market supply at the going priceis the sum one would get if all suppliers are maximizing their respective profit. So defined,a nonclearing market implies that at the going price demand is not equal to supply. When-ever the market does not clear at a going price, then necessarily at least one supplier or onedemander is not maximizing (see Boland, 1986, pp. 23-28).


A guide to critiques of positive accounting tiieorySince 1982 many articles that criticize and evaluate positive accounting theoryhave been published. ^* The criticisms can usually be put into one of threegroups depending on whether they are (1) technical criticisms about researchmethods, (2) criticisms about philosophy of science issues, or (3) criticismsabout economics-based research in accounting. Although some papers fall inmore than one group, most are easy to categorize.

Among the authors primarily concemed with technical issues are Lev andOhlson (1982), who claim that the positive accounting papers they surveyed(including Watts and Zinunerman, 1978) failed to model multiperson, multi-period equilibria and lacked both strategic considerations and game-theoreticapproaches that might aid in developing a formal theory.'^ Also in 1982, Balland Foster criticized Watts and Zimmerman (1978) on the basis of "constmctvalidity" in which the variable "size" may proxy for other omitted variables.'^ In1983, Houlthausen and Leftwich argued that a dichotomous dependent variablerepresenting agreement or disagreement with a proposed accounting standard isproblematic.'^ In the next year, McKee, Bell, and Boatsman (1984) criticizedWatts and Zimmerman based on statistical biases identified in the Watts andZinrnierman (1978) study. •*

Much of the philosophical criticism stems from the emphasis that Wattsand Zinunerman put on the positive/normative distinction. Papers in this groupinclude Tinker, Merino, and Neimark (1982), Christenson (1983), Schreuder(1984), Whittington (1987), and Whitley (1988). To this list we add the papers ofSterling (1990) and Mouck (1990), which appeared after Watts and Zimmerman(1990). The most interesting group of critiques are those concemed with thelindtations of economics-based explanations. This group includes Tinker et al.

14 Thomas (1981) is the first paper to comment on Watts and Zimmerman, but he is not a critic.He indicates that he is attempting to model "the function and subject matter of accounting" toprovide "a positive science of accounting" (p. 550). According to Thomas, his contribution isbroader than, but inclusive of, the Watts and Zimmerman positive accounting theory.

It should be noted that, with one exception (Mattessich, 1984), we have limited our"reader's guide" to articles published in widely available joumals.

15 In Watts and Zimmerman (1990) they recognize but do not actually attempt to answer Lev andOhlson.

16 Also, they criticize the model's "extemal validity" since discritninant analysis was usedwithout the use of a holdout sample or other correcting statistical technique (Ball and Foster,1982, pp. 182-183).

17 First, it cannot capture the intensity of the management's position and second, it carmot dis-tinguish between total agreement and agreement on some points but disagreement with others(Holthausen and Leftwich, 1983, pp. 104-105). Without mentioning Watts and Zimmerman(1978), Holthausen and Leftwich also criticize the use of size as a proxy for political vis-ability (called political sensitivity elsewhere) (1983, p. 108). They agree with Ball and Poster(1982) that size may actually be a useful proxy for industry effects.

18 These biases included failing to use a holdout sample and the use of sample proportions asthe prior probabilities for the discriminant analysis test. McKee et al. furdier question the useof (Uscriminant analysis since Watts and Zimmerman used qualitiative explanatory variables,which means that multivariate normality may not exist.

150 L.A. Boland l.M. Gordon

(1982), Whittington (1987), Demski (1988), Whitley (1988), and now Sterling(1990).

Only eight critical papers were formally recognized as worthy of a responsefrom Watts and Zimmerman.'^ We will not discuss the papers that comment onlyon technical issues of research methods or testing techniques (viz., those foundin Ball and Foster (1982), Lev and Ohlson (1982), Holthausen and Leftwich(1983), and McKee et al. (1984)). Instead, we will be concemed with thosethat focus on the philosophical and methodological elements of economics-based explanations since our purpose is to determine why they were generallydismissed by Watts and Zimmerman. Special consideration is given to some ofthe papers that Watts and Zimmerman failed to recognize.

Critiques based on philosophy of science issuesGiven that Watts and Zimmerman did not rely on philosophy of science ar-guments in their first paper to support the methodology they were promoting,it is difficult to see how an attack from philosophy of science could ever betelling. This is even more so since most of the philosophy of science critiquesare irrelevant. Nevertheless, we review the possible critiques.

The methodology that Watts and Zimmerman practice is exactly the method-ology that the Chicago School economists George Stigler and Gary Becker(1977) advocate. Specifically, the researcher explains phenomena as a conse-quence of utility maximization or indirectly of profit or wealth maximization(Watts and Zimmerman, 1986, p. 3). The explanation is implied entirely by thelogic of the situation facing the decision maker. One must specify the objectivecost functions facing the decision maker such that whenever a parameter of thecost function changes, the individual decision maker responds as necessary tomaintain the objective of maximization. Most importantly, the only reason foran individual to change his or her choice would be that the cost parameters havechanged. According to Stigler and Becker, economic analysis is exclusively con-cemed with the objective cost function. That is, changes in behavior, if they areto be explained economically, are not explained as consequences of changes inthe tastes of the individual (e.g., of changes in their utility functions) (see Stiglerand Becker, 1977, p. 76).

The methodology of this approach proceeds as follows. The first step is tobuild an explicit model of the cost situation, the second step is to assume thatthe players are maximizers, and the final step is to feed the model appropriatedata and determine whether the model fits the data. Of course, models rarely

19 We have not included Christie's (1987 and 1990) two relatively uncritical contributions tothe discussion. His contribution to the positive accounting theory area has been suggested tobe twofold. First, Christie (1987) supports the suggestion that the variable specification is-sues that surround the contracting and political cost theories will be resolved when "a theoryrelating expectations of future cash flows to accounting variables" (p. 242) is formulated.Second, Christie's (1990) results indicate that six contracting and size variables provide ex-planations across studies and that the theories of contracting, and size when taken as a wholehave a posterior probability of having explanatory power close to one.


fit the data perfectly (Zimmerman, 1980). The challenge of the Stigler-Beckermethodology is that, if you think you can do better with some other behavioralassumption or model, then do it and we can all see whether your model fits thedata better (Watts and Zimmerman, 1990, p. 146).

According to this view of methodology, theories are merely catalogues orfiling cabinets for data. For anyone to claim more for the notion of "explanation"they would have to say something about the truth status of the model's assump-tions. Whether this Stigler-Becker methodology corresponds to what philoso-phers call conventionalism or alternatively to Friedman's instrumentalisni de-pends on whether one is claiming that the model is a good approximation ofreality or whether one is claiming only that the model is useful. Of course, agood approximation could be useful but most often those who rhetorically pro-mote usefulness are doing so to avoid making claims for the truth status of theirtheories.

Given such a modest methodology, how could one expect ever to launch asuccessful criticism? Clearly, complaining that Watts and Zimmerman are notfollowing the dictates of popular philosophers of science is not very effective.Moreover, all that the philosopher Karl Popper requires is that the researcheradopt a critical attitude. Being willing to submit one's research to empiricaltests would seem to be sufficient. Arguing that one's assumptions should beverified as realistic prior to conducting the research is at cross purposes. Besides,one can always say, if you think your assumptions are more realistic, then putthem to work in a model and test the results. Recognizing these methodologicaldifficulties, which always occur when trying to form an effective critique of sucha deliberately modest methodology, let us examine the methodological critiquespublished so far.

Since Watts and Zintunerman call so much attention to their work by labelingit with the banner of "positive," it is not uncommon to see critics engagingthem on this form of rhetoric. The first paper to do so is Tinker et al. (1982),who argue that although Watts and Zimmerman claim that positive accountingtheory (in contrast to normative accounting theories) is objective, nonbiased,and descriptive, positive accounting theories are as value-laden as the normativeaccounting theories Watts and Zimmerman argue against. Unfortunately, Tinkeret al. are more interested in promoting an alternative view of social research,one which they call historical materialism.^*' The next year brought the broadattacks of Christenson (1983) and Lowe, Puxty, and Laughlin (1983), which setout to criticize the methodological underpinnings of positive accounting theory.Christenson is promoting a rather specialized (viz., somewhat distoned) versionof Popper. Christenson's main objective is an outright philosophical rejection of

20 Noting the economics basis of positive accounting theory. Tinker et al. point to a fundamentalreliance on "marginalism" (i.e., utility maximization) and economic "Value Theory." Wattsand Zimmerman (1990) recognize Tinker et al. (1982) but distniss them primarily on thegrounds that arguments from different paradigms are involved (Watts and Zimmerman, 1990,p. 149).


positivism.^' Lowe et. al (1983) take an equally negative approach by claimingthat positivism may not be "justified." Unfortunately, they offer a detailed andtedious critique of the philosophy of "hypothetico-deductive method" (whichthey assume is the methodological basis of the positive accounting theory ofWatts and Zimmerman, 1979). ^̂ They implicitly claim that one should notadvocate anything unless one can give a prior justification. Of course, this isnothing but 18th century scepticism, which, in tum, is unjustified. Schreuder(1984), on the other hand, accepts the positive/normative distinction to promotethe normative approach. Schreuder is concemed with the general question of theusefulness of positive versus normative theories.^^

After a shon lull, Whittington (1987) launched his attack on Watts and Zim-merman (1986) by stressing the limitations and biases of Chicago School eco-nomics. And in the following year, Whitley questioned the use of scientificmethodology from the natural sciences being applied to the social or humansciences.^ Hines (1988) offers a rather narrow complaint about some technicalphilosophical questions surrounding the views of Popper. ̂ ^ In particular, sheargues against a reliance on "falsificationism" in accounting research. ̂ ^ Later,

21 His criticisms are (1) that the "positive" research of Watts and Zimmerman (which he callsthe "Rochester School") is a prerequisite to having normative accounting theory; (2) thatpositive accounting theory is based on a confusion of phenomenal domains; (3) that positiveaccounting theory is based on outdated philosophy of science and it is misnamed since itshould be called "empirical," not "positive," theory; (4) that simply because a theory is tobe used to predict it should not be known to be false; and (5) that the RochesterSchool's arguments to dismiss their theories' failures are not "scientific" according to Popper(1959).

22 Lowe et al. (1983) argue that Watts and Zimmerman's positive accounting theory may be crit-icized on several points. First, positive accounting theory's methodology is suspect (i.e., not"justified" by Watts and Zimmerman). The testability of the Watts and Zimmerman position isa second questionable issue since Watts and Zimmerman do not outline what would be accept-able evidence for rejection of their theory. Third, Lowe et al. question the empirical evidenceprovided by Watts and Zimmerman to support their position and finally, Lowe et al. claim toprovide empirical evidence that does not support the contentions of Watts and Zimmerman.

23 Schreuder (1984) makes two comments regarding positive accounting theory. In his footnote6, Schreuder (1984, pp. 228-229) indicates that positivists such as Zimmerman (1980) havedifficulty distinguishing between positive and descriptive research. Schreuder's second claim isthat if positive theories cannot provide prescriptions, then these theories are equally incapableof providing explanations. According to Schreuder (p. 228), this means that the "main conclu-sion is that positivist methodology leaves the question of the practical or political usefulnessof theories entirely open" (Schreuder's emphasis).

24 Whitley bolsters his criticisms by referring to Lowe et al. (1983), which was ignored in Wattsand Zimmerman (1986), and to Christenson (1983).

25 Hines (1988) takes Christenson to task over his belief in Popper. Unfortunately, she confusesImre Lakatos with Popper and thereby confuses the issues further by arguing that Popper isnot the appropriate philosopher to follow. Fortunately, her mistaken views of Popper do notmatter. Since Watts and Zimmerman do not really rely on Popper and do not need to rely onLakatos, it is questionable why anyone might think this a viable line of criticism.

26 Falsificationism is merely a variant of conventionalism since it emphasizes falsifiabiiity asthe criterion of choice. It is unfortunate that this variant is attributed to Popper (e.g., Blaug,1980; Christenson, 1983; and Hines, 1988) since Popper does not offer an altemative method-ology to choose the best theory. In fact. Popper rejects the view that there must be a scientificmethodology that, if followed, produces scientifically acceptable results. For a detailed ex-


Mouck (1990) agrees with Hines by promoting Lakatos over Popper and fur-ther argues that although Watts and Zimmerman cannot base their methodologyon Popper, they might be able to base it on Lakatos. Both Hines' and Mouck'spapers (and to a certain extent, Christenson's) are inputs of bystanders into along-standing family dispute between professional philosophers. As such, thesepapers are only exercises designed to impress philosophers and are thereby oflittle use to accounting researchers.^^

We find it difficult to see much utility in such philosophical critiques. Thereason is that they emanate from the views of philosophers that are equally opento question. Few philosophers know much about economics and surely fewerare familiar with the intricacies of accounting theory. Watts and Zimmerman areequally culpable in this area due to their apparent unfamiliarity with standardphilosophy literature and to their being naive enough to think it is simply amatter of finding a few (usually out-of-context) quotations that might seem tosupport their research program (e.g.. Watts and Zimmerman, 1986, pp. 10 and12).

Critiques about economics-based research methodologyThe group of critiques that focus on the methodology of economics-based expla-nations currently includes Tinker et al. (1982), who express their philosophicalobjections to what they call "marginalism" and Whittington (1987),^* Demski(1988), and Whitiey (1988), who focus on the use of equilibrium concepts andnow Sterling (1990), who complains in general about the Chicago School formof economics-based models. ̂ ^ While Tinker et al. (1982) may be correct tocomplain about "marginalism," (i.e., the standard technique that economists useto analyze maximizing behavior), they do not appear to be willing to providea useful criticism. Such is not the case with Demski (1988).^" Here we have

aminadon of Blaug's mistaken view of Popper's view, see Boland (1985 and 1982, chap.10).

27 In the case of Hines and Mouck, they wish to impress the anti-Popperian philosophers.28 Whittington (1987) is a review of the Watts and Zinrunerman 1986 book. He argues that it

presents an unbalanced and biased view of positive theory, that the theory is value-laden, thatWatts and Ziimnerman are incorrect in their conclusion that if a theory is not empiricallytestable then it is normative, that their enthusiasm for positive theory's reliance on the effi-cient market assumption and the Chicago School economics makes them ignore the associatedlimitations, and, finally, that while Watts and Zimmerman admit positive accounting theory'slimitations that they are less sympathetic to altemative approaches.

29 Sterling charges that the major empirical finding of Watts and Zimmerman (1986, p. 356)is nothing more than what they asstmied. Specifically, he claims they start by assuming thateveryone is a maximizer and then eventually reach the startling empirical conclusion thateveryone is a maximizer (1990, p. 128). Sterling, however, does not outright reject economics-based models when he observes (1990, p. 131) that other economists reject the ChicagoSchool version of economics-based explanation.

30 Demski's (1988) review of Watts and Zimmerman (1986) is somewhat supportive of the Wattsand Zimmerman approach. However, Demski raises several weaknesses in the positive ac-counting theory work that Watts and Zimmerman (1990) fail to address formally. For instance,given that positive accounting theory relies on equilibrium-based economics, there are exam-ples where because of ambiguous boundaries between components (e.g., political activitiesand regulation boundaries) of the theory, "we see extensive use of behavioral constructs in-stead of formal equilibrium analysis" (p. 627). As well, Demski notes that, by ignoring the


a critic who sees merit in the positive accounting theory of Watts and Zim-merman, yet finds room to question the substance of their approach. Moreover,with Demski's criticism, we have someone who does not argue from a differentparadigm with different rules nor without common ground.

Demski (1988) and Whitley (1988) reach similar conclusions even thoughthey come from different perspectives to question the appropriateness ofequilibrium-based explanations for the empirical issues that concem Watts andZimmerman. Whitley offers criticisms of Watts and Zimmerman that rest onthe inadequacy of equilibrium-based economics to explain sociological occur-rences. Demski (1988, p. 625) is concemed with the use of "the rhetoric ofperfect markets" as "a substitute" for theory.

The key issue with all of the critiques of economics-based methodology isthe use of neoclassical economics as the primary basis for understanding ac-counting theory. While few critics dispute the essential role of methodologicalindividualism in neoclassical economics methodology, it may be important torecognize that the use of maximization as a method of analysis also requiresthe existence of states of equilibrium (cf. Jensen, 1976, pp. 15-16). Specifically,when a decision maker calculates his or her cost function, the calculation al-ways involves prices. Are these equilibrium prices (i.e., market-clearing prices)?If so, then the deck has been stacked in favor of the market-oriented system ofsocial coordination that is favored by Watts and Zimmerman and their recog-nized predecessor Myron Gordon (1964). This stacking of the deck is not oftenappreciated by noneconomists.

Economists have long recognized that it is easy (and logically consistent) fora decision maker to use equilibrium prices but only if there is good reason toassume that all markets are in equilibrium (i.e., all markets are cleared). Whatis open to question is what it means to use equilibrium prices when there is notsufficient reason to assume that all markets are cleared. At minimum there isa logical contradiction. When any market is not cleared, demand is not equalto supply at the going price. 31 Using such a disequilibrium price will lead tomathematical difficulties since either not all demanders are maximizing or not allsuppliers are maximizing.32 Since the presumption of universal maximization iscentral to the Watts and Zimmerman methodology, it is not possible for them toconsider market failures or any other disequilibrium situations. Hence, Demskidefers from equilibrium analysis in favor of "behavioral constructs."

Since it is easy to admit that markets are rarely in perfect equilibrium, some

existence of information sources other than financial reporting. Watts and Zimmerman mayhave developed myopia.

31 See footnote 13.32 Although it is consistent to presume that a maximizing decision maker is a price taker in

equilibrium, if the market is not in equilibrium, not all individuals can be maximizing. Butmore important, who adjusts the price so that it is the one price needed for equilibrium?How does the market reach the equilibrium? Someone must adjust the price, but this wouldcontradict the assumption that all decision makers are price takers. For more on this problemof price adjustment, see Kenneth Arrow (1959) and George Richardson (1959).


may think that an imperfect but approximate equilibrium will nevertheless besufficient to assure equilibrium prices. There are, however, some fundamentaldifficulties with our understanding of such "imperfect" or "second-best" equi-libria. ̂ ^ Since equilibrium states imply the absence of change, they are easilyunderstood or mathematically modeled. That is, whenever everyone is maxi-mizing their utility or profit, there are no reasons to change prices (or choices).In a state of nonperfect equilibrium, there are reasons for change.^

Even though a second-best equilibrium may for the moment be the bestpossible imperfect equilibrium, being imperfect implies potential instability. Ifsuch equilibria do persist, however, they face a problem in that fundamentalconstmcts such as income may not even exist (see Beaver and Demski, 1979,pp. 39-41). 35 Until models are explicitly developed that include "behavioralconstmcts" to deal with how decision makers respond to such imperfections,imperfect equilibrium models cannot be considered a reliable basis for assumingthe existence of stable equilibrium prices.

Neoclassical economics does not contain any "behavioral constmcts" for dy-namic circumstances such as changing prices. Moreover, in a state of disequilib-rium it is unclear how decision makers know there is a state of disequilibrium. Ineconomics literature, this is called the problem of disequilibrium awareness andremains an unsolved puzzle. ̂ ^ In a disequilibrium state, we may know that theprice will be bid up or down but we are still unable to explain the extent of theprice adjustment. In a state of disequilibrium, since not everyone is maximizing,we have no basis to determine which of the demanders or suppliers are not max-imizing. Neoclassical economics was designed to explain equilibrium states, notdisequilibrium states! The best that we can do is recognize that whenever a price

33 Such second-best equilibria are usually characterized by their attendant contracting, mon-itoring, and transaction costs, and similar disequilibrium phenomena. It is, of course, suchdisequilibrium situations that Watts and Zimmerman (1990, pp. 134-135) are interested instudying.

34 When there is not a state of perfect equilibrium, there must be at least one person who isnot successfully maximizing. At the going market price, either some demanders cannot buyenough or some suppliers cannot sell enough (or both). Either the demanders need to com-pete among themselves by trying to outbid each other or suppliers need to compete amongthemselves by undercutting each other. Only when demand equals supply at the going price isthere no need to engage in price competition. Only in a perfect equilibrium is there reason toexpect prices to be stable. In a perfect equiUbrium we know what everyone is doing (they aremaking maximizing choices). But when prices are changing, we do not know what people aredoing.

35 Moreover, attempting to obtain more information may not lead to less disagreement andbetter decisions if information is costly since the cost of the extra itiformation may exceedthe expected benefits of improving the likelihood of choosing the best investment. That is,there is an "economics of information" (see Stigler, 1961). But it must be recognized thatthis conception of information presumes that information is a homogenous quantity thatcan be optimized on the margin. It is certainly possible that the next little bit of marginalinformation might contain evidence that refutes someone's optimistic income expectationswhich if ignored might lead to major losses (see Boland, 1982, chap. 4).

36 Many economic theorists (e.g., see Hahn, 1970; and Fisher, 1981) have tried to solve suchproblems of price adjustments as the one raised by Arrow, but none have been entirely suc-cessful and many methodological difficulties remain (see Boland, 1986, chap. 9).


is unstable, its instability is a clear indication that we must be careful whenexplaining behavior as only a matter of making maximizing choices. Given thatdisequilibria involve dynamics which are not present in equilibrium models,the real world of positive accounting research cannot be seen to be a mereapproximation of an equilibrium world. Care requires at least that werecognize the limited applicability of models that assume all prices are equi-librium prices.

At root of Demski's critique is the recognition that neoclassical economics iswoefully weak on questions of dynamics (Demski, 1988, p. 626). Specifically,he says that the imponant question is "not how accounting method choices varythrough time and circumstance, but why the organization has been designed tomotivate this particular behavior in the accounting domain" (p. 626, emphasisadded). "How" questions are the domain of descriptive research and "why" ques-tions are that of theories. The logical consequence of Demski's critique is tosuggest that Watts and Zimmerman are offering descriptive theories even thoughthey claim to be offering positive explanations. Most imponantly, Demski ap-pears to find positive accounting theory (i.e., economics-based explanation) tobe an inadequate basis for accounting research.

Unfonunately, Watts and Zimmerman fail to formally recognize Demski'scritique in their 1990 anicle even though they claim to respond to their critics.We think Demski's critique points to the hean of applied economic analysis. Ifeconomic analysis is to be used, then at least it would be wise to understandthe requirements and limitations of economic analysis.

Background of "positive economics"In their 1990 anicle. Watts and Zimmerman do not respond to any of the claimsthat there are limits to applications of economic methodology—except to reit-erate that

the methodologies that survive are the ones that produce useful theories. Competitionin the marketplace of ideas will produce future research that uncover the errors of ourpresent ways. Time will tell whether our approach is inappropriate. (1990, p. 148)

In this regard, they claim that "methodological criticisms have failed the markettest" (1990, p. 149). We wish to offer an alternative explanation for why most ofthe methodological critiques have failed. We think the failed critiques are due toa shifting target presented by Watts and Zimmerman in their various anicles anda confusion by all panies over what economists mean by "positive economics."We also explain why references to "positive" can easily lead to confusion. Wattsand Zimmerman stated that they "adopted the label 'positive' from economics"(1990, p. 148). We will show that even leading economists do not agree aboutwhat constitutes positive economics and thus accounting researchers ought nottake "economic positivism" for granted.


What the word "positive" means in economicsEvery economics student is taught to clearly distinguish "positive" from"normative" questions by characterizing the distinction with an "is/ought"dichotomy. ^' While promoting "positive methodology" in his famous 1953essay, Milton Friedman tried to deny the "is/ought" dichotomy by arguing thatanswers to "ought" questions necessarily depend on a prior establishment of"what is." Nevertheless, most critics of Friedman's methodology think he wasarguing against normative economics and thus assume that he was only arguingin favor of positive economics (e.g., Koopmans, 1957; and Simon, 1963). Thepresumption seems to be that one must always choose between "is" and "ought"questions as if they are inherently mutually exclusive.

Is the use of the word "positive" merely rhetoric?There is a sense in which the distinction between positive and normative iscompletely confused. Positive policy advisers are in effect always recommendingthat their policy is the best way to achieve the given ends.-'^ It is difficult toconceive of a way one could ever avoid normative judgements. So, what is onetmly accomplishing when demanding that one's research or advice conform tothe dictates of positivism?

Whenever an author is extolling the virtues of a theory by claiming it isa positive theory, he or she is usually asserting that it is not something of ascientifically unacceptable nature. What is acceptable in these matters is usuallydictated by the prevailing view of "scientific method." But it is not often clearwhy the word positive must always indicate something acceptable or desirable.

Up to the time of Hume (late 18th century), most thinkers seemed to believein the power of rational or logical thought and especially in its embodiment inscience. By the word science, it was usually implied, following Francis Bacon's17th-century view, that all science can be reduced to positive evidence fromwhich in tum all systematic knowledge could be justified by the logic of in-duction. This gives us a clue as to why the accolade of "positive" has for solong implied something good. Any theory that offers or is based on positiveevidence—that is, on observations or hypotheses that make positive contribu-tions toward an inductive proof of one's systematic knowledge—is worthy of thetitle "positive." And given the common 19th-century belief in the viability of in-ductive science, "positive" implied "scientific," "rational," and even "objective."The implication of objectivity follows from Bacon's promotion of inductivism

37 John Neville Keynes is most often quoted to support the dichotomy despite the fact that,as Blaug (1980, p. 141) points out, Neville Keynes actually provides a threefold distinctioninvolving (1) the "establishment of [existing empirical] uniformities," (2) the "determinationof ideals" or the "criteria of what ought to be," and (3) the development of a practical "art"to formulate "maxims or precepts by obedience to which given ends may best be attained"(see Keynes, 1917, pp. 32-35; emphasis added). Unfortunately, the widespread reliance onthe "is/ought" dichotomy has nullified Keynes' best efforts to improve our understanding ofpositive economics.

38 This is evident even in John Neville Keynes' original 1917 discussion.


as antidote to self-interested or prejudicial claims of knowledge (see Agassi,1963). To be scientific, inductive proofs were to be based only on objectiveobservations. Whether one's theory makes a positive contribution to scientificknowledge is solely a question of one's personal research skills. A tme scien-tific researcher is objective, unprejudiced, and unbiased to the point that anyreported data will be beyond question. The remainder of science is simply amatter of objectively based inductive logic. As a corollary, if anyone errs in hisor her scientific claims to knowledge, it could only be due to introduced biases,prejudice, or injecting his or her subjective values.

In social science research over the last 50 years, the infiuence of the logicalpositivists and the retrospective influence of Max Weber have combined tomake the rhetoric of positivism even more confused. The logical positivistswere those analytical philosophers who thought verifiable scientific knowledge isdistinguishable from unverifiable "metaphysics." The tum-of-the-century socialscientist Max Weber is now credited as being a leader in developing the ideathat scientific knowledge could be "value free." And to confuse things still more,the philosopher Karl Popper presented a critique of logical positivism based onthe logical grounds that one's theory makes a positive contribution to scientificknowledge only if it is falsifiable (which most commentators seem to thinkmeans only that it is not a tautology).

What economists seem to think "positive" isPositivism as it is currently practiced in economics seems to be available in fourdifferent versions. The first and most ambitious version is Harvard positivism. Itis represented by the recent attempts to develop "experimental" economics andhas it origins in the early teaching of the Harvard economist Edward Chamberlin.At the other extreme is MIT positivism, a weak minimalist version of positivismthat is based on the methodological views of the MIT economist Samuelson.Its weakness is due to its weak methodological requirement that says to be ofscientific interest, a theory need be only potentially refutable—there is no addi-tional requirement that it needs to be supported or tested by empirical evidence.Between these two extremes are two more modest versions. One is Chicago pos-itivism, which includes both the simplistic instrumentalism of Friedman and themore complex confirmationism of the Chicago economists Becker and Stigler.The other one is LSE positivism, which has been promoted by the former LSEeconomist Richard Lipsey. Although it does not require controlled experiments,LSE positivism does see economics as a scientific endeavor that emphasizes anecessary role for empirical, quantitative data (with the emphasis on quantita-

Harvard positivism. In neoclassical economics the usual approach is to builda model of the economy based on the maximization hypothesis and try to deter-mine whether the model can be confirmed when confronted by the data available

39 For a more detailed discussion of economic positivism, see Boland (1991).


after the event. ̂ Harvard positivism offers a different approach. Rather thanaccept the limitation of available data (which are usually aggregative and thusopen to many methodological questions), experimental economics proposes tocreate a real-world situation in which the assumptions of the typical neoclassicalmodel are true. Specifically, the experimental economists attempt to determinewhether the behavior implied by the neoclassical maximization hypothesis^' islogically consistent with the experimentally observed phenomena. The extent ofthe laboratory skill of the experimenter is always the sole determinant of whetherthe experiment represents a successful exercise in economic positivism.

MTTpositivism. The adoption of a much less fimdamentalist view of economicpositivism was proposed by Samuelson (1947). Seeking to ensure the optimisticpromises of positivism, he argued that the minimum condition for a positivecontribution to economic understanding is that anyone's positive theory must becapable of yielding to refutations based on positive evidence. In short, all tmlypositive theories are empirically refutable in principle (1947, p. 4).^^

Chicago positivism. Usefulness is the keystone of the positivism promoted bythe followers of Chicago School economics. There are two aspects of usefulness,however, policy making and ideology promotion. Providing positive theories thatcan be used as instmments by policy makers is an obvious goal for ChicagoSchool economists. However, providing positive theories and methodology thatwill be useful for confirming beliefs in the omnipotence of the market systemin particular is also a goal of most Chicago School economists (e.g., Friedman,1962).

By arguing for an instmmentalist methodology in his famous 1953 essay,Friedman was not arguing against positivism but only against the more sophis-ticated logical positivism. Positive evidence still matters for Friedman. His onlyrestriction is to limit the evidence to that of results or predictions and therebyexclude a priori or logical analysis of models, assumptions, and theories as adeterminant of the usefulness of positive theories.'*^

40 Unfortunately, the available data are seldom decisive in any direct way. Instead, many addi-tional assumptions must be made and thus any conclusions reached are always conditional.

41 Although other hypotheses could include Herbert Simon's "satisficing behavior" (1959, 1979)or Marxist "acting according to class interest," experimental economics is dotninated by theneoclassical tnaximization hypothesis (e.g., Dopuch et al., 1989). This is true as much forthose who favor this assumption as it is for those who run experiments to challenge beliefs inthis assumption (e.g., Kahneman and Tversky, 1979).

42 All that is ensured by such a weak requirement is that the proposed positive theory is not atautology. This was explicitly recognized in the late 1930s by the economic methodologistTerrence Hutchison (1938). It should be clear that this minimalist version of positivism isserving the interests of mathematical model builders, who wish to avoid all of the menialunpleasantness of dealing with complex real-world empirical data, more than the interestsof those who are concemed with promoting truly positive economics. For the mathematicaleconomists, the elegance of one's model is always much more important than whether themodel's assumptions are empirically realistic or whether the model's implications are usefulwith respect to economic policy.

43 Positive data obviously play an essential role in Friedtnan's methodology. But for Friedman


When it comes to ideological questions, however, other members of theChicago School are much more prominent. In 1977, Stigler and Becker offereda manifesto for those who believe in neoclassical economics. Their argument,simply stated, was that the Chicago School economists will offer models of theeconomy that do not engage in analysis of the psychological (subjective) makeupof individual decision makers but instead offer analyses of the objective (pos-itive) cost situations facing the individual decision makers and thereby explainany observable, positive behavioral evidence in question. All observed changesin behavior will be explained as consequences of observable and objective costsituations facing decision makers who are assumed to be maximizing accordingto their psychologically given utility functions (see Stigler and Becker, 1977).

Each positive economic model that succeeds (they never seem to report anyfailures) is offered as yet more confirming evidence that one can explain anysocial or behavioral phenomena with an appropriately constmcted neoclassicalmodel (i.e., where the model builder has assumed maximization behavior in afree market system). For this branch of the Chicago School, the real purpose ofneoclassical model building is once again to confirm the tmth of a market-basedsystem of social coordination (Boland, 1982; see also Gordon, 1964).

LSE positivism. Stigler and Becker may be correct in promoting neoclassicaleconomics as the only tme explanation of social and individual behavior, butif so, it ought to be tested in a more critical manner. At the end of the 1950s,a group of economists at the London School of Economics (LSE) proposed amore critical approach to economic model building. Although it is easy to findpositive evidence to confirm anyone's favorite model, the "scientific" issue isone of approaching the evidence in a less predisposed manner. Such an approachdoes not preclude a priori beliefs; it merely cautions one to let the positiveevidence do the talking.'**

Although most economists may believe in the market as a basis for social co-ordination, except for Chicago positivists, such a belief is not required. Instead,what is required is a critical attitude. The combination of testing and measure-ment is the hallmark of LSE positivism.*^ It is thus not surprising to find that

the only relevant positive data will be successful predictions, which ensure the usefulness ofone's model or theory. There is nothing inherent in Friedman's methodological essay thatwould prevent his form of instrumentalism from being used by post-Keynesian economists oreven Marxists.

44 The LSE approach to positivism was the self-conscious product of a group of youngeconomists led by Lipsey who formed what was called the LSE Staff Seminar in Method-ology, Measurement and Testing. The seminar was to some extent inspired by Popper'spresence at LSH and his emphasis on criticism and empirical testing as the true basis forscience (see de Marchi, 1988). Popper's views were initially called upon to support the sem-inar's goal, which was to develop an antidote to those economic thinkers at LSE (e.g., LionelRobbins) who were satisfied with purely theoretical explanations (i.e., ones based on onlyassumptions and definitions such as "economics is about scareity") and who at the same timesaw no need to get their hands dirty dealing with real-world data.

45 The message of the LSE seminar was captured in Lipsey's well-known 1960s textbook. Intro-duction to Positive Economics. The main thrust for L.ipsey was the advocacy of developing an


econometrics plays a prominent role. But unlike the instrumentalist tendencyfound among American econometric model builders (see Boland, 1986), LSEeconometrics is supposed to be helping us to assess any economic propositionthat might arise. The positive/normative distinction was to play a central roleonly because it was thought that all normative statements are untestable and this"unscientific."

How positive economics is practicedEven though the philosophy of economic positivism has not been well thoughtout by its main proponents (see Boland, 1991), it still captures all the satisfyingnotions that most mainstream economists seem to desire. Those econonniststoday (including those firom MIT or LSE) who see themselves as scientistsoffering explanations of economic phenomena will be pleased to find that ad-herence to positivism only requires assurances that the assumptions of one'smodel are falsifiable. Falsifiability of one's assumptions merely ensures that theconclusions and explanations provided by the model will not be what economistscall tautologies.'** The problem is that there are some statements of the form thateconomists call tautologies, yet that can also appear to be confirmed. Confirminga statement that cannot conceivably be false cannot really contribute anythingpositive to economic science.

If one could measure such things by examining leading economics journals,one would find that the dominant version of positivism in empirically orientedeconomic research is the LSE version. This is due mainly to the success ofLipsey's introductory textbook and its promotion of econometrics methodology.Among mathematically oriented theorists, the dominant version is the MIT ver-sion. The Chicago version is almost exclusively found among Chicago-trainedeconomists or those economists who identify with the ideological stance pro-moted by Chicago-trained economists (see Reder, 1982).

Shifting the prohlem toward the domain of Chicô positivismWhile there are some examples of Harvard positivism in accounting research(e.g., DeJong, Fbrsythe, and Uecker, 1985; Smith, Schatzberg, and Waller, 1987;and Dopuch, King, and Wallin, 1989), examples of MIT positivism are somewhatlimited.**̂ When Watts and Zimmerman promote their form of applied economic

appreciation for real-world empirical data. His textbook became the major platform for all ofmodem economic positivism.

46 Why are economists so concerned with avoiding tautologies? The only methodologicalproblem solved by avoiding tautologies is the one facing economists who wish to claim thattheir empirical tests of their models or theories represent positive contributions on the basisthat their empirical evidence verifies or confirms tfieir models (see Boland, 1989).

47 Possible examples of MIT positivism in accounting literature are the mathematical modelingof agency theory in an accounting context (e.g., Baiman, May, and Mukherji, 1990). Thissupposition is based on the suggestions of the articles' authors that their theoretical work tnayprovide guidance to interested accountants, managers, or regulators. Simulation studies (e.g.,Matsimiura, Tsui, and Wong (1990) may also be examples of MIT positivism to the extentthat such studies may be "possibly refutable."


positivism, it is not always clear whether they are promoting LSE positivismor the Chicago version. As we demonstrated earlier, an examination of thevarious papers published by Watts and Zimmerman reveals mixed signals. Onsome occasions, their methodological pronouncements seem to lead us to thinkthey are interested only in increasing the scientific status of accounting research.However, in their most recent paper (Watts and Zimmerman, 1990) they seem toavoid calling upon any philosopher of science to defend them from the numerousmethodological critiques.^^

Although Zimmerman (1980, pp. 107-112) claims that positive accountingtheory is capable of offering explanations (answers to "why"-type questions)whereas older empirical accounting research (e.g.. Ball and Brown, 1968; Balland Watts, 1972; and Kaplan and Roll, 1972) was limited to descriptions (an-swers to "what"-type questions),"*^ the promoted notion of an explanation tumsout to be the rather limited one found in neoclassical microeconomics.'^ Theprimary limitation is that of static choice situations. As noted above, the issueof applying neoclassical economics to questions beyond the obvious domain ofeconomics always raises the question of applicability. The question of applica-bility in tum necessitates a recognition of limits of applicability. The Watts andZimmerman methodology is entirely invested in limiting accounting research toonly questions for which neoclassical economics can be applied. But is limitingaccounting research to questions of static choice sufficient to ensure applica-bility? One determines applicability only by examitung the assumptions of thetheory in question. Let us critically examine them.

While it may be considered appropriate for a neoclassical economist to as-sume that everyone is a maximizer, it is equally imponant to recognize objec-tions to such an assumption. For example, Herben Simon (1959, 1979) has longnoted that in many circumstances, decision makers are interested in achievinga targeted satisfactory level of utility. The cost of fine tuning the process toactually achieve the analytically tme maximum may be too high. When onegoes further to argue in favor of maximizing expected utility, things are worse.As is well-known, Kahneman Euid Tversky (1979) have called into question thelogical consistency of such an objective function (see also Kahneman, Knetsch,and Thaler, 1986; Tversky and Kahneman, 1986).

As noted earlier, criticism of the assumption of maximization is easily handledby followers of Stigler and Becker (1977) with the counterchallenge: If youthink the appropriate model ought to recognize "satisficing" or the limitations

48 Actually, as we explained earlier, each of their other papers uses different philosophicalarguments and different authorities. Some papers seem to promote a form of Friedman'sinstmmentalism (the view that claims only "usefulness" matters) and others seem to promotea more orthodox philosophy of science—the one philosophers call either conventionalism orfalsificationism.

49 The distinction is not always clear in economics. As Samuelson pointed out, explanation is the"honorific title" given to a better description (Samuelson, 1965, p. 1171).

50 Mattessich (1984, pp. 77-80) calls this a shift from "a theory of accounting measures" to "abehavioral theory of accounting standards setting." See also Mattessich (1990).


of "expected utility," then build your model and put it to test against the availabledata.

Have Watts and Zimmerman stacked the deck in their favor? Certainly theyhave shifted the research questions toward the domain where neoclassical eco-nomics would seem to be appropriate—for example, the static choice situationsfacing the managers and practicing accountants who must decide which pro-cedures to use (Watts and Zimmerman, 1986, p. 3). And, certainly, they haveadopted a methodological stance that allows them to deflect criticism and evento put the onus on the critics to perform better. This is not new. But in ac-counting (which by design should be unbiased), when it comes to a questionof serving the interest of business versus the interests of society in general, itmight be problematic if there is an ideological perspective promoted that is seento favor business over society—particularly whenever it cannot be ensured thatthe world is in a state of equilibrium.

Although it is tme that it is possible for managers of corporations to try toinfluence the accounting standard-setting bodies, is this really consistent withthe purpose of such bodies? It is conceivable that some individual membersof such bodies look beyond their potential for personal gain to be more con-cemed with the social role of accounting standards. So the question is, is therean inconsistency between concem for social consequences and personal utilitymaximization? According to Watts and Zimmerman (1979), however, a publicinterest argument is merely a self-interest argument in a different guise and thusis a matter of maximization. When confronting an accounting researcher whowants to promote a contrary view, the Stigler-Becker methodology is easily seento be the appropriate response.

The methodological question here is whether it is easier to build models thatassume personal utility maximization than to build models in which the indi-viduals have a concem for the social consequences of their actions. Moreover,to build competing models for the purpose of the methodological competition,a fair competition requires ceteris paribus that given the same data, the com-peting models have a methodologically equal chance. Unfortunately, modelsthat incorporate social concems in private utility functions are more difficult todevelop and certainly more difficult to fit to the available data.^' This is usuallydue more to mathematical and econometric complexities than obvious questionsof verisimilitude. In other words, equilibrium-based maximization models areeasier to apply to data than other models. This would be tme even if the othermodels are more realistic. A cmde model that does not assume personal max-

51 Although it is conceivable that one could make a minor change by adding other people'sutility as an argument in an altruist's utility function, the mathematical modeling of this isvery complex. Apart from complexity, how would one know whether the other person's utilityis increased or decreased? At miiumum one would have to form rational expectations of otherpeoples' actions, and this would involve difficult questions of uncertainty as well as learningmethodology. If society's interest is the included variable, this question of knowledge can bevirtually impossible to model except in trivial cases—compare Becker (1976) with Richardson(1959), and (Bacharach, 1989).


imization may for reasons of complexity yield a bad fit even when it betterrepresents real behavior. All this is made possible by the recognition that we arenot dealing with exact fits but something less. A poorly fitting nonmaximizationmodel may better represent reality than a maximization model that provides agood {but imperfect) fit! Once one relies on degrees of imperfect fit, anythingis possible.

Moving toward effective methodol(^cal critiquesOf course, researchers are free to do whatever they want. There is no reasonto think any philosopher or methodologist has an advantage when it comes todeciding what to do and how best to go about it. If Watts and Zimmerman wishto limit their explanations to that of Chicago School economics, then so be it.And if others wish to contribute methodological critiques, then so be it.̂ -̂

We agree with the conclusion of Watts and Zimmerman (1990) that method-ological criticisms have failed the market test.'3 Nevertheless, we still think it isimportant to understand why methodological criticisms have failed the markettest.

There is no reason why debating methodology has to be a "no win" situationdespite the claim of Watts and Zinunerman (1990). As they implicitly recognize,if the criticism emanates from the same paradigm using the same mles, thenthere is no reason to automatically dismiss it. We think that the reason whymost critiques have failed to meet the test of the market is that their quality orrelevance has not been sufficient to warrant purchase. Too many critics wavepages and quotes from the books of their favorite philosopher as if consultingwith philosophers is an essential ingredient. Moreover, too often the quotes areout of context (this is typical of almost all of the quotations from Popper'swork in the literature—and by all parties). If one's methodological criticism islogically sound it ought to be possible to explain it in a convincing mannerwithout references to authorities (cf. Sterling, 1990, pp. 121-126).

While the neoclassical maximization assumption is always open to question,its realism is virtually impossible to determine. Thus, whenever someone wishesto criticize a model with that assumption, other considerations must be examined.Extemal criticisms that come from a different paradigm will not be interestingto someone who sees an aspect of accounting theory to be a fertile ground onwhich to apply neoclassical economics. Only an intemal criticism that is basedon the same paradigm using the same mles will be an effective and interestingcriticism worthy of consideration. The most obvious form of intemal criticismwill be directed at the applicability of a neoclassical economics explanation.

52 However, the task of the methodological critic has its limitations. The methodological criticmust decide what to do as well as determine the best way. Methodological considerationsapply to methodology critiques as well as empirical research.

53 To be consistent, however, one would have to presume that the only exceptions are themethodological criticisms that Watts and Zimmerman have provided to argue against "nor-mative" and "prescriptive" accounting research.


Applicability involves many different assumptions whose realism, unlike that ofmaximization, can be determined. Although it may be acceptable to constmctmodels that include assumptions whose tmth status is virtually impossible todetermine (as long as one is willing to submit his or her predictions to empiricaltest), it is surely unacceptable to constmct models using assumptions that areknown to be false. ^

So far, the most fruitful questions of applicability are those which recog-nize that a necessary condition for deliberate maximization is that the decisionmaker must be able to calculate the benefits and costs. If what a theorist meansby assuming the decision maker is a maximizer is that the decision maker is asuccessful maximizer (it is difficult to think otherwise), then such calculationsmust be based on the correct prices. The only sustainable correct prices areequilibrium prices since only equilibria allow universal maximization.'^ Thus,successful maximization would seem to require the establishment and continu-ation of a state of perfect equilibrium.'^ If the decision maker faces a second-best, disequilibrium situation, neoclassical economics is not easily applied (seeClower, 1965).

We think that Whitley's and Demski's critiques raise this methodologicalissue of applicability quite clearly. While Whitley's may not be from the sameparadigm as that of Watts and Zimmerman, Demski's clearly is.'^ Demski'sprimary concem with Watts and Zitnmerman (1986) is the applicability of theirimplicit assumption of perfect markets. Specifically,

Market value maximization, present value and wealth are useful constructs from the worldof perfect and complete markets. Accounting is most (or perhaps only) interestitig whenmarkets are tiot pristine. Contracting and political costs emerge in Positive AccountingTheory as an important acknowledgement that markets are not perfect. . . . Is marketvalue maximization sufficiently descriptive? Is present value sufficiently well defined in aworld of significant market imperfections? . . . Formal economic modeling of muWperson

54 While one can be sure the conclusions derived from a logically valid model will be true when-ever all the assumptions are true, one cannot be sure any of the logically valid conclusions aretrue whenever any one of the assumptions is false (see further Boland, 1979, pp. 503-505).

55 See, again, footnote 13.56 This is particularly so given the failures of neoclassical economists to successfully deal with

disequilibrium dynamics. See above, foomote 32.57 It should be noted that we have chosen to emphasize only one aspect of Demski's critique.

Demski presents his criticism as one of noting that Watts and Zimmerman are providing whathe calls a "revealed preference" approach. But what he describes does not correspond towhat economists mean by the term "revealed preference." We think that by his using the term"revealed preference," Demski is arguing that whenever a neoclassical theorist builds a modelaround the assumption of maximization and then declares that the model is successful, ineffect it is being claimed that the model's success reveals maxinruzation to be the true purposeof the agents in the model. In other words, every logically successful neoclassical model isdeclared to be positive evidence in an ongoing methodological process of inductively provingthe veracity of neoclassical economics. By targeting the "revealed preference" approach,Demski is saying that one cannot infer the purpose of a model's agents unless dl of thenecessary conditions for the inference are fulfilled. Demski is claiming, as we are, that one ofthe essential conditions is the existence of perfect markets. For a methodological discussion ofthe type of criticism Demski is making, see Boland (1982, chap. 7).


phenomena uses the notion of equilibrium behavior. Here, by contrast, we see extensiveuse of behavioral constructs instead of formal equilibrium analysis. (Demski, 1988, pp.625-626)

Even if we ignore Demski's complaints about assuming the existence of astate of perfect-market equilibrium, there are other questions of apphcability thatwould be fertile avenues for criticism of positive accounting theory. ̂ ^ Does themaximizer have sufficient knowledge of the conect prices? Does the maximizerhave sufficient knowledge of the objective constraints other than prices? Doesthe decision maker have sufficient knowledge of even his or her utility functionto make a successful decision prior to realization? What must be assumed toensure that the decision maker has sufficient knowledge?

Questioning the applicability of economic theory does not necessarily in-volve methodological prescriptions. So, contrary to what Christenson argues,we think it is evident that methodology does not have to be either prescriptiveor normative. Whether Watts and Zimmerman ought to be promoting ChicagoSchool ideology is inelevant. Nevenheless, methodologists can perform an im-ponant and marketable service of revealing and explaining the limitations ofthe ideological and methodological preferences embodied in any research. If,for example, one wishes to follow the lead of Watts and Zimmerman and as-sume that the markets are sufficiently in equilibrium so that one has equilibriumprices available for the calculation of one's costs and benefits of adopting anypanicular accounting procedure, one would be wise to recognize the limitationsof such an approach if being wrong matters. For consumers shopping in themethodology market, it cenainly can be useful to know exactly what they arebuying.

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Documents

Criticizing positive accounting theory