Positive Accounting Theory

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Markus J. Milne Accountancy and Business Law University of Otago Dunedin New Zealand Ph: 64-3-479-8120 Fax: 64-3-479-8450 Email: mmilne@commerce.otago.ac.nz

* The author would like to thank Alan MacGregor, Carolyn Stringer, Gregory Liyanararchchi, Ros Whiting and an anonymous conference reviewer for their helpful comments on earlier drafts of this paper. Thanks are also due to seminar participants from the Department of Accounting and Finance, University of Aberdeen, Scotland, and to conference participants at the 2001 BAA Annual Conference at the University of Nottingham.



This paper critically reviews the literature seeking to establish evidence for a positive accounting theory of corporate social disclosures. It carefully traces through the original work of Watts and Zimmerman (1978) showing their concern with the lobbying behaviour of large US oil companies during the 1970s. Such companies were argued to be abusing monopolists and likely targets of selfinterested politicians pursuing wealth transfers in the form of taxes, regulations and other ‘political costs’. Watts and Zimmerman’s reference to “social responsibility” is shown to be a passing remark, and most likely refers to “advocacy advertising”, a widespread practice amongst large US oil companies at that time. Subsequent literature that relies on Watts and Zimmerman to present a case for social disclosures is shown to extend their original arguments. In the process, concern over the “high profits” of companies is shown to diminish, and the notion of political costs is so broadened that it blurs with other social theories of disclosure. Consequently, the positive accounting-based social disclosures literature fails to provide distinct arguments for self-interested managers wealth maximising. This paper also shows that the empirical evidence gathered to date in support of a positive accounting theory of social disclosures largely fails in its endeavour.

Keywords Positive Accounting Theory, Political Costs, Social Disclosures, Watts and Zimmerman, Advocacy Advertising.

INTRODUCTION Along with numerous other rationales (e.g., decision usefulness, legitimacy theory, stakeholder theory, critical or political economy theory—see Gray et al., 1995 for a review), positive accounting theory or the political cost hypothesis has been suggested to explain why firms make voluntary social disclosures. Based on the original work of Watts and Zimmerman (1978, 1986), several empirical studies (e.g., Belkaoui and Karpik 1989; Ness and Mirza, 1991; Panchapakesan and McKinnon, 1992; Lemon and Cahan, 1997) have directly sought to establish evidence for the political cost hypothesis as an explanation for firms’ social disclosures. Several related empirical studies have also sought to use the political cost hypothesis to explain other types of voluntary disclosure, including value added statements (Deegan and Hallam, 1991), disclosures by statutory authorities (Lim and McKinnon, 1993), and disclosures in pursuit of reporting excellence awards (Deegan and Carroll, 1993). Along with numerous others1, Gray et al., (1995, pp. 51-52) dismiss the positive accounting arguments and literature on the grounds of the underlying assumptions of the theoretical framework. As they suggest, positive theories are not about what (social) reporting should be, but rather about what it is. As a basis for change and improvement, positive theories are seen to offer little or no development of corporate (social) reporting. Gray et al. (1995, p.52 and fn. 11) go on to admit, however, having been persuaded by many of the critiques, that they have not seriously engaged this literature because they believe it to be “virtual rubbish” and prefer their position as “heretics”. On the face of it, however,...
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