My guess is that most doctoral students in accounting are still being taught the same history I have been:  In the beginning, accounting research was shapeless and without form.  Wait, I meant normative and qualitative.  Then, with the publication of Ball and Brown’s 1968 paper, the literature has taken a sharp turn toward positivism (drawing conclusions only on what is, not on what should be), and almost entirely based on formal economic modeling, experimental studies or econometric studies.

Is this focus on positivist quantitative research too narrow to provide useful guidance to standard setters?  Debates now gaining traction in economics — and in particular, observers and academics blaming academic economists for the financial crisis — suggest this is a question worth exploring.

Accountants have certainly complained about the narrowing of the research literature, and given some explanations for why. For example, consider Hopwood’s address to the AAA (republished in the October 2007 Accounting Review, “Whither Accounting Research).  Hopwood argues that we adhere to a narrow quantitative method because we are insular, conformist, and want research to be ‘auditable’:

The research community has invested insufficiently in mechanisms for engaging with the ever-changing world of practice. No longer recruiting so heavily from those with a background in the practice of the art, the world of research has become an increasingly autonomous one with the primary conversations being internal to the community rather than of a more heterogeneous nature. Even within the academic world, accounting scholars seem to relate primarily to themselves. At least that is the suggestion that emerges from citation studies (Biehl et al. 2006). We seem to have become more cautious about incorporating new perspectives, new insights, and new interdisciplinary involvements.

…Similar preference for conformity also exists on the part of a particularly influential group of users of the outcomes of research, the deans, chairs of tenure committees, departmental chairs, and so on. For among this community there is often a preference for research that stays within well-established intellectual boundaries and that uses well understood and easily verifiable methods. For such research is more readily interpretable by those outside the discipline. For as Power (1997) has so ably demonstrated in his important study, The Audit Society, auditing, which is akin to at least some of the processes that enter into career monitoring and evaluation, creates pressures to make things auditable. So, in this setting, field studies are seen as less verifiable and more difficult to assess than quantitative analyses, experimental methodologies, and simple theorizations, even though that might not be the case. Certainly they are adequately evaluated in other disciplines and the alternatives have as many difficulties associated with them below their apparent surface of ease of comprehension. Equally, pressures can arise to stay within well-established disciplinary boundaries. Keeping within the conceptual landscapes already existing within business schools may thereby be preferred to excursions into anthropology, postmodern sociology, or political science.

But now in economics a bigger fight is brewing about the ‘illusion of objectivity’.  Such concerns are hardly new, and Deirdre McCloskey has written about this topic extensively.  But the new criticisms are more pointed:  the overemphasis on postitivist and quantitative research kept academic economists from anticipating the financial crisis, and the academics are even more directly responsible, since they created complex financial instruments that no one could understand, based on models with flawed assumptions, which lent the illusion of certainty and objectivity.

For example, here is this article from the American, the journal of the American Enterprise Institute

Some of the causes of our contemporary crisis are well known by now. There were governmental errors: monetary policy that was too loose; government monitoring agencies that were too lax; and government policies specifically intended to encourage home ownership among African-Americans and Hispanics that had the unintended but quite anticipatable effect of extending mortgages to those who lacked the ability to repay them. There were perverse alignments of market incentives, incentives that put personal interests at odds with corporate interests, and corporate interests at odds with the public interest. There were principal-agent problem within firms, where traders were remunerated with bonuses for selling collateralized debt obligations without regard to the long-run viability of the underlying assets. Rating agencies were corrupted because they were paid by the sellers of the goods they rated, offering unreliable evaluations that redounded against the purchasers of mortgage-backed securities. Large profits were made by companies that packaged and sold mortgages and mortgage-backed securities without needing to be concerned with their ultimate viability. It turns out that intermediation of risk reduces the incentives for adequate risk management: so long as risk is intermediated, from a mortgage loan broker to a commercial bank to an investment bank to an investor, there is really no incentive, at each stage of the game, to have adequate risk-managing policies in place.

These factors have received a good deal of attention. But they are not the whole story, and certainly not the most original part of the predicament. What seems most novel is the role of opacity and pseudo-objectivity. This may be our first epistemologically-driven depression. (Epistemology is the branch of philosophy that deals with the nature and limits of knowledge, with how we know what we think we know.) That is, a large role was played by the failure of the private and corporate actors to understand what they were doing. Most heads of ailing or deceased financial institutions did not comprehend the degree of risk and exposure entailed by the dealings of their underlings—and many investors, including municipalities and pension funds, bought financial instruments without understanding the risks involved. We should keep this in mind when we chastise government agencies such as the SEC for failing to monitor what was going on. If the leading executives of financial firms failed to understand what was taking place, how could we expect government regulators to do so? The financial system created a fog so thick that even its captains could not navigate it.

The cult of “accountability” was related to diversification. As companies grew larger and more diverse in their holdings, new layers of management were needed to supervise and coordinate their disparate units. From the point of view of top management, the diversity of operations means that executives were managing assets and services with which they have little familiarity. This has led to the spread of pseudo-objectivity: the search for standardized measures of achievement across large and disparate organizations. Its implicit premises were these: that information which is numerically measurable is the only sort of knowledge necessary; that numerical data can substitute for other forms of inquiry; and that numerical acumen can substitute for practical knowledge about the underlying assets and services.

A good deal of our current economic travails can be traced to this increasing valuation of purportedly objective criteria, so denoted because they can be expressed and manipulated in mathematical form by people who may be skilled at such manipulation but who lack “concrete” knowledge or experience of the things being made or traded. As Niall Ferguson has put it, “Those whom the gods want to destroy they first teach math.” The paradigm—and the precursor of our current crisis—was the rise and fall of Long Term Capital Management, founded by two of the fathers of quantitative options financing, Myron Scholes and Robert C. Merton. Knowing a great deal of math, but not very much history, they developed trading models that radically underestimated the risk entailed in their financial speculation, leading to a dramatic collapse of the company in the summer of 1998. But the phenomenon is more widespread. Attaching a number creates a belief that the information is more solid than is actually the case. That is what I mean by “pseudo-objectivity.” In each case, it is a response to what (to recoin a phrase) one might call alienation from the means of production, the attempt to substitute abstract and quantitative knowledge for concrete and qualitative knowledge.

It is worth noting that the criticisms are not coming from the left, but from the right.  The American Enterprise Institute is a conservative institution, and similar criticisms are found in the Weekly Standard by conservative historian Harvey Mansfield:

…Thus the predictions of economists tend to give the impression that the economy can be predicted. Economists are intelligent people, well-connected and well-educated, gainfully employed in prestigious institutions. Although they rarely reach the top offices, they are often the top advisers to the top officers. So they seem to know what they are doing. They impart confidence in their predictions, which are often or mostly in the ballpark. Except when they are not, as at present. In a crisis the confidence they impart most of the time is exposed as overconfidence, a delusion that sets us up for surprise and disillusionment. We are not so surprised by the delusions of crowds and mobs–who does not know they are unreliable?–but that their delusions should be supported and promoted by scientists of the rank and caliber of economists might easily shake our confidence in the reliability of our elites and even of our scientific civilization.

Overconfidence in overcoming chance is the way of life recommended by economists. It is the way of life known as progress by liberals and as growth by conservatives, who are secretly united by overconfidence in their knowledge of the future which they describe diversely and call by different names. This recommended overconfidence transforms the predictions of economists into overall advice–not advice with a condition, such as if you want to get rich, do this, but advice on how to live while getting and being rich. Of course economics has been known as the dismal science because it confronts human necessities with the fact of scarcity, and in theories of overpopulation like that of Malthus, it may find that we will not get as much as we need. But it could also be called, whether dismal or promising, the triumphal or hubristic science for what it claims to be able to predict.

It isn’t just the pundits, though.  Here is the abstract from a paper by a number of academics:

Abstract: The economics profession appears to have been unaware of the long build-up to the current worldwide financial crisis and to have significantly underestimated its dimensions once it started to unfold. In our view, this lack of understanding is due to a misallocation of research efforts in economics. We trace the deeper roots of this failure to the profession’s insistence on constructing models that, by design, disregard the key elements driving outcomes in real-world markets. The economics profession has failed in communicating the limitations, weaknesses, and even dangers of its preferred models to the public. This state of affairs makes clear the need for a major reorientation of focus in the research economists undertake, as well as for the establishment of an ethical code that would ask economists to understand and communicate the limitations and potential misuses of their models.

These criticism provide food for thought.  Do you buy them?  What are the alternatives?  Can qualitative studies complement our usual fare of quantitative research?  I have a number of opinions, but will leave them for a later post.