Following up on my last post, I had a very entertaining discussion with a Very Successful Accounting Researcher (VSAR) last week at the AAA meetings on the topic.  After VSAR criticized some decision or other of the FASB, I asked “Why do standard setters make such awful decisions?”  We were talking in a noisy room over drinks at one of the late-night receptions, so my recollection may be imperfect, but the conversation went something like this:

Me:  Why do standard setters make such awful decisions?

VSAR: Dogma!

Me:  Well, that is similar to something I’ve heard Tom Linsmeier say. More than once.  He refers to “religious wars” over fair value accounting.  But I assume you mean that the standard setters are being dogmatic.

VSAR:  Of course.

….a little more discussion of specific accounting topics, and then….

VSAR:  Any security issued by the firm that has any non-equity element should be classified entirely as a liability.  For example, stock options should be liabilities, not equity.

Me: Really?  That would seem to allow some major distortions in financial statements.  For example, if a firm raises a billion dollars with a security that includes a dollar’s worth of stock options and the rest in pure equity, you would want to call it all a liability?

VSAR:  Exactly.

Me:  But wouldn’t that horribly distort reported leverage?  Don’t you care about the quality of information creditors get on the firm’s financial position?

VSAR:  No, they can look out for themselves.  Most big creditors have the ability to demand additional information from the firms, or the credit analysts can do that for them.

Me.  But the equity holders actually own the firm, and can demand whatever reporting they wish or fire the management.  [Note:  this is what drinking at receptions does to me:  it makes me believe that equity holders actually have power over the people managing the firms they own.]  And what about suppliers or customers, who also need good information about a firm’s creditworthiness?

VSAR:  Financial reporting should be for the benefit of the common equity holder and no one else.

Me:  No one?  Why not?

VSAR:  Dogma!

Now, obviously we were both having a bit of fun, and the VSAR surely could have defended his position on the substance a little further.  But I suspect that most of the standard setters who take what seem to be crazy positions could talk just about any academic researcher into a corner, and get them to admit that (1) their particular recommendation has flaws, as revealed by particularly tricky business arrangements, and (2) academics hold a lot of unexamined assumptions about the purpose and problems of financial reporting.  Are both sides being dogmatic?  Is there a way beyond that?