The AAA meeting in Denver had a number of interesting panel sessions.  One that I found enlightening concerned financial reporting and the financial crisis.  The panelists were Greg Waymire, Mary Barth, and Shyam Sunder.  I was not sure what to expect.  The punchline was that none of the panelists felt financial reporting was a prime suspect in the crisis.  A couple of them viewed it as conspirator – it may have raised the intensity of the problems.

But the biggest thought provoker for me came from Greg – he questioned how useful the conceptual framework would ever be if it continues to ignore human behavior.  Deducing standard practices from a framework might be possible if the practices were applied to/by objects that could not alter their behavior given the standards.  However, we are all familiar with cases where financial engineers are at work soon after the ink is dry on a new standard.

Shyam had an interesting photographic analogy – if a reconnaissance satellite takes a photo, the subject of the photo has no idea that his/her picture is being taken.  Therefore the person does not take any special action at the time the shutter clicks.  On the other hand, when a studio photographer is taking a picture of a model, the model responds to each click of the shutter.  I believe Greg and Shyam view the FASB and IASB conceptual frameworks as being designed to govern satellite photography whereas the reality of accounting practice is closer to studio photography.

I have heard some standard setters opine that their standards should not anticipate “economic consequences”.  But totally ignoring the feedback from standards to behavior seems a little too strong.  Two recent posts to this blog (Lisa Koonce: compensation disclosures and me: disclosures regarding the use of minerals from certain countries in Africa) discuss disclosures that are apparently intended to shame companies into different (better?) behavior.  These are not isolated incidents; a variety of standards (remember SFAS #123 pro forma disclosures?) are designed implicitly to change behavior of the reporting entity.

So I tried to think of how one would change the conceptual framework to incorporate the interaction between standards and people who apply the standards.  One possibility that the panelists mentioned was to avoid being overly prescriptive (somewhat like principles instead of rules) because people often respond badly when authorities (e.g. parents) impose very restrictive and detailed rules of behavior.  What other changes would we need in the conceptual framework?  This is very important, as many people are calling for more work on the framework once the crush of convergence projects are completed.  While I think imbedding behavior into the framework will be very difficult, but we should at least have the discussion on whether/how it could be done.