The accounting profession doesn't have the best reputation. Because of their role in business scandals of the late 1990s many investors think that the main job of accountants is to conceal underperformance by businesses by hiding losses, avoiding taxes and inflating gains. On the flip side, many entrepreneurs thinks that accountants and accounting standards are too stodgy for the modern economy. Many executives look warily at the big accounting firms, privately (and sometimes publicly) complaining that accountants manage to emerge from each round of business scandals with new rules that bring in ever more fees.
And it has long been so. As John Steele Gordon illustrates in his article on the history of American accounting in this week's Barron's, businesses were very resistant to even the idea of giving reports on their performance, much less having those reports audited by professional bean counters.
"When in 1866 the New York Stock Exchange asked the Delaware, Lackawanna, and Western Railroad for its financials, the railroad curtly replied that it 'makes no reports' and 'publishes no statements.' Translation: Drop dead," Steele reports.
So what changed things? The power of a monopoly and expanding capital needs. "In 1869, the New York Stock Exchange merged with its chief rival, the Open Board of Brokers, and became the overwhelmingly dominant institution on the Street. For the first time it became important for brokerage firms to belong to the exchange and for companies to have their securities listed. The NYSE quickly began to impose rules on both brokers and on the companies that sought listings" Steele explains.
As the country's industrial economy exploded in size in the last decades of the 19th century, the need for capital exploded as well. Increasingly, that capital could only come from the great Wall Street banks, of which J.P. Morgan & Co. was the apotheosis. These banks needed to be sure the books were honest before floating an issue of securities.
To ensure honesty, the stock exchange and the banks increasingly required that the books be certified by independent accountants, a profession that quickly grew at this time. As late as 1884, only 81 self-employed accountants were listed in the city directories of New York, Chicago, and Philadelphia combined. Five years later, there were 322 listings.
What Gordon doesn't point out, however, has been the negative effects of accounting as providing a partially illusory legibility to business activity. Balance sheets and financial statements have expanded and become more complex as transparency and disclosure have become the leading paradigms required by law and general practice. But all too often often--as the investing public has learned time and again, good and hard--the idea that the disclosed facts and figures, the more the better, describe the actual business prospects of an enterprise works better in theory than practice.
Shedding Light on Business Accounts [Barron's]