1. Contract Theory of Accounting
Shyam Sunder
Yale University
7/18/2019
Contract Theory of Accounting

2. Contract Theory of Accounting
Three Basic Ideas
Organizations as a set of contracts
Shared facts for conflict resolution
Control in organizations as balance and equilibrium
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Contract Theory of Accounting

3. Contract Theory of Accounting
Micro and Macro Theory
Micro
Functions of accounting
Managers and Income
Shareholders, stock markets, and auditors
Macro
Basic features of accounting
Social choice criteria, mechanisms and standardization
Government and public good organizations
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Contract Theory of Accounting

4. A Framework for Contract Theory of Organizations
Chester Barnard, President, Bell Telephone Company of New Jersey
Functions of the Executive 1937
Herbert A. Simon, Administrative Behavior, 1946
Foundation Idea: Organization as a set of contracts or an alliance
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Contract Theory of Accounting

5. Firm as a set of Contracts
Economic agents
Contracts
Contributions
Resource Entitlements
Necessary Conditions
Individual condition
Aggregate Condition
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Contract Theory of Accounting

6. Contract Theory of Accounting
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Contract Theory of Accounting

7. Contract Theory of Accounting
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Contract Theory of Accounting

8. Contributions and Entitlements of Various Agents
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Contract Theory of Accounting

9. Contract Theory of Accounting
Assumptions
Economic Agents
Preferences
Consistency of Actions
Contracts as Mutual Understanding or Expectation
Not Always Explicit
Role of Social Conventions
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Contract Theory of Accounting

10. Contract Theory of Accounting
Goals and Scope
Goals of Each Individual
Organization’s Goals Not Considered
Organization as an arena
Organization as a Tournament
Applicable to All Organizations
Focus Here on Business Firm
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Contract Theory of Accounting

11. Functions of Accounting
To Help
Assemble
Implement
Enforce
Modify
Maintain
the contract set by five processes
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Contract Theory of Accounting

12. Processes of Accounting
Measuring Resource Inflows
Measuring Resource Outflows
Determination of Contract Performance
Information for Factor Markets
Common Knowledge for Contract Renegotiation
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Contract Theory of Accounting

13. Measuring Resource Inflows
Vendors: At the Receiving Dock
Customers: Cashier, Acc. Rec.
Labor: Clock, Inspection
Managers: Intangible
Shareholders: Shareholder Accounts
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Contract Theory of Accounting

14. Measuring Resource Outflows
Employees: Payroll
Customers: Shipping
Vendors: Account Payables
Government: Tax Accounts
Data Organized by Cause-Effect
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Contract Theory of Accounting

15. Contract Theory of Accounting
Contract Performance
Compare resource inflows and outflows
Determine Who Has Fulfilled contracts, How Much
Comparative Reports
Examples:
Customer Account Statement
Managerial Accounting
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Contract Theory of Accounting

16. Information for Factor Markets
What resources are needed
What resources to distribute
Find people who have/want them
Factor Markets for Labor, managers, customers, supplies, investors
Proforma financial statements, business plans and budgets by the entrepreneur
 No permanent occupants, find replacements
Costs and Benefits
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Contract Theory of Accounting

17. Common Knowledge for Contract Renegotiation
All contracts have finite terms (except shareholders)
Conditions Change
Potential for Empty as well as Serious Threats and Bluffs
Public Disclosure and Common Knowledge
Cut Deadweight Losses to Society
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Contract Theory of Accounting

18. Contract Theory of Accounting
Necessary Conditions
1) Individual Condition: Each participants expects to receive at least the opportunity cost of contributions he/she makes to the organization
2) Aggregate Condition: Contributions of all participants can produce enough output to meet the expectations of all
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Contract Theory of Accounting

19. Special Problems in Control of Managers
At the procedural hub of the contracts
Control resources, have information
Monitor and negotiate with others
Difficult to measure their contributions
Can appropriate resources and information
Misappropriation difficult to detect
Devising a scheme to induce managers to contribute what is expected of her
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Contract Theory of Accounting

20. Classification and Synthesis of Accounting
Pick three broad themes
Classical
Stewardship
Market-based
Differences in the Assumptions
Differences in the Range of Phenomena Organized
Differences in the degree of development of markets
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Contract Theory of Accounting

21. Contract Theory of Accounting
Thank You
The paper, and slides will be available at
or to
7/18/2019
Contract Theory of Accounting