Positive Theory / Specific Scientific Theory (1970-2000): Positive Accounting

The end of normative period led to the shift of accounting theory development to a new form of empiricism, which operates under the broad label of ‘positive theory.’ This ‘specific scientific theory’ or the ‘positive era’ in fact is not new as it was also based on the empirical approach, which provided the basis for ‘general scientific theory.’ Positive theory sought to provide a framework for explaining the practices, which were being observed. A prominent positive theory in accounting is Positive Accounting Theory (PAT) developed by Watts and Zimmerman in 1978. According to Watts and Zimmerman (1986, p.7) PAT “is concerned with explaining accounting practice. It is designed to explain and predict which firms will and which firms will not use a particular method but it says nothing as to which method a firm should use.” Three key hypotheses are used in PAT literature to explain and predict support or opposition to an accounting method - bonus plan hypothesis, debt hypothesis and political cost hypothesis, which predict the use of accounting numbers in compensation and debt contracts and in the political process that affects a firm’s accounting.

PAT, which revolutionised accounting theory development in late 1970s, capitalized on the concurrent developments in finance and economic, to explain some of the puzzles faced by accounting researchers and practitioners during that period. The impetus to Watts and Zimmerman’s work was the seminal work of Jensen and Meckling (1976) that altered the course of the corporate finance literature through the articulation of the implications of the agency problem between a firm’s shareholders (principal) and the management (agent) and between shareholders and bondholders in an informationally-efficient capital market. The agency problem arises in part because of the imperfect observability of managerial effort and costly contracting. This nexus of contracts view of a corporation enabled Watts and Zimmerman to develop hypotheses – bonus and debt as to why there should be predictable variation in how firms account for their economic activities as well as why accounting standards would matter, even if capital markets were informationally efficient. Further, Watts and Zimmerman’s political cost hypothesis extends the economics literature on regulation in a political process, as distinct from a market process. Overall, this theory explains the economic or wealth effects of accounting, and why accounting is important to various parties such as shareholders, lenders and mangers – all of whose personal wealth is affected by accounting decisions.

However, positive approach in accounting has attracted much criticism due to the seemingly biased manner that these theorists dismiss alternative viewpoints. This has resulted in resurgence especially in the 1980s, the behavioural research in accounting, which is concerned mainly with the broader sociological implications of accounting numbers and the associated actions of key players such as shareholders, lenders, managers and the government as they react to accounting numbers. Behavioural Accounting Research (BAR) tends to focus on psychological and sociological influences on individuals in their use and/or preparation of accounting. Although

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BAR had resurgence in the 1980s and continues to be important, it emerged in the early 1950s and first appeared in the accounting literature in 1967 as cited by Birnberg and Shields (1989). Initially, BAR explored the production and use of financial information. However, it gradually started focusing on the decision processes and decision outcomes of individual users, drawing upon the discipline of psychology for its concepts, models and methods.