Graeme Dean, Professor Emeritus, University of Sydney Business School
This is the third blog entry discussing the ideas of Professor Ray Chambers and other members of the University of Sydney’s School of Accounting (see earlier blogs by Graeme Dean: 28 January 2019, Accounting Thought and Practice Reforms: Ray Chambers’ Odyssey – with over 36,600 downloads and 29 March 2021, ‘Accounting Theory and Standard-Setting – Antecedents of Fair Value Accounting?’ – with over 5,500 downloads).
“Corporate Capers, Group Accounting Reforms”, which was published online 29 April 2022 in Accounting History Review (https://doi.org/10.1080/21552851.2022.2059531), had an unusual genesis as outlined in this extract from the ‘Acknowledgments’:
Following comments of University of Sydney colleagues from accounting and cognate disciplines, what began as a book review of John Preston’s Fall, morphed into its present article form. In the early 1970s leading accounting theorist, Ray Chambers’ thinking about theory development also influenced the larger focus on group accounting reform, drawing on the premise that actual accounting, finance and management practices provide a laboratory setting basis for developing the conceptual framework of accounting thought.
Chambers had observed that throughout the 1950s and 1960s he had found little success in trying to find some common theoretical core in the principal expositions of accounting – the conventional mode and of modes of accounting — that would reduce the alleged enduring flaws in conventional accounting. He turned to other sources from the domain of commerce for guidance on theory development: ‘[I] … read the accounts of the histories of a number of business firms, and of mergers and takeovers, disputes, frauds and failures; accounts written by lawyers, journalists, and businessmen themselves, and thus free of the overtones or verbal uses of accountants.’[1] Those accounts proved fruitful to Chambers in augmenting other observations that extant accounting often fails to produce serviceable information in applied commercial settings.
“Corporate Capers …” adopts a similar approach. It draws on John Preston’s Fall: The Mystery of Robert Maxwell (Viking, 2021), and earlier biographies of the media baron, juxtaposed with evidence outlined in Frank Partnoy’s account of the 1920s larger-than-life Swedish engineer, businessman and financier Ivar Kreuger (The Match King: Ivar Kreuger, the Financial Genius Behind a Century of Wall Street Scandals, Public Affairs, 2009). Cameos of other business histories are interposed to suggest these cases are not outliers. Events in the former financial imbroglio were said to have increased suggestions of the ‘limitations of accounts’ in the 1970s UK accounting standards setting literature[2], while the latter scandal presaged major US corporate regulatory changes in the post-SEC reporting period.[3]
Both narratives, appearing decades after the rise, fall and mysterious death of their subjects are revisionist accounts benefitting from access to extensive sources of evidence. They shed substantial light on the deceptive actions of dominant, bullying business tycoons; actions facilitated through complex corporate groups structures, intertwined financing arrangements, and misinformation in conventional consolidation accounting. In both cases there was as an unexpected company failure. The wheeling and dealing of Robert Maxwell and Ivar Kreuger provide the commercial equivalent of a laboratory setting, with the evidence confirming circumvention of the separate legal entity notion within corporate groups, impeding effective regulatory and governance controls.
The latter section and related Appendix of “Corporate Capers …”, examine a hypothetical illustration, drawing on a previously developed alternative group accounting system.[4] The two main cases highlight how disclosure of additional, more serviceable group information to interested parties would likely provide a check on actions of a dominant manager, and result in a greater likelihood of a company failure trajectory being identified. They show that the shareholders and creditors of a parent company are provided limited useful information in conventionally prepared aggregated (consolidated) accounts. The aggregated alternative accounts mechanism adheres to the separate legal entity notion, stressing separate disclosures (current exit values) of the assets and liabilities of the parent company and subsidiary company; a capital maintenance adjustment to adjust for the effects of inflation, a focus on disclosure rather than elimination of all intra-group transactions; and specifically, the disclosure of the legal and financial implications of the types of off-balance sheet financing of the sort evident within the Kreuger and Maxwell groups as well as in the early 2000s within the Enron group of 3000 subsidiaries. While the Appendix illustration focuses on the Statement of Financial Position, similar “aggregated” statements of performance and cash flow could have been shown.
Where, as in the Maxwell and Kreuger cases, money is moved around in corporate groups, such as where an operating company has borrowed from, say, a pension fund or a subsidiary, the natural assumption that the auditors (in the 2020s, generally the same audit firm will be used by both entities) would adopt is that the loan will be reported in both the borrower’s and the lender’s accounts at face value. However, if the lender were forced to undertake a ‘market’ valuation (recoverable amount) of the loan, one might get a very different result and start some alarm bells ringing as should have happened in the two main cases examined. Additionally, the reform proposes that all intra-group company loans, as well external loans to group companies are disclosed using a matrix flow illustration. This disclosure provides considerably more information than presently under conventional consolidation accounting which eliminates all the intercompany cross claims (indebtedness) as part of the consolidation process
The conclusion of “Corporate capers …” notes that Maxwell and Kreuger interposed hundreds of private, family companies with hundreds of public companies (some having securities listed on the New York and/or London Stock Exchanges). These practices resulted in significant non-disclosures of loan and other transactions between those private and public group companies. Further obfuscation occurred due to the companies being registered in many national jurisdictions. The separate legal entity notion was circumvented, exacerbated by inadequate aggregate (group) disclosures, due to the transactions-elimination mechanics of conventional consolidation accounting. Misleading information about the performance and position of the corporate groups resulted, as well as neither effective corporate audit nor proper external oversight by regulatory bodies.
Many in the financial community supposedly in the know, were caught unawares when the Maxwell and Kreuger financial empires collapsed unexpectedly. The companies and their founders were confronted with their ‘Minsky Moments’[5].For Maxwell, it was the financial pressures linked to falls in the share prices of the Maxwell Group of listed companies in the aftermath of the October 1987 Stock Market Crash. For Kreuger, it was pressure created by the October 1929 Great Market Crash. In both cases, stock price declines reduced the collateral for future borrowings or likely share capital raisings and, thereby, reduced the potential source of funds to continue their founders’ growth ambitions — those prospects had been facilitated previously by payment of dividends often out of capital, rather than as is legally required, out of profits. As such, each had features akin to a Ponzi scheme.
While the actions of the founder managers suggest that there is nothing new under the sun, there are enduring deficiencies in the group information disclosed to interested parties using malleable standards-based accounting, especially conventional consolidation accounting. These recurring issues are known to regulators and accounting standard setters but remain inadequately addressed. It is worth noting, that notwithstanding the change from what was termed a principles-based regime (generally accepted practices in the 1920s that continued for many decades) to a committee-determined standards (rules)-based regime in the 1980s and beyond, little fundamental change in consolidated accounting practices has taken place, notwithstanding that the co-regulatory regime has moved from national to international in scope, with governance controls and financial reporting standards now overseen by international bodies like IOSCO and the IASB.
[1] R. J. Chambers, 1970, “Second Thoughts on Continuously Contemporary Accounting”, Abacus 6 (1): 39–55. In of Securities and Obscurities: A Case for the Reform of the Law of Company Accounts (Gower Press, 1973) Chambers partly drew on a corporate pathology approach as a means of observing ‘anomalies’ in financial reporting. Evidence from failed companies, takeover sagas, inflationary periods and other commercial settings supported his proposed current value to financial reporting system, known as Continuously Contemporary Accounting (CoCoA).
[2] R.J. Edwards, 2019, A History of Corporate Financial Reporting in Britain, New York: Routledge
[3] F. Partnoy, 2009, The Match King: The Financial Genius Behind a Century of Wall Street Scandals, New York: Public Affairs; Flesher, D., and T. Flesher. 1986, “Ivar Kreuger’s Contribution to U.S. Corporate Financial Reporting”, The Accounting Review 61: 3, 421–434.and Taylor, J., 1941, “Some Antecedents of the Securities and Exchange Commission”, The Accounting Review 16 (2): 188–196.
[4] In his 1968 article “Consolidated Accounting Statements Are Not Really Necessary”, The Australian Accountant, 38:2, 89-92) Chambers identified the limitations of consolidated accounts, and he proposed in principle an alternative set of aggregated statements. Concerns about consolidated accounts also were explored in the Sydney Schooler R.G. Walker’s “An Evaluation of the Information Conveyed by Financial statements”, Abacus, 1976 12:2, 77-115 and Consolidated Statements: A History and Analysis, Arno Press, 1978). Operationalising through an illustration the ‘in principle’ reform envisaged by Chambers (1968) first appeared in the accounting literature in 2002 by Clarke, F., G. Dean, and E. Houghton, “Revitalizing Group Accounting: Improving Accountability”, Australian Accounting Review 12:3, 58–72; Clarke, F., G. Dean, and M. Egan, 2014, The Unaccountable and Ungovernable Corporation: Companies’ Use-by Dates Close in, London: Routledge. I wish to thank Steve Zeff who, after receiving a copy of “Corporate Capers …”, emailed noting that he often used Chambers’ 1968 critique of consolidated statements, together with Delmer Hylton (“On the Usefulness of Consolidated Financial Statements”, The CPA Journal, October 1988), to show students that consolidated statements have important limitations in respect of providing useful information to the creditors of the parent company.
[5] ‘Minsky Moment’ refers to economist Hyman Minsky’s financial instability hypothesis. A ‘Minsky Moment’ is said to occur when risky financial deals lead to an accumulation of debt unable to be covered by revenues and reduced asset backing, thus resulting in severe financial deleveraging.
