Volume 9, Issue 2 -

We develop a conceptual asset-based framework of credit creation based on three leading variables: (i) the amount of assets acceptable as collateral, (ii) the level of leverage and (iii) the level of trust. As credit expands along these dimensions in a non-linear dynamic, the financial system becomes more liquid. At the same time, it becomes more prone to endogenous feedbacks and vulnerable to internally generated instabilities manifested as booms and busts. Applying this framework to the global financial crisis, we show that the subprime crisis was both a signature and only one possible trigger in an increasingly unstable financial system. Using historical data, we demonstrate a significant shift in the components of US bank balance sheets and a decoupling of bank assets from deposits since the mid-1980s, marking the rise of “securitized-fractional reserve banking”. The subsequent decades were a period of growing leverage, with debt-securities assuming money-like functions and serving as collateral for further credit creation. As trust began to recede, the high levels of leverage were no more viable, precipitating a reduction of the amount of assets acceptable as collateral, and leading to a contraction in credit and to liquidity spirals. We discuss the potential general applicability of this framework of credit creation and define extensions in future research.

This paper examines whether a one-book-system that takes the commercial law profit definition as tax base (the so-called authoritative principle) is adequate from an evolutionary point of view. We consider firstly the case that European International Financial Reporting Standards (EU-IFRS) are relevant for all statements with the authoritative principle based on EU-IFRS. Secondly, we examine the fact that EU-IFRS focus on the consolidated annual accounts and that the national accounting principles are relevant for individual statements. Tax law analysis under genuine uncertainty requires a framework and we present such a framework. It entails an interpretation of equality of taxation, a hypothesis on the functioning of markets, an interpretation of realizable and desirable market goals, tax effects hypotheses, and action hypotheses for personal and corporate companies under genuine uncertainty. Contrary to the mainstream of accounting literature, from our evolutionary point of view, the authoritative principle is adequate. The reason is that commercial profit is an adequate instrument to achieving the tax goal equality of taxation in the sense of reducing expectable tax avoidance decisions. This is the case because according to evolutionary action hypotheses as well as tax effects hypotheses, commercial profit can be a subjectively rational decision criterion for personal and corporate companies alike. Equality of taxation is for its part in line with the evolutionarily interpreted social values freedom of choice and equality before the law. Since we focus on the question if the existing commercial profit concept can be an adequate tax base, we do not discuss whether we would have more reasons to take a conservative profit concept as tax base rather than EU-IFRS. Just as little, we analyze whether it is better to take EU-IFRS profit as tax base although national accounting principles are relevant for individual statements.

Shyam Sunder’s monograph ‘Rethinking Financial Reporting: Standards, Norms and Institutions’ explores the extent to which it is possible to deliver ‘better financial reporting’ so as to support investment decision making and valuation. In this review paper it is argued that a more fundamental and radical challenge is required in a world where financial reporting is politically and socially constructed. The institutions governing financial reporting have pursued a project that has been complicit in undermining the social license granted by limited liability. The priority is to explore how financial reporting might contribute to securing the social license granted by limited liability.

Professor Sunder’s book raises significant issues about the state of financial reporting, particularly his concern at the proliferation of complex rules for which there are only questionable justifications. In this review essay issue is taken not that there isn’t a problem with current financial reporting, but with the unexamined premise about the nature of that problem and the role that accounting and auditing play in the regulation of the modern, powerful corporation. It is argued that rules are the logical consequence of a competitive order and that resorting to norms as an alternative to rules or standards promises no better alternative unless there is a critical examination of who is to be the community to which norms apply. Thus, it is crucial to question the premise of decision usefulness as the underlying purpose of accounting vis-a-vis the publicly traded corporation. I argue that re-considering the historical norms of accounting that are based on the premise that holding corporations accountable, is crucial to really rethinking financial reporting.