Positive and Normative Accounting Methodologies

Positive and Normative Accounting Research MethodologiesThe extensive literatures on accounting research generally include books, journals, the press and electronic materials, offered by some experts, scholars, groups, corporations, and public sectors. These data can be collected in different ways: laboratory experi-ments, field experiments, field studies or case studies, survey research and archival research. All of them show us many sorts of research methods. However, research methodologies are different from research methods. “Research methods are concerned with the technical issues associated with the conduct of research; research methodol-ogy is concerned with the philosophies associated with the choice of research meth-od.” (Malcolm Smith 2003: xii)This article is to focus on two fundamental research methodologies: positivism and normative research.1.The normative accounting research methodologyNormative accounting is roughly named; it can be distinguished into several terms, such as ethical normative, pragmatic normative, conditional normative accounting theories (Richard Mattessich 1992). This article will not discuss them one by one; just totally regard them as the normative accounting research methodology.1.1 The relevant literaturesA not so accurate description is that normative methodology dominated prior to 1968 in accounting research. Numerous scholars contribute their works to this area, the fa-mous such as C.E. Sprague (Philosophy of Accounts, 1907), W · A · Paton (Account-ing Theory, 1922), Canning (The Economics of Accountancy, 1929), A·C· Littleton (Accounting Evolution To 1900, 1933), S.H. Moore (A Statement of Accounting Prin-ciple,1938), Gilman (Accounting Concepts of Profit,1939), Paton Littleton (An In-troduction to Corporate Accounting Standards, 1940), Littleton (Structure of Ac-counting Theory,1953), Grady(Inventory of Generally Accepted Accounting Princi-ples,1965).These classic works advance and improve the frameworks of accounting theories; and develop the accounting system greatly. However, although these scholars all take the normative methodology, there are some differences among them. Paton is a repre-sentative of deductive accounting theory; Littleton represents the inductive accounting theory; and Canning is the leader figure of school of Real Benefits.1.2 What is it?Normative accounting methodology is based upon what the researcher believes should occur in particular circumstances. This methodology describes what financial ac-counting should be: what should be regarded as assets, liabilities and so on, and how they should be valued. (Quintus V orster, 2007) The goals on which normative meth-odology is based need not to be actual. The researcher need not accept or subscribe toA normative theory is a goal-oriented theory that represents real-world situations, not as they are, but as they should be. It is prescriptive rather than descriptive theory that explains, and set out, principles of what ought to be. Normative theories are charac-terized by goal assumptions and deductions. (Eno L. Inanga and WM. Bruce Schnei-der 2005)1.3 A normative accounting research paradigmAccording to PATRICK S. KEMP (1970), “Accounting postulates can be defined as broad, controlling assumptions upon which accounting principles rest. Accounting principles are broad guides to action or broadly applicable directives. Accounting procedures are narrower guides to action or means of applying accounting principles. Accounting methods are different was of implementing account ing procedures.”More specifically, in term of this paradigm the first thing what we need to do is to in-vestigate and analyze abundant accounting practices, and then through it we can gen-eralize the favorable ones to be the standards of our practices in someday in the future. The normative accounting research does not limit to the available conventions; it usu-ally demonstrates us what are the better accounting practices in virtue of many lo-gistic statements.2.The positive accounting research methodology2.1 The relevant literaturesThe positive methodology comes from positivism. The study initiated by Ball and Brown (1968) and Beaver (1968) represents a watershed event in the contemporary history of accounting research. Ball and Brown (1968) had run the first empirical in-vestigation on the association between accounting earnings, as the premier infor-mation item in the financial statements, and stock returns in order to assess the use-fulness of accounting information.Since 1970, accounting research has increasingly moved away from normative (e.g. Chambers, 1996) to positive (e.g. Watts and Zimmerman, 1986), the positive method-ology has dominated mainstream accounting research. This development, according to Watts and Zimmerman (1986), has been attributing to the introduction of large-scale empirical studies that use economics and finance concepts to analyze the behavior of capital markets, and which led to the development of efficient market hypotheses with significant impact on accounting research.( Eno L. Inanga and WM. Bruce Schneider 2005)According to Zimmerman (1980:108) says, "A positive theory is of the form, 'If A then B', that is capable of being refuted." This represents some progress over the statement by Watts and Zimmerman (1979:273): "We would prefer to reserve the term 'theory' …for sets of hypotheses which have been confirmed [sic]."Positive methodology attempts to describe real world situations as they are. Research based on positive methodology involves empirical observations of the relevant phe-nomena from which a problem is defined. Data relevant to the problem are then col-lected and hypotheses formulated and tested by independent process. If the theory re-sults in an accurate representation (description) of the empirical phenomena, such a theory can be used for predictive purpose. Induction follows empirical observations and takes the form: "if event Y takes place, then the outcome will be Z". The greater the number of empirical observations, the better supported the related induction will be. (Eno L. Inanga and WM. Bruce Schneider 2005)Positive accounting methodology focuses on explaining and predicting accounting practice. It is based on observation and it often leads to accounting research that is termed positive accounting research. Through observation of existing phenomena, it attempts to predict possible future outcomes, for instance, what particular accounting policies are likely to be adopted by managers in particular circumstances.( QuintusV orster 2007).2.3 A standard positive accounting paradigm: case studyFor example, the study of the relationship between the management holdings and corporation value in process of corporate governance.Step1.What’s relationship between the management h oldings and corporation value?We use the pattern of “if X…, Y…” it means that the research topic is to reveal the causality between X and Y. In fact, the causality is not so obvious in reality, so we have to consider many other factors: Is the capital market valid? Is the accounting in-formation useful? What is the different influence to corporation value within the dif-ferent patterns of corporate governance?Step2.To find the hypothesis through presuming Y=if(X).In this case, there are two opposite theories: Convergence-of-interest hypothesis and Entrenchment hypothesis. The “convergence-of-interest hypothesis” (Jensen and Meckling, 1976) proposes that as management ownership increases so does the value of the firm, suggests a uniformly positive relationship. The entrenchment hypothesis predicts that corporate assets can be less valuable when managed by an individual free from checks on his control, suggests that market valuation can be adversely for some range of high ownership structure (Morck et al., 1988).Step3.Joel Demski (2001) in his Presidential Address to the AAA Annual Meeting in Atlanta, Georgia, observed that accounting research has linerarised everything. That is, most research methodologies are based on correlation analysis.In this step we also take the multiple regression function. As for the induced variable Y, besides the independent variable X, probably there are many other factors A, B, C…And each one has the influence on Y. In our case, these may be including the firm’s market value (usually To bin’s Q), R&D expenditure, marketing expenditure, enterprise size and so on (Morck et al., 1988).In order to get the relationship between X and Y, we can do: (1) maximize X’s vari-ances; (2) control the exogenous variables; (3) minimize Y’s ran dom error.Step4.Select the samples and collect data.We quote Fu-Mei Liang’s study (2007)i, selecting the samples of publicly-listed 279 electronic companies in Taiwan. And the data came from a variety of sources includ-ing annual reports, stock exchange filings, newspapers and magazine reports.Step5.According to Fu’s results, there are two tables:1*:p＜0.05 (2-tailed);**:p＜0.01 (2-tailed); n=279Table2Regression analysis for the relation among board ownership, interlocks, and firm performanceNotes: All coefficients in the table are standardized†:p＜0.1;*:p＜0.05; **:p＜0.01;***:p＜0.001From the above two tables, we can draw some conclusions:The two opposite theories: Convergence-of-interest hypothesis and Entrenchment hypothesis are not always against with each other. They can be appropriate in differ-ent levels and explain different situations. When the board ownership is at low and medium levels, there are positive impacts of board ownership on firm performance, especially at medium level, the impact is stronger. So the convergence-of-interest hypothesis is supported. And when the board ownership is over 25%, there are nega-tive impacts on firm performance. The entrenchment hypothesis may explain the re-lationship.parison between the two research methodologiesGenerally speaking, the basic of the two research methodologies is different.First in the philosophical sense, the normative research methodology is on the basis of deductive method and induction; while the positive methodology is found on Empiri-cism or Popper's Falsificationism Methodology.Second, from the view of economic theory, the normative research methodology is based on the normative economics, and the positive accounting research depends on the positive economics. The distinction between these two is just like Friedman cites from J.N. Keynes, who wrote (1891, pp. 34-35:7):Positive science may be defined as a body of systematized knowledge concerning what is; a nor-mative or regulative science as a body of systematized knowledge relating to criteria of what ought to be, and concerned therefore with the ideal as distinguished from the actual…Besides the basis, the research purpose and means of these two methodologies arehighly different.According to Beattie (in Ryan et al.: 107), the positive accounting methodology such as Watts and Zimmerman: “argue that scientific research can only be concerned with what is questions, it cannot be used to answer what ought to questions: Positive ac-counting theories can be contrasted with normative accounting theories. The latter describe what accounting practices should be pursued, the former seeks to explain and predict accounting phenomena. Examples of positive accounting theories include the use of agency theory to help explain and predict managerial choice of accounting pol-icies (Deegan and Unerman, 2006:212).Some economists make a distinction to describe theories based on description and those based on prescription. To illustrate the distinction between "normative" and "positive" research questions, Jensen (1976:11-12) presents two lists of examples, re-produced as Figure 1. The most obvious difference between the two lists-as Jensen intended is that each question on the "normative" list contains the word "should" and each question on the "positive" list contains the words "why," "what," or "how."(Charles Christenson 1983).FIGURE1 EXAMPLES of “POSITIVE” AND “NORMATIVE” QUESTIONSFrom figure 1, we can see that: a positive statement is a statement about what is and that contains no indication of approval or disapproval. While a normative statement expresses a judgment about whether a situation is desirable or undesirable and is couched in terms of what should be or ought.It is a little simplistic to suggest that statements can be categorized as purely positive or purely normative because underlying all statements are unseen assumptions. (M J R Gaffikin 2007)4.Some conclusions(1)Although there are a lot of differences between the two methodologies, it is not correct for us to dissever them completely. On the contrary, the positive accounting research and normative accounting research are mutually complementary. Normative accounting research needs to be validated by positive accounting research and posi-tive accounting research needs foundation and precondition supported by normative accounting research. And at the same time, as for accounting, both positive and nor-mative methodologies should provide a framework for evaluating current and devel-oping new accounting practice.(2)Both of the two accounting research methodologies have their own strength and weakness.With regard to the normative methodology, its strength includes:First, the research method is more mature, for its basis has very long history. Second, the major strength is its feasibility, and ability to demonstrate convincingly, that a specific event should take place if a specified goal is to be attained. The induc-tive process of descriptive theory and the deductive process of normative theory are interrelated in that the deductive process may also be applied to empirical observa-tions, if reality is to changed to a more preferred as indicated by the assumed goals (Ijiri 1975).And third, also argued by Ijiri, a normative theory need not be counter-empirical. This is particularly so where the existing system is optional.Its weakness includes: (a) lower accuracy; (b)subjectivity to a certain extent ;(c)lack of falsifiability.Considering about the positive methodology, its major strength is predictive ability. It also enables hypotheses to be tested against observations. Positive theories can take various descriptive forms. One form is the verification of the accuracy of its repre-sentation through logical deduction. Another is appraisal of the extent to which ob-servations agree with deductions. Checking the size and selection method of observa-tions and the induction process itself is yet another form of defense of descriptivetheory. But if the observations are biased there can be prediction errors. (Eno L. Inanga and WM. Bruce Schneider 2005)It also exits some weakness, for instance positive accounting research emphasizes model and quantification. Sometimes maybe some secondary factors will be ignored for granted, which possibly will result in simplification of the research object and the systemic warp of the research results.(3)Even we stand in the methodology’s view, still some scholars argue that:” we have suggested that the "decision usefulness" theory of accounting, on which GAPP is based, is a grounded theory. It is normative, based on a set of assumptions that have not been tested. Accounting, as a discipline, is not a science and as suggested by Goldratt, research results in this context are limited to correlation analyses. The use of sophisticated scientific research methodologies does not change the basic situa-tion.”(Eno L. 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