Review of “How the Balance Sheet Misrepresents Shareholder Claims”
C. Richard Baker
Adelphi University
This paper begins with a quotation from the Conceptual Framework for Financial Reporting of
the US Financial Accounting Standards Board, which says that the balance sheet provides
“information about the entity’s economic resources and the claims against the reporting entity.”
(FASB 2010, Paragraph OB12). Then, drawing on recent legal scholarship, the paper argues that
a financial report that categorizes undistributed profits as a subset of shareholders’ equity fails to
faithfully represent “….the phenomena that it purports to represent.” (FASB 2010, QC12). The
authors assert that misrepresenting the legal rights of shareholders to the profit and net assets not
only runs counter to the accounting profession’s goal of providing useful information, but also
potentially results in misallocating global resources, environmental degradation, and income
inequality. According to the authors, the paper represents a preliminary attempt to educate the
accounting community about the legal reality of shareholders’ equity and, given that reality, to
encourage the community to re-consider its representation on the balance sheet.
Comments
The comments are organized into two parts. First, there will be some substantive comments, and
then, some technical comments.
Substantive Comments
1. Not being a lawyer or legal scholar, it is difficult to express an opinion regarding the
argument of the first part of the paper that there is a consensus among legal scholars that
shareholders do not possess the residual ownership interest in a corporation. However, it
seems that in putting forth this argument the authors may be equating legal scholarship
with law. In the United States, only the legislatures of the fifty states can determine what
the corporate law is, or should be, and it is doubtful that the consensus among the fifty
legislatures is that the shareholders are not the residual owners of the corporation. This
difference between legal scholarship and legislation does not mean that the authors should
not argue that it would be preferable if the residual owners of the corporation were not the
shareholders, but instead some other group, perhaps someone representing the public
interest. This type of argument would be totally consistent with Critical Perspective on
Accounting.
2. From another perspective, even if is accepted that there is a consensus among legal scholars
that shareholders are not the residual owners of the corporation, this does not mean that
this is the “legal reality” of shareholders’ equity pursuant to corporate law in the United
States. The legal scholarship cited in the paper seem to relate more to the inability of
shareholders to sue corporations to receive dividends, rather than with respect to the nature
of their residual ownership interest. There did not seem to be citations that indicated that
the shareholders are not the residual owners of the corporation according to the corporate
laws of the United States.
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3. As is true of all American law, if it is intended that the shareholders should not be the
residual owners of the corporation, then the laws could be changed to specify who the
residual owners are. However, if the consensus of the laws of the fifty states is that
shareholders are the residual owners of the corporation, then arguing that the FASB
Conceptual Framework is not properly presenting “information about the entity’s
economic resources and the claims against the reporting entity” is incorrect, and the basic
premise of the paper might therefore be questionable.
4. Selecting a particular phrase from the Conceptual Framework, such as faithfully represent
the phenomena that it purports to represent, as the basis for the argument of the paper may
be problematic. It might also have been possible to quote FASB Statement of Financial
Accounting Concepts No. 1 regarding the overall purpose of financial reporting:
“Financial reporting should provide information that is useful to present and potential
investors and creditors and other users in making rational investment, credit, and similar
decisions”. This overall objective seems to make it clear that the purpose of financial
statements is to provide information to investors (i.e. shareholders) and creditors. Thus, the
orientation of the Conceptual Framework is towards providing information that is useful
to shareholders, again reflecting the idea that the shareholders are the residual owners of
the corporation. As stated previously, the authors could argue that this is not an appropriate
orientation for the Conceptual Framework, but it seems incorrect to say that this orientation
is not consistent with US corporate law.
5. It should also be pointed out that the Conceptual Framework does not constitute a part of
US Generally Accepted Accounting Principles, but rather that the Conceptual Framework
provides guidance to the establishment of GAAP. Reliance on a particular part of the
Conceptual Framework to form the basis for the argument of a paper may therefore be
problematic.
6. The exhibits to the paper provides information about the excessive compensation of
corporate executives. While this is interesting information and while it supports the
author’s argument that the shareholder perspective should not be the only perspective for
corporate governance, at the same time, the corporate law does not seem to support this
argument. If the consensus of the corporate laws is that it is the corporation itself that can
decide the appropriate distribution of earnings, and not the shareholders, then awarding
large amounts of compensation to corporate executives would seem to be permitted by law.
Merely, changing the orientation of the Conceptual Framework would not achieve the
desired end.
7. Finally, the primary concern of the paper seems to be located in the second section which
recites numerous reasons why the shareholder perspective is detrimental in terms of
inequality of incomes and effects on the environment. While these effects are relatively
undisputable, tracing the effects to the Conceptual Framework seems dubious. In addition,
while claiming that legal scholarship disputes the shareholder perspective is interesting as
an argument, as was pointed out above, legal scholarship is not the same as law, and
consequently, the author’s desired result may only be achievable by changing the corporate
law.
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Technical Comments
1. The paper is not very long in terms of number of pages. Perhaps the arguments could be
developed further in order to make a longer paper.
2. The referencing style is inconsistent, and it does not conform to any particular journal style.
If the author is interested in submitting to Critical Perspectives on Accounting, the style
should be consistent with that journal.
3. There are many footnotes written in the style of a law review. The author should decide
whether the paper should be oriented towards a law review or towards an accounting
journal.
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