Diverging Paths:
American and German Financial Reporting in the 1920s and 30s
Author: Dr. Christopher Kobrak, Professor of Finance, ESCP-EAP, European
School of Management, Paris
Kobrak@escp-eap.net
Draft: August 21, 2004 Not to be quoted without permission of the author.
European Business History Association, September, 2004.
“The foundation for creating investment capital from national wealth was the
popularization of securities, highly developed exchanges and banks; the foundation of
international investment capital is international banking houses and exchanges.”
K.v. Reibnitz, Staatsminister, in Der Wirtschaftsprüfer, May 1932.
“We do not have the time in Germany to repeat all the developmental steps of the United
States and England. We can spare ourselves many difficulties by carefully following and
accepting the development in the United States … .”
Dr. Fritz Mezger, in Der Wirtschaftsprüfer, May 1932.
Abstract: This paper exams the different paths taken by American and German
accountants in the early part of twentieth century, especially during the crucial two
decades that followed World War I. It argues in part that different views about the nature
of equity investment in the two countries helped shape those countries’ accounting
practices. In the late 19th century, America began what has been termed by some as an
“equity revolution,” an enormous shift in the number and geographic dispersion of
investors as well as a change in expectations regarding common stocks. Germany’s
experiences with capital markets even before World War I discouraged stock
“speculation” and encouraged greater reliance on intermediaries, closely tied to firms, to
perform many capital market functions. Whereas the armistice in 1918 unleashed in the
United States a euphoric boom in public interest for common stocks and shortly
thereafter an upsurge in private, outward foreign investment, the peace terms reinforced
German fears of instability and loss of national autonomy, which inhibited equity
investment, despite capital shortages.
1
I. Introduction.
Much has been written about the revolutions in transportation, communication,
production, and marketing – which are viewed as the building blocks of the modern
corporation and managerial capitalism. Considerably less attention has been paid to the
revolution in capital markets and an accompanying revolution in accounting systems.
Not all national accounting systems followed the same path, however. In 1873,
the German and American accounting reports and accounting theory, for example, had
fewer points of departure than in 1933. In the globalized pre-World War I world,
international investors found little about each others approach to accounting baffling.
The accounting principles, on which public accounting statements were based in both
countries, were vague at best regarding the requirements for the contents of financial
reports and disclosures. In both countries, moreover, there was little in the way of
auditing standards and liability to shareholders.
Government bodies, especially sector
regulators, such as those for rail and banking, oversaw accounting rules. Insofar as there
was a philosophy about what to present, it was more focused on the interests of debtors as
opposed to shareholders.
Neither country had developed a professional class of
specialists as a standard-setting body. Until World War I, a relatively tight network of
banking relationships monitored and controlled international capital flows and
information. Germany may even have been more advanced in all of these areas than the
United States, but this changed abruptly during the interwar period.
Accounting
statements rarely divided operating from other expenses. Net income was arrived at, in
large part, after management had accrued for sufficient contingencies that it was
comfortable dividending out what all the revenues that had not been “expensed.”
Between 1873 and 1923, in the United States, however, tax and book accounting
were separated, a shift occurred from asset and capital valuation to income flows and the
distinction between liabilities and owner’s equity, a series of principles for income and
balance sheet valuation rather than fixed but vague rules (laws) were developed, and a
professional accounting body, responsible in large part to shareholders, was established.
The concept of operating income was developed and incorporated in financial statements.
2
Some companies added segment reporting, annual comparisons, and funds flow
statements.
The experience in Germany was very different.
Until recently, the German
financial accounting system was largely focused on tax issues, asset and capital valuation
– neglecting the income statement and the flows in and out of the firm – and accounting
experts exerted little influence on setting accounting principles.
The purpose of this paper is to outline the contrasting responses of Germany and
the United States, and to suggest some aspects of the historical context in each country
that might explain their disparate accounting adaptations. Although some important steps
were taken before World War I, the paper exams in more detail the different paths taken
during the crucial decades of the peace, in the 1920s and 30s, when very different
reforms to accounting systems in these two countries were instituted. It will highlight
some of the historical cultural, economic, and political circumstances that shaped
business behavior and each country’s system of corporate governance.
Accounting
systems entail many aspects of a financial system, not just the specific and general rules
for financial reporting. These include but are not limited to the how rules are established,
the status, education and attitudes of accountants, what role accounts play in creating
financial information and monitoring company reports. Although some authors have
focused on attitudinal differences to explain differences between the two systems, more
commonly, different approaches to solving the agency cost problem, particularly
Germany’s bank dominated financial system, are cited as explanatory factors.1
In this
paper, I will argue, in contrast, that a broad range of cultural and political differences
contributed to a rupture between American and German accounting, which developed
slowly around the turn of the century. During this crucial period just after World War I,
however, Germany’s economic dependencies and turbulent political environment – set
1
See Lisa Evans, “Auditing and Audit Firms in Germany Before 1931,” The Accounting Historians
Journal, Dec. 2003, Vol. 30. for a good discussion of how agency costs affected accounting decisions and
how banks were used to overcome owner-agent frictions. Although America’s financial system was very
bank dominated before the turn of the century, she exaggerates the degree to which the two accounting and
audit systems evolved in a parallel manner up to that point. As will be discussed, distance of shareholders,
the importance of railroads, and bankruptcy were pushing American accounting along a different path long
before the turn of the century. For a discussion of attitudinal differences see, Demski, Joel S., et al, “Some
thoughts on the intellectual foundations of accounting,” Accounting Horizons, June 2002, Vol. 16. and
3
against America’s new role as capital exporter – accelerated the different trajectories and
retarded Germany’s participation in what some authors have called the “equity
revolution.”2 My sole objective here is to compare some of the differences in how equity
markets developed in the United States and England, on the one hand, and Germany, on
the other, and to suggest how these different financial paths – which go well beyond the
role of banks in Germany as intermediaries – may have influenced the development of
accounting and the accounting profession in Germany and in the United States.
II. Germany and the Equity Revolution.
Equity financing is probably the oldest form of investing. While capital markets
only started to develop in the seventeenth century, we have evidence going back 3,000
years for venture capital investments in highly risky undertakings.
Most of the
civilizations and religions that influenced Western Europe and North America’s cultural,
political and economic development, however, shunned charging interest and encouraged
capital investment in which the providers of funds shared the risks of those who were
using the money and took an active part in the management of those enterprises.
Borrowing and lending was clearly a part of ancient and medieval society, but passive
investing – that is, as Aristotle put it, the pure “making of money from money” – was
tainted with a host of socially undesirable attributes. Nevertheless, governments and
private interests found many ways of evading society’s social and at times legal
prohibitions. The nineteenth century growth in business activity, associated with the
Chandlerian revolutions in transportation and communication, were accompanied by an
enormous increase in debt financing, with most of the equity capital coming from the
founders of businesses and their families. Banking houses such as the Rothschild family
turned their attention from financing governments to big private projects with debt.
Although equity markets in many respects grew out of debt markets, the transformation
was not frictionless and entailed some false starts until the institutional and attitudinal
framework for investing caught up with financial interests. Indeed, the first crises in
Harston, Mary, “The German accounting profession – 1931 and before: A reflection of national
ideologies,” The Accounting Historians Journal, Dec. 1993, Vol. 20.
2
See Jonathan Barron Baskin and Paul J. Miranti, Jr., A History of Corporate Finance (Cambridge:
Cambridge University Press, 1997) 167-209.
4
equity markets were connected with government efforts to trade its debt for equity in
private companies. Governments’ sloppy control of that transformation contributed to
retarding interest in and controls of equity financing.3
Well into the nineteenth century, many investors and managers had a great
preference for debt rather than equity.
In the mid-nineteenth century, the English
government had to statutorily limit the percentage of rail financing that could come from
debt. Most of the large rail projects in the United States, for example, were financed by
heavy investments of debt from the United Kingdom. In 1913, English debt financing
alone was USD 5.0 billion, roughly 50 percent of the total value of U.S. equity markets.
German investors were also eager to put their money into American railroads.
The distance that separated investors from companies, the amount of capital tied up, and
the financial fragility of those companies reshaped the nature of investment and
accounting information. Not only did this sector have the same spin off effects that it had
everywhere else – iron productions, the telegraph, construction of terminals and railroad
cars, etc – in the U.S., it opened whole new markets hitherto isolated from trade and
stimulated cross border investments, transforming capital market and accounting
practices. The growth in track alone was staggering. By 1890, there were nearly 180,
000 thousand miles of track, more than all of Europe’s and nearly seven times that in
Germany.4 American creativity contributed to new service industries designed to exploit
the faster and more reliable transportation method.
American firms led the way in
developing new management and accounting techniques to cope with the large
companies that developed.5 By 1893, the railroads were providing public information
comparable to that in modern financial reports.
The market for their securities was large and very international.
Even
conservative, distant investors understood what railroads did and what security they could
offer. They flocked especially to the secured bonds and preferred stock of railroad
3
Niall Ferguson, The Cash Nexus (New York: Basic Books, 2001) 311-313.
Karl Helfferich, Georg von Siemens: Ein Lebensbild aus Deutschlands groβer Zeit (Berlin: Verlag von
Julius Springer, 1921) Vol. 2, 220-225.
5
Alfred D.Chandler, Jr., compiled and edited. The Railroads: The Nation’s First Big Business (New York:
Harcourt and Brace, 1965) and Chandler, The Visible Hand (Cambridge: MA.:Harvard University Press,
1977)
4
5
firms.6 But by the early 1890s, the controlling interest in many railroads was held outside
of the United States, amounting to 33% of the nominal value of all the U.S. railroad
securities.7
But like many sectors in the U.S. in the last quarter of the 19th century,
transportation was still highly splintered. (There were 43 companies with over 500 miles
of track.)8 Railroad firms suffered from duplication of services, a lack of connection and
compatibility between lines, over construction, price competition, and client pressures, all
of which contributed to boom and bust cycles and a desperate need for consolidation and
reorganization that provided a great deal of opportunity for clever bankers armed with
detailed accounting information, often acquired from great distance.
Moreover, by the 1880s, Germany was nationalizing its own rail system, putting a
great deal of cash into the hands of companies and individuals, who had once held
railroad securities. By 1899, German investment in this sector amounted to USD 103
million. Fifteen years later, it had tripled.9 By 1881, Deutsche Bank, for example, had
already purchased from “friendly banks” in London, bonds in three American railroads.
Soon after, Deutsche Bank took over its first Northern Pacific Securities, a 6% First
Mortgage Bond. The acquiring of this investment and the bankruptcy of the Northern
Pacific in the 1890s illustrated how the nature of investments changed and the role played
by accounting information.10
The bankruptcy of the Northern Pacific in 1893 came as a, to say the least, very
unwelcome shock to Deutsche Bank. Until that time, it had relied on a German-born
American, Henry Villard (né Heinrich Hilgard) to find and manage its U.S. interests.
Those interests included purchases for its own account, but Deutsche Bank’s primary
activity was marketing the securities to European individuals and institutions, mostly in
Germany. The collapse of the rail line made the need for better accounting information
6
Janathon Barron Baskin and Paul J. Miranti, Jr. A History of Corporate Finance (Cambridge: Cambridge
University Press, 1997) 146-157
7
Mira Wilkins, The History of Foreign Investment in the United States to 1914 (Cambridge, MA.: Harvard
University Press, 1989), 197-198.
8
Alfred D.Chandler, Jr., compiled and edited. The Railroads: The Nation’s First Big Business (New York:
Harcourt and Brace, 1965), 17.
9
Mira Wilkins, The History of Foreign Investment in the United States to 1914 (Cambridge, MA.: Harvard
University Press, 1989), 169.
10
Karl Helfferich, Georg von Siemens: Ein Lebensbild aus Deutschlands groβer Zeit (Berlin: Verlag von
Julius Springer, 1921) Vol. 2, 220-225.
6
all to clear. Tainted by this failure, Deutsche Bank could not simply organize German
investors to represent their interests based on the bank’s or Villard’s reputation.
Managers needed a clear picture of what was going on and better financial control. They
were shocked to find that American bankruptcy law, unlike that of Germany, was
relatively favorable to shareholders and management. Under the American receivership
system, the assets of the company were not simply taken over by debt holders. They
were managed by receivers and the former management to insure the continued use of the
assets and that the maximum of payments were made to the debt holders. This required
extensive financial reporting to monitor the monitors. Moreover, relatively early on in
the crisis, Deutsche Bank agreed that the company should be financially reorganized.
This required working more closely with some other railroads, selling some assets,
forming a shareholder Voting Trust to oversee the company’s own board of directors,
and, finally, reducing the company’s debt level with the swapping of some debt for
equity.
All of the participants, some of whom were at great distances, needed
convincing, some sense that the risks of the remaining debt that they held were not too
high and that the upside of the common equity offered were sufficiently favorable to
agree to the reorganization. All of this required extensive financial statements that were
virtually unheard of in Germany at the time. (See Appendix I)11 In short, many investors,
who began their involvement by holding debt instruments, had to decide whether to
accept new debt and equity on the basis of accounting information.
Late in the nineteenth century, the mode of financing in most countries, to various
degrees, began to change enormously, for other reasons, too. The first was the desire of
many of the founding families of the new industries to exit their companies, which, as it
were, transformed privately held companies to public companies, increasing the supply of
public shares. Banks could directly absorb these new shares to some extent, but most of
them recognized that this tied up too much of their equity and entailed unwanted risks.
They needed to offload those new shares to foreign investors, large private investors,
11
Reorganization of the Northern Pacific Company, Plan of Reorganization, HADB, A-1149 and
Reorganization of the Northern Pacific Company, Announcement by the Reorganization Committee,
HADB, A-1149.
7
some of whom who had been enriched by the sale of their family businesses, and even to
smaller domestic retail clients. The number of shareholders in the United States climbed
from 0.5 million in 1900, to 2.0 million in 1920, to 10.0 million in 1930.12
The second
was in some countries the regulatory pressure to consolidate companies, rather than to
allow smaller companies to coordinate supply and demand conditions. This regulatory
predilection was clearly more pronounced in the United States, where the Sherman AntiTrust Act set the tone for decades of court decisions that tended to tolerate consolidations
that produced economic efficiencies but rejected collusion among independent
companies. As a recent article in Foreign Affairs pointed out, continental European antitrust thinking has always been oriented around protecting smaller, less competitive
companies from larger, more powerful ones, rather than looking for economic
efficiencies that might lower customer prices.13
Many of the mergers, during the early
phases of mergers in the United States, for example, were financed with new equity
capital. Lastly, the great increase in new technologies – electrification and electrical
appliances, automobiles, and chemical, to name just a few – requiring large amounts of
upfront investment and entailing a great deal of uncertainty, tended to be financed with
equity capital. All of this, contributed to increased interest in, appetite for, and need to
understand equity capital.14
Although broad, anonymous markets for equities were prevalent in many
countries, America set the pace. There, especially, a growing number of middle class
investors were enticed by the promise of high dividends and capital gains to commit
significant amounts of their savings in industrial and utility shares. Total share turnover
on the New York Stock Exchange (NYSE) grew in 1900 from 159 million to 1.1 billion
in 1929. The value of common and preferred shares underwritten jumped from USD 405
million in 1910 to USD 9.4 billion in 1929. The Standard and Poor’s Composite Index
shot up from 6.15 in 1900 to 26.02 in 1929.15 Corporate managers enticed investors to
buy shares with high dividends, loosening the hold of creditors and banks over
12
Baskin and Miranti, 190.
David S. Evans, “The New Trustbusters: Brussels and Washington May Part Ways,” Foreign Affairs,
January/February, 2002.
14
Baskin and Miranti, 167-209.
15
Baskin and Miranti, 167.
13
8
corporations. From 1921 to 1929, corporations tripled their net cash position, financed in
part by the floatation of USD 19.0 billion in new equity issues.16
Although Germany’s need for equity financing was substantial, culture and
political events hindered the development of capital markets and widespread demand for
equity investments. German attitudes about capitalism and reactions to the Panic of 1873
contributed to a strong distrust of capital markets in general and equity investment in
particular, and Germany’s reliance on a corporate governance system, in which a close
relationship between banks, especially large, universal money center banks, and
companies played a central role in monitoring corporations and avoiding the ravages of
speculative capitalism.17 Whereas the central role played by large banks may have
created some inefficiencies by over centralizing economic power, it did restore public
and private confidence in equity financing, probably giving commercial companies
greater flexibility in their financing activities.18 Indeed, there is much evidence that the
German managers found financing their projects with common equity easier than their
British counter- parties did.19 But the German system, in which the large banks played
such an important role, stressed stability over other economic virtues, undermining the
association of risk taking and equity investment, and concentrated ownership and control
removed much of the raison d’etre of public financial reports. Moreover, as has been
often discussed, German banks had a wide-range of financial interests in their client
companies, which may have created a conflict of management interest in the companies’
activities and reporting, but also at the same time, gave those who invested their funds
through the bank a diversified portfolio in commercial companies.
Moreover, Germany’s equity markets never fully recovered from World War I.
In 1928, the peak year of the German recovery in the 1920s, stock were 11 percent below
16
Gary John Previts and Barbara Dubis Merino, A History of Accountancy in the United States (Columbus:
Ohio State University Press, 1998) 250.
17
See Christopher Kobrak, “Mark Roe and the Roots of German Corporate Governance,” EBHC, Helsinki,
2002.
18
Richard Tilly, “An Overview on the role of the large German banks up to 1914,” in Youssef Cassis, ed.
Finance and Financiers in European History, 1880-1960 (Cambridge: Cambridge University Press, 1992)
93-110.
19
See Tilly, 102. Although Tilly does not give the figures on a comparable basis for English firms,
German companies between 1880-1911 were getting over half of their external financing from new equity
(he does not distinguish between common and preferred) and over half of all their overall financing needs
from internal sources, a kind of equity financing.
9
their average levels from 1900-1913.20 Between 1907 and 1929, the value of German
equity capital increased from USD 6.6 to 7.2 billion. In the same period, nominal capital
grew by only 61%. In the heyday of equity investment during the 1920s, between 1925
and 1929, Germany increased the nominal value of share capital by approximately 25%.21
Many Germans recognized the problem. In May 1932, at the height of the Depression,
businessmen and government pointed to the lack of investment in Germany as one of the
root causes of the Depression and a major impediment to recovery. Even in 1913,
investment in securities accounted for only 20% of national wealth, far less than in
England (42%), France (51%), and the United States (30%).22
The great increase in equity financing required institutional and attitudinal
changes. Equity ownership generally entitles the holder to a contingent gain, one based
on a the residual of income produced by an enterprise in accordance with his ownership
interest.
Modern equity investing entails many significant differences from debt. Most
holders of equity have the right to make certain decisions for the firm in proportion to the
their ownership holding, but it is rare that shareholder are also active managers or that
any single shareholder owns enough of a firm to control it. The gains to equity holders
come in the form dividends paid by the firm and any appreciation of the value of the
price of their shares (capital gains), all of which is contingent on the earnings of the firm
and the investment decisions of managers. Debt holders have contractual claims on the
firm, sometimes collaterialized by the firm’s assets. In short, the equity holders is said to
have riskier returns and greater control issues in the firms in which they invest.
Investor appetite for and understand of risky equity financing, with its less predictable
cash returns, had to increase substantially, along with sufficient confidence in
management’s competence and shareholder control, to forgo immediate dividend cash
flows for capital gains, one of the principal advantages of equity over debt financing for
companies and investors.
These economic changes paralleled many changes in the attitude about equity that
were the basis of many changes in accounting principles. Common equity in the mid-
20
Volker Berghahn, Modern Germany (Cambridge: Cambridge University Press, 1982) 287.
Calculated from the tables, 294, Deutsches Geld- und Bankwesen in Zahlen, 1876-1975, ed. Deutsche
Bundesbank (Frankfurt am Main: Fritz Knapp Verlag, 1976)
21
10
nineteenth century, as it was used in England, Germany, and the United States, still had
much more in common with debt instruments than its more modern variant. Par values
were high and resembled a bond’s face value in many ways. The par value of common
equity was supposed to provide security and to indicate the value of underlying assets.
Because companies were expected to pay out most of their “earnings” in dividends,
income statements were constructed to indicate the amount of earnings managers wanted
to dividend out. Actual dividends seemed to be only way of measuring future earnings.
Investors had little patience for leaving earnings in a company (retained earnings) – only
earnings that could be hidden in the form of reserves were kept by the company. They
counted little on capital gains and tended to measure the company in terms of the
dividend earning power of the company, which in all countries was talk about as a
percentage of nominal capital (paid in capital), like a bond’s coupon rate.
III. Accounting Response in Germany and the United States in 1920s and 1930s.
Ironically, the turmoil in capital markets and measures to re-establish stability
after World War I, had for different reasons that greatest impact on Germany and the
United States, an effect for which neither country was particularly well-prepared and one
which would contribute to the severity of the effects of the Depression in both countries.
Both countries lacked a unified accounting profession, and a unified set of accounting
and audit standards approved by regulators and clients. Even investors were lukewarm to
the importance of accounting standards and rigorous audits. Nevertheless, even before
the Crash in 1929, American accountants had begun to make significant changes in
accounting theory.
In the aftermath of the Crash, moreover, in both countries the
accounting profession served as a cornerstone in government efforts to monitor business.
But the position of the professions, and the social and economic conditions in both
countries made the specifics of this role very different.
Although many of the profession’s chief allies in America lost some interest in
accounting and audit reform after World War I, the advisory role of accountants grew
K. v. Reibnitz, “Der international Effektenkapitalismus und Deutschlands Wiederaufbau,” Der
Wirtschaftsprüfer, May 1932.
22
11
immensely in the 1920s.23
The expansion of activities and of the number of
professionals, as well as the proliferation of professional organizations led to many
conflicts among accountants. Heated battles occurred about a whole host of ethical and
professional issues – for example, admission standards to the profession, advertising, and
contingent fees – but for the most part they were contained within the profession. The
purpose of the profession was transformed from merely monitoring business to one in
which CPAs (Certified Public Accountants) worked “with businesses and federal
regulatory agencies to collect and disseminate data so that business could earn a ‘fair
return’ on their investments.”24 This idea of “fair return” helped revolutionize the idea of
equity and accounting. Understanding “fair return” required a clear understanding of
what costs were and how they could be controlled. Long before the crash, accountants in
and outside of corporations were leading the way in categorizing costs, determining
direct and indirect costs, creating flexible budgets, full-cost and cost plus income
statements and Return on Investment (ROI) calculation, which helped drive changes to
financial accounting in the 1930s.25
While many issues such as taxes, replacement cost accounting and par value
preoccupied accountants in the 1920s, the importance of the income statement and a
manager’s right to hold on to retained earnings became much more accepted aspects of
accounting theory. These two ideas were not unconnected. The emphasis on the balance
sheet (primarily conservative asset valuation for creditors, proprietary theory) and the
view that income was what should be distributed to shareholders, contributed to sketchy
income statements with overly conservative charges, which made determining what
returns were actually be made on the value of assets employed nearly impossible. The
balance sheet was still at center stage of accounting, but the emphasis was shifting to the
valuation of equity capital. Although not all of the ideas of accountants were accepted in
the 1920s, more and more emphasis was placed on the income statement as a measure of
managerial effectiveness in the use of assets entrusted to them and as an indicator of
expected future earnings, which might eventually be distributed to shareholders. The
accounting profession was not only moving toward the entity view of the firm (as
23
24
Previts and Merino, 237-241.
Previts and Merino, 239.
12
opposed to the older proprietary view), which focused on inflows and outflows, but also
to economic theory to further develop accounting information.
The recognition of the need for segregation of income into tow distinct
flows (financial and operating) by accounting theorists in the twenties
seems to have been the result of the increasing sophistication of
economics literature dealing with income determination, not, as some have
suggested, a natural result of the adoption of entity theory.26
By 1929, the accounting principles of realization and matching were well accepted.
One of the many innovations in American accounting during the interwar period
was a rigorous distinction between Liabilities and Owner’s Equity, without which
understanding the position of the shareholder is almost impossible.
As shareholders
were predisposed to take possession in the form of dividends of anything that belonged to
them “outright,” most accounting systems did not highlight that retained earnings as
opposed to third party liabilities and paid in capital. The term “reserves” was often used
for a kind of nebulous sort of liability that should be segregated for future investment or
to shelter the firm from future losses. Indeed, even many American accountants used the
word ‘equities,’ for both third party liabilities and owners equity well into the twentieth
century, when the division between amounts owed to third parties and shareholders was
codified in the accounting equation. In many national accounting systems, the distinction
between what belongs to third parties and what belongs to the holders of common equity,
however, is still not clear. The basic accounting equation in most continental countries is
expressed as assets=passives.
German accountants were troubled by many of the same theoretical accounting,
ethical, and educational standard-setting issues that troubled their Anglo-Saxon
colleagues. In comparison with English and American counterparts, however, German
accounts were few in number and fragmented in their organizations. In 1930, England
had 17,172 qualified accountants, who belonged to three accounting associations. In
contrast, in 1932, Germany possessed 457, who, despite their lower numbers, were
divided into five main organizations and a lot of smaller ones, in which lawyers and
25
26
Previts and Merino, 251-253.
Previts and Merino, 261.
13
others providers of business services participated.27 Conflicts between sole practitioners
and larger firms (Treuhandgesellschaften), many of which had been established by banks,
contributed to the profession’s inability to mount a united front against government
regulators and companies. In Germany, the audit function was considered part of the
Aufsichtsrat’s (Supervisory Board) responsibility. Unlike the United States and England
where auditing was well known around the turn of the nineteenth century, in Germany, it
was still a novelty and considered “a sign of financial instability.”28
Whereas several
universities and specialized business schools (Fachhochschulen) gave instruction in
accounting, professors and their course offerings were very general and focused on the
economics of the firm, not accounting theory or practice. Like in England, most of the
professional training was on the job, but in Germany the lower number of practitioners
limited the number and training of new entries. By 1917 England and nearly every state
in the United States, where much of the regulation is still controlled by individual states,
had licensing procedures overseen by a professional body. A controlling body for the
German profession was first created in 1931. It established the first rigorous testing and
admissions procedures for licensing auditors.
The history of Germany’s largest “accounting firm” illustrates the different role of
these firms in that country. An outgrowth of America’s bouts with corporate insolvency,
Deutsche Truehand Gesellschaft, was an extraordinary institution, which still indirectly
plays an important role in financial affairs. Founded in 1890 with a capital of 20.0
million mark (approximately, USD 5.0), the Treuhand had the purpose of issuing its debt
instruments for the purchase of solid American securities and to represent the interests of
all German investors in the United States. The original idea of creating an institution to
protect German capital investments in North America came from Deutsche Bank’s Georg
von Siemens. Deutsche Bank and the banker Theodor Stern each held roughly half the
original equity. Georg von Siemens, Deutsche Bank’s president, personally held 0.5 %
of the new company.
The company possessed good political connections. Bernhard
Dernburg, who later became head of the government’s colonial office and Karl Schrader,
27
H.B. Markus, The History of the German Public Accounting Profession (New York: Garland Publishing,
1997) 1-62.
14
director of the national railroad, served on the first Vorstand. The Aufsichtsrat was
dominated by owners and representatives of Deutsche Bank.
Originally conceived as a kind of trust company, which would sell its own debt
and invest the proceeds in American securities, management quickly determined that the
risks of future investment were too high. In 1894, one million of capital was returned to
investors and the company by-laws were changed to allow for more of a European focus
and to issue “certificates or opinions about securities.”29 By 1901, it was reconstituted as
the Deutsche Treuhand Gesellschaft (DTG) and focused more of its attention on auditing
American companies.30 Scandals in several German companies around the turn of the
century led to demands for more audits of German firms and DTG stepped into this
function as well as managing the “turnarounds” of troubled firms. By 1907, the company
was preparing the financial statements for 400 German firms. Although audits were not
required of large German companies until 1931, some say that DTG laid the foundations
for the accounting and audit profession in Germany. Clearly, with offices in Germany
and many other countries, DTG played an enormous role in the history of the accounting
profession in Germany during the 20th century. In 1986, DTG merged with the Big-Eight
accounting firm, Peat, Marwick, Mitchell to form KPMG.31
The establishment in 1931 of an auditing control body and the audit requirements
for joint stock companies came after nearly two decades of political and economic
turmoil for Germany. The war and hyperinflation, which followed it, had destroyed an
enormous amount of economic value and, perhaps for the accounting profession even
more important, it had made pre-war economic comparisons nearly impossible. The
inflation boom was quickly followed by a deep recession, credit shortages, and an influx
of foreign investment, the likes of which Germany had never seen before. Though no
one knows for sure how much, most of the capital that came into Germany at this time
was in the form of debt. By 1930, Germany owed 26 billion RM in foreign debt – mostly
28
Markus, 9. The German financial system is often characterized as one with more trust than the AngloSaxon. Attitudes about auditing companies seem to fit into this view. You only audit, if you have some
reason to believe something is wrong.
29
KPMG Deutschland vom Ende des 19. Jahrhunderts zum Beginn des 3. Jahrtausands. Teil 1. (Berlin:
KPMG Deutsche Treuhand-Gesellschaft, 2003), pp. 13-16.
30
Wilkins, p. 511.
15
foreign denominated and much of it in the form of short-term instruments – at a time
when the German national income was roughly 75 billion RM. Between one-third and
fifty percent was owed to American individuals and institutions.32
Numerous financial
scandals highlighted the shortcomings of the financial control system.
By 1931, the financial and political crisis had reached such proportions that
normal democratic institutions and procedures had been shelved. The very law that gave
the accounting profession its new stature and structure by mandating audits for public
companies with more than RM 3.0 million in capital (later extended to smaller firms) and
by creating the Hauptstelle für die öffentlich bestellten Wirtschaftsprüfer (Controlling
Body) was not passed by the Reichstag, but rather, like all of the acts of the period,
enacted by presidential decree.33 In short, even before 1933, the profession was weak
and dominated by political issues. As one historian of the profession put it,
Unlike the other professions (in other countries, my note) which
evolved in times of economic growth, the German profession was created
barely a dozen years after a lost world war, some seven years after the
worst inflation of modern times and in the midst of the catastrophic world
economic crisis; all of these conditions led to a high degree of political
instability, the consequences of which were to hang as a dark cloud over
the new profession for more than the first decade of its life.34
German accounting theory, while in some ways very innovative, did little in the
1920s and 30s to adapt to the equity revolution. It hardly even adapted to the two great
shocks to the German economy in the 1920s, the inflation and monetary stabilization.
Although accounting theory was dominated by “business economists,” and the post-war
inflation and currency stabilization dominated Germany’s economic environment in the
early 1920s, oddly, accounting rules adapted little to the new economic circumstances.
There were, for example, no rules developed for inflation accounting or for the creation
of post-inflation balance sheets.
Some accounting theorists highlighted the
Scheingewinne (fictitious profits) of the inflation period and recommended that
31
KPMG, pp. 31-37.
William C. McNeil, American Money and the Weimar Republic (New York: Columbia University Press,
1986) 18-19.
33
Markus, 29-33.
34
Markus, 27-28.
32
16
companies and tax authorities move to some form of replacement cost accounting, but
their proposals were rejected by the government and business leaders as being too
complex and not in the national interest.35 Companies were, by and large, left on their
own to value their post-inflation balance sheets.
Companies were tempted to give
exceedingly high valuations to fixed assets and inventories to raise the value of their
capital to attract investors, especially the great number of new foreigners who were very
enthusiastic about the equity and debt of German companies during the early days of the
stabilization. The degree to which the new shareholders were with inevitable losers was
evidenced by the great number of companies that had to right down the value of their
paid in capital in 1925 and the paucity of shareholder returns throughout even the best
years of the Weimar Republic. The average market value of industrial shares was 20
percent lower between 1926 – 1929 than from 1905-1913. Dividends for the same period
during Weimar were 28 percent below their prewar level. 36 Financial reports just after
the stabilization and even into the mid-20s suggest that managers and even the
accounting profession were still focused on the value of tangible assets, the Sachewert,
which so dominated economic thought during the inflation, and less interested in the
future flows of corporate earnings as a measure of value.
During this period, Eugen Schmalenbach, Professor of Business Economics in
Cologne and advisor to the Krupp and Flick families, stands out among his colleagues.
He developed many ideas, designed to free accounting from its cost-based, segmented
approach. He called his new approach Dynamic Accounting and recommended that more
emphasis be put on the income statement.
Like other thinkers of the period – Oswald
Spengler, for example – Schmalenbach’s work was full of organic metaphors. For him,
the accounting system must be treated as a holistic system; no part could be understood in
isolation.
The various aspects of costs and prices fit together as a whole.
His
terminology is full of terms such as ‘organs,’ ‘cells,’ and ‘systems.’ He pushed for more
focus on the inputs and outputs of the firm (income statement), and substitution of market
for historical values in accounts. Understandably given the inflation period, he even
advocated moving away from money as a measure of those flows, because it was too
35
36
Gerald Feldman, The Great Disorder (Oxford: Oxford University Press, 1993) 299, 581.
Feldman, 842-843,
17
affected by economic oscillations and crises. He recommended focusing more on activity
and prices, which would somehow be adjusted, held constant, over time. Although
Schmalenbach encouraged more emphasis on the income statement, like most
economists, he preferred marginal to full costs.37
Unfortunately, much of his thinking did not translate well into an operational
system of accounting principles for financial reporting. His main interest involved the
problems of management accounting for factories, marginal costing, the proper allocation
of overheads, and activity accounting. Although “dynamic balance sheet theory” put the
income statement at the center of accounting, as an academic economist, he himself had
no professional experience preparing financial statements.38 How could accounts create
financial reporting based on non-monetary inputs and outputs?
His calls for better
valuations of assets during and after the inflation period went mostly unheeded.39
Moreover, government rules, not professional standards, determined financial reporting.
The profession, despite Schmalenbach’s pleas, also remained wedded to the balance sheet
as a “presentation of the reservoirs of power for the firm.”40 Many accountants even
questioned the necessity of double-entry bookkeeping, because the recording of the assets
was by far the most important element of value, not the source of the additions to assets,
which we call liabilities and owner’s equity. They were convinced that single entry
accounting had served nineteenth century businesses well. Single entry ledgers were
advocated by many accounting teachers and persisted well into the 1930s; the guidelines
of the Göring Plan permitted its use by smaller firms. Even Schmalenbach focused on
the ledger, the statistical database for analysis, which in continental countries is mandated
for companies. Additions to assets ostensibly revealed progress for the firm.41 The
balance sheet was central, because it brought together all the aspects of and most of the
37
David Forrester, Eugen Schmalenbach and German Business Economics (New York: Garland
Publishing, 1993) 113-117.
38
Erich, Potthoff, “Schmalenbachs Leben und Wirken für die Betriebswirtschaftslehre,” in 100 Jahre
Betriebswirtschaftslehre – 125 Jahre Eugen Schmalenbach, eds. Erich Potthoff, et al,
Betriebswirtschaftliche Forschung und Praxis, March/Paril 1998. Schmalenbachs practical experience was
limited to a short internship in an iron works and serving as accounting advisor to the Cologne Chamber of
Commerce. Pp. 141-147.
39
Potthoff, p.144.
40
Forrester, 117.
41
Forrester, 144-146.
18
stakeholders of the firm, the creditors, entrepreneurs, and society at large. As one of the
most important theorists of the day put it, the balance sheet reflected:
The economic motive, the furtherance of public well-being, the
welfare of the totality as well as of each individual, and yet must deal
justly with special interests … the creditor interested approach from
commercial law, and the entrepreneur interest … (all viewed from) the
business unit, its longest possible life and greatest economic
effectiveness.42
There was a very strong social component, as Osbahr goes on to say. The
business unit was “both dividing line and connecting line between the national economy
and the entrepreneur of the moment.”43
International accounting firms were operating in Germany and introduced many
accounting techniques and principles to Germany, but in very special circumstances. The
Price Waterhouse 1925 audit of Phoenix Mining and Steel Co. (Phoenix) and the
presentation of that company’s financial statements offer an interesting case in point and
contrast between the two systems. They illustrate the influence of foreign money and
foreign accounting firms on Germany’s accounting practices.
These reports, a
continuation of work that had been done just after the currency stabilization in December
1924, were the first Phoenix had issued since the introduction of the Dawes Plan. As part
of the Dawes Plan, the company had issued nearly RM 24.0 million in debentures with
interest and sinking fund payments of RM 1.4 million to mostly foreign investors. Under
these special circumstances, the “audit” function of the Aufsichtsrat appeared inadequate.
Like the public statements of normal German financial statements, the English reports
provided by Price Waterhouse did not do a full consolidation of Phoenix’s subsidiaries, in
which 50% or more of the shares were held by the parent, but it did contain a funds flow
statement. According to the auditors, depreciation and reserving policy was at times
arbitrary and overly conservative, although the asset values on which the rates were based
appeared unnecessarily low after the inflation period. Nearly all the statement were
comparative, showing at least two periods.
Price Waterhouse provided segment
42
Wilhelm Osbahr, Die Bilanz vom Standpunk der Unternehmung (Berlin,1918), quoted in Forrester, 148149.
19
breakdowns of profitability (Steel works and collieries). The income statement should
total revenues, operating expenses broken out by cost of production and administrative
expenses, followed by financial costs and other income and expense. These were very
modern statements indeed. Most telling, however, was PW’s comments about Phoenix’s
accounting records. While complementing the financial staff for its help in preparing the
statements and improving the accounting system, PW wrote:
The Company’s accounting System as it present operated, is
however, not suited to the production of Earnings Statements on the lines
of those presented herewith, and consequently, a very considerable
amount of time was required both for their production and for their
verification. …
Special difficulty was experienced during the investigation in
segregating the purely operating figures from transfers to and from
Reserves, and other items of a Non-Operating nature, and generally the
book results have been obscured by reason of unscientific Works
Accounting.44
As a consequence, PW claimed that it could not provide more relevant information.
As late as 1934, the published accounts of Vereinigte Stahlwerke, audited by
Price Waterhouse and reputed to be one of the most modern companies in Germany,
contained very few aspects of modern financial reporting.
Although most of the
companies that went into the giant merger –for example, August Thyssen Hütte,
Gelsenkirchener Bergwerks, and Dortmund-Hoerder Hüttenverein – had their
contributions to land, machinery, factory, and patent accounts delineated, it is not clear
whether or on what basis a full consolidation was done. Total revenues, cost of goods,
and operating expense for the year were not provided. Little comparative and segment
information can be found, making assessment of how the firm made its money,
impossible to determine for anyone who was not an insider.45
In 1932, soon after the expansion of audit requirements and the founding of a
united accounting professional organization, accountants established a journal, in which
they began to address systematically their own history and accounting issues that were
vital to understanding the value of equity. The author of the first introductory article
43
Ibid.
Price Waterhouse report to Phoenix, February 13, 1926.
45
Vereinigte Stahlwerke A.-G. 1933/34 Annual Report, Phoenix-Rheinrohr Archiv. R1 40 35.1 Se.2
44
20
acknowledged that German accountancy was
behind
the English
Chartered
Accountants.46
In the second issue, one article outlined the elements of income and expense
calculation in accordance with the new commercial law. Although the article praised the
new law for its new categorization of revenues and expenses, the author admitted that the
law ignored important issues about production and other overheads, concluding that the
regulations are only sufficient for the simplest of firms. But he himself neglected many
issues that a modern reader would expect to see.
First, there was no theoretical
discussion of why certain items should be included and others not. Second, as he
admitted, there was nothing in the law about how the numbers should be presented.
While large American companies like Anaconda, Bethlehem Steel, and American
Telephone and Telegraph began income statements with revenues and moved through
operating expenses and then other charges, German companies at this time were listing
only gross profit and charges categorized by time of expenses. Neither the law nor his
article made any effort to remedy this. Lastly, he did not discuss how cartel payments
should be included income.47 Several later articles discussed the failings of the code to
define more clearly certain kinds of tricky expenses; none proposed principles for doing
so, none addressed the issue of inter-cartel payments, and only one the booking of and the
reporting of sales.
In the same issue, the question of Stille Reserven (hidden or silent reserves) was
addressed. The subject of hidden reserves played an important role in the debates about
corporate reforms. Nevertheless, the new law was silent about to what extent companies
could book silent reserves that potentially could be used to manipulate profits and were
hidden from shareholders in order to reduce demands for higher dividends. Thus the
practice of booking hidden reserves was based on the long-standing notion that assets and
capital values should be based on management’s judgment of what dividends they would
generate with a high degree of certainty. Although the author believed that hidden
reserves were necessary, he bemoaned the new law’s failure to set limits on their use.
Acknowledging the arbitrariness of hidden reserves, he proposed no principles for their
46
Dr. Bernhard Brockhage, Geleitwort, Der Wirtschaftsprüfer, January 1932, I, No.1.
21
use other than they should be booked in special accounts and appear as extraordinary
items in the income statement, which would make them more transparent to shareholders
and less capable of manipulating earnings.48
Other articles over the following months discussed such critical questions for
German accountancy as consolidation, the relationship between public, statutory financial
statements (Handelsbilanz) and tax filings, and the proposed creation of a mandatory
chart of accounts.
The profession also bemoaned its frailty compared with its
counterparts in other countries. Dr. Fritz Mezger wrote in May, 1932: “In English
speaking countries yearly audits are not demanded by the State.” In those countries, the
stock markets and economic actors themselves recognized the importance of regular
audits. For a hundred years, English auditors have played an important role; in the
United States, their role dramatically increased after World War I.
In both those
countries a huge literature was developed about both audit and accounting principles,
from which German accountants could learn a lot.49 The German profession seemed to
recognize also that part of the cause of its weakness lay in the weakness of capital
markets. In an article in that same issue, it was reported that German investment in
securities as a percentage of national wealth was substantially below that in England and
the United States. What was never addressed directly, however, was the exclusion of
professional accountants from the process of creating accounting rules, an activity still
restricted to government bureaucrats.
Accounting rules in the United States, not without criticism, were formulated by
accountants. The criticism of capital markets that accompanied the Crash and Depression
brought government into the rule-making process for the first time, but with an approach
that still relied heavily on the accounting profession.
The Securities Act of 1933
mandated severe penalties for misstatement of fact in financial statements and
empowered the newly-created Securities and Exchange Commission (SEC) to create
regulations for publicly traded companies. Although the accounting profession feared the
Dr. Otto Keinzle, “Die Gewinn- und Verlustrechnung nach dem geänderten Handelsgesetz,” Der
Wirtschaftspüfer, January 1932, No. 2.
48
Dr. Alfred Weiß, “Stille Reserven und ihre Auflösung nach der Aktienrechtsvovelle vom 19. September
1931, Der Wirtschaftspüfer, January 1932, No. 2.
49
Dr. Fritz Mezger, “Die amerikanischen Accountants und der deutsche Wirtschaftsprüfer,” Der
Wirtschaftsprüfer, May, 1932, Nr.10.
47
22
new sanctions and powers of the state, leaders of the SEC wisely convinced the
profession to draft new accounting principles that had, through the SEC, the force of law,
thereby, giving them independence from the corporate masters. Quickly, the American
Institute of Accountants organized itself to create rules that would provide regulators with
the transparency, consistency, and economic reasonability that they felt market makers
needed to avoid the follies of the 1920s.50
Within a few years, the SEC in close
cooperation with the profession started issuing Accounting Research Bulletins (ARBs)
about the reporting of sales, matching expenses, consolidation, the valuation of assets, the
recording of liabilities, that would become the backbone of American accounting and
audit procedures.51
Like the requirements for the organization and powers of boards of directors and
the frequency and powers of shareholders meetings, accounting rules in Germany were
vague and established by – actually incorporated into – federal Corporation Law
(Aktiengesetz), first in 1870 and then amended several times (prior to World War Two in
1884, 1897, 1931, 1937) and to some extent embellished in the Commercial Codes
(Allgemeine Deutsches Handelsgetzbücher). With the removal of state permission for
creating a joint stock company in 1870 – the boom in the formation of new companies
(from 1870 to 1873 the number of public companies grew from 203 to 843) was quickly
followed by a stock market panic in 1873 – the necessity of outside audits was
recognized by many, but the responsibility for the oversight of financial reports was
given to the Aufsichtsrat (Supervisory Board, or outside directors), which was expected
to a large extent to use “good judgment” in determining what information to give
shareholders and how to test the veracity of information provided by the Vorstand (Inside
Directors).
Despite the Crash of 1873 and the ill feeling it caused toward equity
investment, there was little change in the nature of accounting rules and the powers of
auditors until the 1930s.52 As mentioned, although banks supported new legislation
calling for mandatory audits of public companies, until the 1930s audits by external
50
Thomas McCraw, Prophets of Regulation (Cambridge: Mass.: Belknap Press, 1984)189-192.
See discussions of Accounting Research Bulletins (ARBs), Jan R. Williams, GAAP Guide (New York:
Harcourt Inc., 2000)
52
Reiner Quick, “Die Entstehungsgeschichte der Aktienrechtlichen Pflichtprüfung in Deutschland,”
Zeitschrift für Unternehmensgeschichte, 1990, Nr.1.
51
23
examiners were less frequent than in the United States and England, and usually
associated with fears that the company was already insolvent.
Much of the pressure for outside audits came from foreign investors and was
associated with foreign intrusions that had unwelcome political and economic
consequences.
Some of the conflicts involved challenges to the German corporate
governance system and provided a foreshadowing of attacks on globalization and
economic imperialism. With German assets appearing cheap during the inflation period
and the only source of capital for Germany coming from that country’s recent foes, many
Germans during the 1920s were desperately afraid that the jewels of German industry
would be sold to hostile, greedy foreigners. Although it was not clear that foreign
political or business leaders were really interested in sizeable equity investments in
Germany after World War I, Germany’s desperate capital needs coupled with a fear of
being overwhelmed by foreign buyers of German assets (Überfremdung) was one of the
many hot buttons of German politics and economics during the 1920s and early 30s.53 As
the president of one company that tried to avoid being taken over by a foreign firms
wrote as early as 1919 about the risk of Germany losing control of its economy, “The
greatest possible participation of German firms in sale of German assets was beyond
question in the general German interest.”54
Moreover, many investors demanded changes in the structure and nature of
German boards. They doubted the capacity of the Aufsichtsräter, dominated by banks, to
adequately oversee companies. Even with the influx of American capital, there was little
enthusiasm for German equity in the 1920s. Despite high payout ratios, share prices in
1926 were only 10 percent above their lows in 1924.
Most sectors were already
significantly below their 1928 highs when the Crash came in New York in October
1929.55 Many critics had been calling for clearer accounting standards to better assess
the value of assets and the quality of earnings.
As The Economist pessimistically
Gerald D. Feldman, “Foreign penetration of German enterprises after the First World War: the problem
of Überfremdung,” in Historical Studies in International Corporate Business, eds. Alice Teichova, et al.
Cambridge: Cambridge University Press, 1989) pp. 87-111.
54
Otto Antrick, General Manager, Chemische Fabrik (Vormals. E. Schering) Memo to file, December 11,
1919, SchA B2/122.
55
Volker Berghahn, Modern Germany (Cambridge: Cambridge University Press, 1989) 286-287.
53
24
concluded on the eve of the Crash in New York about Germany’s efforts to reform its
corporate governance,
On the whole, the outlook should be regarded as very uncertain.
The suggested reforms, if carried through, might make for greater activity,
but could scarcely be expected to influence upward or downward
movements in prices.56
Many American and English investors were only willing to lend money to companies that
had outside audits.57
Doubts about the reliability of German accounts and controls were reinforced by
several scandals with failed firms and accounting irregularities, even during the heydays
of the 1920s. In August 1929 – two months before the crash in New York – of the
Frankfurter
Allgemeinen
Versicherung-Aktien-Gesellschaft
(FAVAG),
one
of
Germany’s largest and most respected financial institutions, whose board included
representatives of the leading banks in Germany, collapsed. Two months before, at
FAVAG’s annual meeting, shareholders had been presented accounting statements with a
profit of 3.1 million RM and a dividend on the nominal value of shares of 12.5%.
Although members of the Vorstand went to jail, blame was laid squarely on lax
accounting rules and audit requirements.58
Ostensibly because of the higher professional standards of the English and
American firms, investors preferred non-German firms for audits, creating economic
pressures and resentment among German accountants, which further exacerbating
resentment of foreigners and led to economic hardship, especially for young accountants
entering the profession during the Depression.59
This may help explain why the accounting profession adapted itself so quickly to
National Socialism assumption of power on January 30, 1933. Criticisms of audit and
accounting standards, as well as conflicts between sole practitioners and larger firms,
contributed to the creation of the Institut der Wirtschaftsprüfer in February 15, 1932. Its
membership consisted of individual auditors and auditing companies. Within 18 months,
56
The Economist, October 19, 1929, 721.
Quick, 228.
58
Quick, 229.
57
25
the Institut, like many similar organizations in other professions, was transformed into an
arm of National Socialist polices.60 In some sense, the Machtergreifung (Nazi Seizure of
Power) did much for the profession. In the spring of 1933, ostensibly to quell disputes
among members about the policies of the Institut (even among some members of the
party), the Reichsministry of Economics established the Institut as the sole recognized
and authorative professional organization for auditors and began taking steps to create
statutes for the Institut that would be based on the Führerprinzip (Leadership Principle)
and to make membership in the Institut obligatory for all auditors.
The Institut’s last meeting free of Nazi-ideology was in late February 1933. A
week later the Reichstag was burned and the Enabling Act gave the new government
extraordinary powers.
The accounting association succumbed to party pressure for
Gleichschaltung, the process of bringing all phases of national life under party control,
faster than most other professions and big business. On April 3, 1933 the leaders of the
accounting profession expressed their support for the new government and announced
that three recently-elected Jewish members of the Institut’s Council, would resign. All
the Jewish members of the Admissions and Examinations Committees were asked to
resign.
Within a few months, they had been replaced by staunch Nazis. The Council
took an active role in quelling the anti-German feeling that Jewish pogroms had
stimulated with professional groups outside Germany.
In order to speed up
Gleichschaltung, the Council established a working committee, made up of long-time
party members to oversee the party’s adaptation to party expectations. Not only did the
working group recommend that Jews no longer be included in the profession, it also
pushed for more auditing requirements for companies. With at least one of these goals,
the committee was relatively successful. From January 30, 1933 to the end of the Third
Reich, only six Jews were admitted to the profession (there were a total of 432 new
admissions in 1933 alone), and they were front line soldiers or children of soldiers who
had died in World War I. By May 29, 1933, the accounting Institut joined the Bund of
National Sozialistischer Deutscher Juristen (The Federation of National Socialist
German Lawyers, BNSDJ), a Nazi umbrella organization for judges, lawyers, notaries,
59
60
Markus, 14-15, 53.
Markus, 50.
26
senior tax inspectors, economists and business economists.
It also recommended that its
members join as individuals. Nevertheless, it fought successfully to keep the Institut as
an independent body, which helped the stature of the profession after the war. 61 For this
compliance, audit requirements were extended to more and more companies
The Institut elected a new president in June of 1933, one of the few members who
had actually joined the party before January 1933.62 By May, 1934, nearly 40 percent of
all the Institut’s members were also members of the party, one of its affiliate
organizations, or the right-wing group Stahlhelm.63
Many Jewish accountants and
lawyers were forced to give up their professions. The lucky ones fled. In March 1933,
Schmalenbach himself was forced to retire from his teaching post and eventually left
Germany before the war.64
By the mid-thirties, German accountants were playing a vital role in government
efforts to keep tighter control on companies, especially in their pricing and investment
decisions. A detailed chart of accountants was established to enhance auditors’ ability to
verify that entries were correctly made and classified. By January 1936, the accounting
profession’s main journal had changed its name to Der Wirtschaftstreuhänder (The
Economy Trustee) and was espousing Nazi doctrines. Although accountants were still
not determining accounting principles, in the lead article, ironically entitled, “The
Independent Auditor,” the journal praised the accountants’ newly found role within the
Third Reich. It stressed that auditors should not serve capitalist stockholders and bank
interests. Rather,
The audit today is a fundamental part of the new economic vision of
National Socialism. Audit standards can only develop from the principles
of National Socialism.65
61
Markus, 83-93. Markus delineates the ideological positions taken by the Institut in support of the new
regime between 1934 and 1937, and the Jews who were expelled from the Institut.
62
Markus, 64-70.
63
Markus, 78. It should be noted that only 10 of the 167 party members had joined before January 30,
1933. Roughly nine percent of the Institut’s members were Jewish as of this date (nearly half of these had
served on the front line in World War I). These statistics should not be misinterpreted. Although 16
percent of Germany’s lawyers were Jewish, they could only practice their profession with severe
constraints. See Saul Friedländer, Nazi Germany & the Jews (London: Phoenix, 1997) 29.
64
Potthoff, p. 142.
65
Dr. Otto Mönckmeier, Der Wirtschaftstreuhändler, January 1936, Vol. 5., No. 1, 1.
27
IV. Conclusion.
The basic contours of the German accounting system were carried forward into
the post-World War Two period. These included a strong influence from tax law, a
multitude of options and valuation methods, the opportunity to control net income with
silent reserves, a lack of full consolidation, and an accounting profession that, unlike in
the United States and Great Britain, was not the main standard setting body. In 1937,
Germany established a uniform chart of accounts for industry segments (Richtlinien zur
Organisation der Buchführung), which with amendments is still required of German
companies.66
Until 1985, German commercial law and tax rules supplemented by
accounting practice governed how corporate accounts were presented.67 Most accounting
rules are proscribed by the Commercial Code (Handelsgesetzbuch, HGB) and although
membership in the Chamber of Accountants is required, only 80% of the 7,800
Wirtschaftsprüfer in Germany belong to the Institut.68
The last two decades has witnessed many changes in German accounting. In
1986, German companies were forced to have full consolidation for the first time. In the
early 90s, in search of equity capital, many of Germany’s most prestigious companies
shocked the German business world by listing on American stock exchanges and
preparing their financial statements in accordance with US GAAP. Under pressure from
the European Union, companies are adopting more open financial accounting standards,
including International Accounting Standards Committee (IASC). Though the IASC has
no direct way of enforcing its rules, over the last decade, it has had a noticeable impact
on German accounting rules and on several of the European Directives (1983), especially
number seven, which calls from more Anglo-Saxon consolidation rules.
Full
consolidation along the lines of a compromise between the older parent company
concept, which basically allowed subsidiaries to be treated on a cost basis, and the entity
concept, full consolidation, was finally implemented in Germany in 1990.69
Nevertheless, German professionals are still highly influenced by the accounting
theories of Herman Veit Simon (statistical theory), Eugen Schmalenbach (dynamic
66
Gottfried Bähr and Wolf F. Fischer-Winkelmann (Wiesbaden: Gabler, 1998) 5.
Christopher Nobes and Robert Parker, Comparative International Accounting (London: Prentice Hall,
1998) 221-223.
68
Nobes and Parker, 224.
67
28
theory), and Fritz Schmidt (organic theory), which emphasized that the primary mission
of accounting was to accurately record asset values and owner’s equity, and that
accounting records should somehow interpret the economic significance of what had
occurred to the enterprise. None of these men were professional accountants and their
principles are very hard to operationalize for the profession. The creation of accounting
principles and rules in Germany have never evolved out of professional experience and
are not directed by professional bodies.70 Despite the internationalization of accounting,
most small- and medium-sized companies in Germany still use the German accounting
standards.
The role of equity markets in the German economy remains relatively weak
compared with that in England and the United States.71 There is no definitive answer as
to why German accounting took the path it did in the inter-war years and why the
accounting profession remained relatively weak. But if my hypothesis is correct about
the role of equity in Germany as an explanatory factor, the question remains: What in
German history might account for the reduction in the importance of equity financing?
There are several plausible explanatory factors that go beyond evoking the role of large
banks in German corporate governance.
First, Germans have a long tradition of
discomfort with capital markets that was reinforced early on by the Panic of 1873.
Second, the nationalization of the German railroads in the late 1870s and 1880s removed
a major industrial sector from equity markets. Third, the cartelization movement that
began during the end of the 19th and continued in the 20th reduced the need for equity
transaction in the consolidation of industry as it had in the United States. Fourth, the
inflation that followed World War I was perceived to have an adverse impact on equity
shareholders. Finally, in the aftermath of World War I, liberalizing equity investment
was associated with the risk of foreign investors “buying up” German and, therefore,
clashed with national passions.
69
70
Nobes and Parker, 310-311.
Jörg Baetge, Hans-Jürgen Kirch, Stefan Theil, Bilanzen (Düsseldorf: IDW-Verlag, 2001)12-25.
29
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In 1998, the market capitalization of equities in the United States was approximately 120% of that
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