Accounting Conventions and StandardsStandard-Setting Groups FAS.docx

Accounting Conventions and Standards
Standard-Setting Groups: FASB, SEC, AICPA
There are three main organizations whose work in supporting
certified public accountants (CPAs) and upholding standard
accounting practices are inextricably linked with the careers of
professionals in this field:
· The Financial Accounting Standards Board (FASB) is a
private, nonprofit organization whose primary purpose is to
develop generally accepted accounting principles (GAAP)
within the United States in the public’s interest.
· The US Securities and Exchange Commission (SEC) is a
federal agency that holds primary responsibility for enforcing
the federal securities laws and regulating the securities
industry, the nation’s stock and options exchanges, and other
electronic securities markets in the United States.
· Founded in 1887, the American Institute of Certified Public
Accountants (AICPA) is a professional organization of CPAs in
the United States. The AICPA has nearly 386,000 CPA members
in 128 countries in business and industry, public practice,
government, education, student affiliates and international
associates.
The Financial Accounting Standards Board (FASB)
The Financial Accounting Standards Board (FASB) is a private,
nonprofit organization whose primary purpose is to develop
generally accepted accounting principles (GAAP) within the
United States in the public’s interest.
Under the direction of the SEC, the Committee on Accounting
Procedure was created by the AICPA in 1939. It was the first
private-sector organization that had the task of setting
accounting standards in the United States. In 1959, the
Accounting Principles Board (APB) was formed to meet the
demand for more structured accounting standards. The APB
issued pronouncements on accounting principles until 1973,
when it was replaced by the Financial Accounting Standards

Board (FASB). The APB was disbanded in the hopes that the
smaller, fully independent FASB could more effectively create
accounting standards. The APB and the related SEC were unable
to operate completely independently of the US government.
The FASB’s mission is to establish and improve standards of
financial accounting and reporting for the guidance and
education of the public, including issuers, auditors, and users of
financial information.
To achieve this mission, FASB has five goals:
1. Improve the usefulness of financial reporting by focusing on
the primary characteristics of relevance, reliability,
comparability, and consistency.
2. Keep standards current to reflect changes in methods of doing
business and in the economy.
3. Consider promptly any significant areas of deficiency in
financial reporting that might be improved through standard
setting.
4. Promote international convergence of accounting standards
concurrent with improving the quality of financial reporting.
5. Improve common understanding of the nature and purposes of
information in financial reports.
The FASB sets standards based on their conceptual framework.
In addition, they offer guidance on how to implement these
standards, but they do not monitor companies for violations of
the financial reporting standards. That is left to the SEC.
The US Securities and Exchange Commission (SEC)
The US Securities and Exchange Commission (SEC) is a federal
agency that holds the primary responsibility for enforcing the
federal securities laws and regulating the securities industry,
the nation’s stock and options exchanges, and other electronic
securities markets in the United States. The SEC was created by
Section 4 of the Securities Exchange Act of 1934 (now codified
as 15 U.S.C. § 78d and commonly referred to as the 1934 Act).
The SEC was established by President Franklin D. Roosevelt in
1934 as an independent, quasi-judicial regulatory agency during
the Great Depression. The main reason for the creation of the

SEC was to regulate the stock market and prevent corporate
abuses relating to the offering and sale of securities and
corporate reporting. The SEC was given the power to license
and regulate stock exchanges, the companies whose securities
were traded on exchanges, and the brokers and dealers who
conducted the trading.
Currently, the SEC is responsible for administering seven major
laws that govern the securities industry:
1. The Securities Act of 1933
2. The Securities Exchange Act of 1934
3. The Trust Indenture Act of 1939
4. The Investment Company Act of 1940
5. The Investment Advisers Act of 1940
6. The Sarbanes–Oxley Act of 2002
7. The Credit Rating Agency Reform Act of 2006
The enforcement authority given by Congress allows the SEC to
bring civil enforcement actions against individuals or
companies alleged to have committed accounting fraud,
provided false information, or engaged in insider trading or
other violations of the securities law. The SEC also works with
criminal law enforcement agencies to prosecute individuals and
companies alike for offenses that include a criminal violation.
To achieve its mandate, the SEC enforces the statutory
requirement that public companies submit periodic reports.
Quarterly and biannual reports from public companies are
crucial for investors to make sound decisions in the capital
markets.
The American Institute of Certified Public Accountants
(AICPA)
Founded in 1887, the American Institute of Certified Public
Accountants (AICPA) is the national professional organization
of CPAs in the United States. The AICPA has nearly 386,000
CPA members in 128 countries in business and industry, public
practice, government, education, student affiliates and
international associates. It sets ethical standards for the
profession and US auditing standards for audits of private

companies, nonprofit organizations, and federal, state, and local
governments. It also develops and grades the Uniform CPA
Examination.
The AICPA’s founding established accountancy as a profession
distinguished by rigorous educational requirements, high
professional standards, a strict code of professional ethics, and
a commitment to serving the public interest. While the AICPA
sets the professional standards for the professional conduct of
accountants, it plays no role in setting the standards for
financial accounting.
Generally Accepted Accounting Principles (GAAP)
Generally Accepted Accounting Principles (GAAP) is the
standard framework for financial accounting used in any given
jurisdiction.
GAAP refers to the standard framework of guidelines for
financial accounting used in any given jurisdiction; generally
known as accounting standards. GAAP includes the standards,
conventions, and rules accountants follow in recording and
summarizing accounting transactions and in the preparation of
financial statements.
GAAP is a codification of how CPA firms and corporations
prepare and present their business income and expense, assets,
and liabilities in their financial statements. GAAP is not a
single accounting rule, but rather an aggregate of many rules on
how to account for various transactions.
Like many other common-law countries, the United States
government does not directly set accounting standards by
statute. However, the US Securities and Exchange Commission
(SEC) requires that US GAAP be followed in financial reporting
by publicly traded companies. Currently, FASB establishes
generally accepted accounting principles for public and private
companies, as well as for nonprofit organizations.
History
Historically, accounting standards have been set by the AICPA
subject to Securities and Exchange Commission regulations.
The AICPA first created the Committee on Accounting

Procedure in 1939, and replaced it with the Accounting
Principles Board in 1951.
In 1973, the Accounting Principles Board was replaced by the
FASB under the supervision of the Financial Accounting
Foundation with the Financial Accounting Standards Advisory
Council serving to advise and provide input on the accounting
standards.
Circa 2008, the FASB issued the FASB Accounting Standards
Codification, which reorganized the thousands of US GAAP
pronouncements into roughly 90 accounting topics. In 2008, the
SEC issued a preliminary roadmap that may lead the US to
abandon GAAP in the future and to join more than 100
countries around the world already using the London-based
International Financial Reporting Standards (IFRS).
As of 2010, the convergence project was underway with the
FASB meeting routinely with the International Accounting
Standards Board (IASB). The SEC expressed its resolve to fully
adopt IFRS in the US by 2014. As the highest authority over
IFRS, the IASB is becoming more important in the US.
The table below demonstrates the differences in accounting
standards between GAAP and IFRS regarding classifying cash
flows.
GAAP vs. IFRS Cash Flow Classification
Transaction US GAAP
Classification
IFRS Classification
Interest received
Operating
Operating or investing
Dividends received
Operating
Operating or investing
Interest paid
Operating
Financing or operating
Dividends paid

Financing
Financing or operating
Income taxes
Operating
Operating unless specifically associated with financing or
investing activity
Basic Objectives
Financial reporting should provide information that satisfies the
following criteria:
· useful to present to potential investors and creditors and other
users in making rational investment, credit, and other financial
decisions
· helpful to present to potential investors and creditors and
other users in assessing the amounts, timing, and uncertainty of
prospective cash receipts
· about economic resources, the claims to those resources, and
the changes in them helpful for making financial decisions
· helpful in making long-term decisions
· helpful in improving the performance of the business
· useful in maintaining records
Four Basic Assumptions
GAAP are established on the following four basic assumptions:
1. accounting entity—Assumes that the business is separate
from its owners or other businesses. Revenue and expense
should be kept separate from personal expenses.
2. going concern—Assumes that the business will be in
operation indefinitely. This validates the methods of asset
capitalization, depreciation, and amortization. In cases when
liquidation is certain, this assumption is not applicable. The
business will continue to exist in the unforeseeable future.
3. monetary unit principle—Assumes a stable currency is going
to be the unit of record. The FASB accepts the nominal value of
the US Dollar as the monetary unit of record unadjusted for
inflation. This is also known at the stable dollar principle.
4. time-period principle—Implies that the economic activities of
an enterprise can be divided into artificial time periods.

Four Basic Principles
Likewise, four basic principles govern GAAP standards:
1. historical cost principle—Requires companies to account and
report based on acquisition costs rather than fair market value
for most assets and liabilities.
2. revenue recognition principle—Requires companies to record
when revenue is (1) realized or realizable and (2) earned, not
when cash is received. Also, under this principle a company
should establish an allowance for bad debt account. This way of
accounting is called accrual based accounting.
3. matching principle—Expenses have to be matched with
revenues as long as it is reasonable to do so. Expenses are
recognized not when the work is performed, or when a product
is produced, but when the work or the product actually makes
its contribution to revenue. Only if no connection with revenue
can be established, cost may be charged as expenses to the
current period (e.g., office salaries and other administrative
expenses).
4. full disclosure principle—Amount and kinds of information
disclosed should be decided based on trade-off analysis as a
larger amount of information costs more to prepare and use.
Information disclosed should be enough to make a judgment
while keeping costs reasonable. Information is presented in the
main body of financial statements, in the notes or as
supplementary information.
Note that the historical cost and the matching principle are
slowly disappearing, having been replaced by FASB No. 157,
which requires companies to classify assets based on fair value.
Five Basic Constraints
The five basic constraints surrounding GAAP reporting are as
follows:
1. objectivity principle—The company financial statements
provided by the accountants should be based on objective
evidence.
2. materiality principle—The significance of an item should be
considered when it is reported.

3. consistency principle—The company uses the same
accounting principles and methods from year to year.
4. conservatism principle—When choosing between two
solutions, the one that will be least likely to overstate assets and
income should be picked.
5. cost-benefit relationship—The company considers the costs
necessary to prepare the information and what benefit users will
get from it.
International Financial Reporting Standards (IFRS)
The International Financial Reporting Standards (IFRS) is a
common global financial language for business affairs that is
understandable and comparable across international boundaries.
Many countries use or are moving toward using the IFRS, which
were established and maintained by the IASB. In some
countries, local accounting principles are applied for regular
companies, but listed or larger companies must conform to the
IFRS, so statutory reporting is comparable internationally,
across jurisdictions.
The IFRS: History and Purpose
The IFRS is designed as a common global language for business
affairs so that company accounts are understandable and
comparable across international boundaries. They are a
consequence of growing international shareholding and trade.
The IFRS is particularly important for companies that have
dealings in several countries. They are progressively replacing
the many different national accounting standards.
The IFRS began as an attempt to harmonize accounting across
the European Union, but the value of harmonization quickly
made the concept attractive around the world. They are
occasionally called by the original name International
Accounting Standards (IAS). The IAS were issued between 1973
and 2001 by the Board of the International Accounting
Standards Committee (IASC). On April 1, 2001, the new IASB
took over the responsibility for setting International Accounting
Standards from the IASC. During its first meeting the new
board adopted existing IAS and Standing Interpretations

Committee standards (SICs). The IASB has continued to
develop standards, calling the new standards the IFRS.
Framework
The Conceptual Framework for Financial Reporting states the
basic principles for IFRS. The IASB and FASB frameworks are
in the process of being updated and converged. The Joint
Conceptual Framework project intends to update and refine the
existing concepts to reflect the changes in markets and business
practices. The project also intends to consider the changes in
the economic environment that have occurred in the two or more
decades since the concepts were first developed.
A financial statement should reflect a true and fair view of the
business affairs of the organization. As these statements are
used by various constituents of the society and regulators, they
need to reflect an accurate view of the financial position of the
organization. It is very helpful to check the financial position of
the business for a specific period.
Accounting Models and Assumptions
The IFRS are based on three basic accounting models as well as
three underlying assumptions. The accounting models are as
follows:
1. Current cost accounting, under physical capital maintenance
at all levels of inflation and deflation under the historical cost
paradigm as well as the capital maintenance in units of constant
purchasing power paradigm
2. Financial capital maintenance in nominal monetary units
(i.e., globally implemented historical cost accounting during
low inflation and deflation only under the traditional historical
cost paradigm)
3. Financial capital maintenance in units of constant purchasing
power (i.e., constant item purchasing power accounting [CIPPA]
in terms of a daily consumer price index or daily rate at all
levels of inflation and deflation under the capital maintenance
in units of constant purchasing power paradigm and constant
purchasing power accounting (CIPPA) during hyperinflation
under the historical cost paradigm.

The three basic assumptions are detailed below:
1. going concern—For the foreseeable future, an entity will
continue under the historical cost paradigm as well as under the
capital maintenance in units of constant purchasing power
paradigm
2. stable measuring unit assumption—financial capital
maintenance in nominal monetary units or traditional historical
cost accounting only under the traditional historical cost
paradigm
3. units of constant purchasing power—capital maintenance in
units of constant purchasing power at all levels of inflation and
deflation in terms of a daily consumer price index or daily rate
only under the capital maintenance in units of constant
purchasing power paradigm
Differences Between GAAP and IFRS and Implications of
Potential Convergence
A major difference between GAAP and IFRS is that GAAP is
rule based, whereas IFRS is principle based.
Principles Based vs. Rules Based
With a principle-based framework, there is the potential for
different interpretations of similar transactions, which could
lead to extensive disclosures in the financial statements.
Although, the standards-setting board in a principle-based
system can clarify areas that are unclear. This could lead to
fewer exceptions than a rules-based system.
Another difference between IFRS and GAAP is the methodology
used to assess an accounting treatment. Under GAAP, the
research is more focused on the literature, whereas under IFRS,
the review of the fact pattern is more thorough.
The following list shows a few examples of the differences
between IFRS and US GAAP:
· consolidation—IFRS favors a control model whereas GAAP
prefers a risks-and-rewards model. Some entities consolidated
in accordance with FIN 46(R) may have to be shown separately
under IFRS.
· statement of income—Under IFRS, extraordinary items are not

segregated in the income statement. With GAAP, they are
shown below the net income.
· inventory—Under IFRS, last in, first out (LIFO) cannot be
used, but GAAP, companies have the choice between LIFO and
first in, first out (FIFO).
· earning per share—Under IFRS, the earning-per-share
calculation does not average the individual interim period
calculations, whereas under GAAP the computation averages the
individual interim period incremental shares.
· development costs—These costs can be capitalized under IFRS
if certain criteria are met, while it is considered as expenses
under US GAAP.
Convergence
The convergence of accounting standards refers to the goal of
establishing a single set of accounting standards that will be
used internationally, and in particular the effort to reduce the
differences between the US GAAP and the IFRS. Convergence
in some form has been taking place for several decades, and
efforts today include projects that aim to reduce the differences
between accounting standards.
The goal of and various proposed steps to achieve convergence
of accounting standards has been criticized by various
individuals and organizations. For example, in 2006, senior
partners at PricewaterhouseCoopers (PwC) called for
convergence to be “shelved indefinitely” in a draft paper,
calling for the IASB to focus instead on improving its own set
of standards.
Convergence is also taking place in other countries, with all
major economies planning to either adopt the IFRS or converge
towards it. For example, Canada required all listed entities to
use the IFRS from January 1, 2012, and Japan permitted the use
of IFRS for certain multinational companies from 2010, and is
expected to make a decision on mandatory adoption.
Implications of Potential Convergence
The growing acceptance of International Financial Reporting
Standards (IFRS) as a basis for US financial reporting

represents a fundamental change for the US accounting
profession. Today, approximately 113 countries require or allow
the use of IFRS for the preparation of financial statements by
publicly held companies. In the United States, SEC has been
taking steps to set a date to allow US public companies to use
IFRS and perhaps make its adoption mandatory.
Full-Disclosure Principle
The full disclosure principle states information important
enough to influence decisions of an informed user should be
disclosed.
Principle of Full Disclosure
The full disclosure principle states that information important
enough to influence the decisions of an informed user of the
financial statements should be disclosed. Depending on its
nature, companies should disclose this information either in the
financial statements, in notes to the financial statements, or in
supplemental statements. In judging whether or not to disclose
information, it is better to err on the side of too much disclosure
rather than too little. Many lawsuits against CPAs and their
clients have resulted from inadequate or misleading disclosure
of the underlying facts.
A good rule to follow is, if in doubt, disclose. Another good
rule is, if you are not consistent, disclose all the facts and the
effect on income.
To be free from bias, information must be sufficiently complete
to ensure that it validly represents underlying events and
conditions. Completeness means disclosing all significant
information in a way that aids understanding and does not
mislead. Firms can reduce the relevance of information by
omitting information that would make a difference to users.
Required disclosures may be made in (1) the body of the
financial statements, (2) the notes to such statements, (3)
special communications, or (4) the president’s letter or other
management reports in the annual report. Another aspect of
completeness is fully disclosing all changes in accounting
principles and their effects.

Importance of Full Disclosure Principle: Subject to Audit
As an accountant, the full disclosure principle is important
because the notes to the financial statements and other financial
documents are subject to audit. To obtain an unqualified (or
clean) opinion, one must have an intrinsic understanding of the
full disclosure principle to insure sufficient information for an
unqualified opinion on the financial audit.
An opinion is said to be unqualified when the auditor concludes
that the financial statements give a true and fair view in
accordance with the financial reporting framework used for the
preparation and presentation of the financial statements. An
auditor gives a clean opinion or unqualified opinion when he or
she does not have any significant reservation in respect to
matters contained in the financial statements.
An unqualified opinion is given under the following
circumstances:
1. The financial statements have been prepared using the
generally accepted accounting principles which have been
consistently applied.
2. There is adequate disclosure of all material matters relevant
to the proper presentation of the financial information subject to
statutory requirements, where applicable.
3. Any changes in the accounting principles or in the method of
their application and the effects thereof have been properly
determined and disclosed in the financial statements.
The Disclosure Process
The process of disclosing financial statements is carried out
through what is known as a Form 10-K. This is an annual report
required by the SEC that gives a comprehensive summary of a
company’s performance. Although similarly named, the annual
report on Form 10-K is distinct from the often glossy annual
report to shareholders, which a company must send to its
shareholders when it holds an annual meeting to elect directors
(though some companies combine the annual report and the 10-
K into one document). The 10-K includes information such as
company history, organizational structure, executive

compensation, equity, subsidiaries, and audited financial
statements, among other information.
In addition to the 10-K, which is filed annually, a company is
also required to file quarterly reports on Form 10-Q.
Information for the final quarter of a firm’s fiscal year is
included in the annual 10-K, so only three 10-Q filings are
made each year. In the period between these filings, and in case
of a significant event (such as a CEO departing or bankruptcy) a
Form 8-K must be filed in order to provide up-to-date
information.
Filing Deadlines
Historically, a Form 10-K had to be filed with the SEC within
90 days after the end of the company’s fiscal year. However, in
September 2002, the SEC approved a rule that changed the
deadline to 75 days for accelerated filers. Accelerated filers are
issuers that have a public float of at least $75 million, that have
been subject to the Exchange Act’s reporting requirements for
at least 12 calendar months, that previously have filed at least
one annual report, and that are not eligible to file their quarterly
and annual reports on Forms 10-QSB and 10-KSB. These
shortened deadlines were to be phased in over a three-year
period; however, in 2004 the SEC postponed the three-year
phase-in by one year.
In December 2005, the SEC created a third category of large
accelerated filers, which are accelerated filers with a public
float of over $700 million. As of December 27, 2005, the
deadline for filing for large accelerated filers was still 75 days;
however, beginning with the fiscal year ending on or after
December 15, 2006, the deadline is 60 days. For other
accelerated filers, the deadline remains at 75 days, and for
nonaccelerated filers the deadline remains at 90 days.
Structure of a Form 10-K
Every annual report contains four parts and 15 schedules:
Part I
· Item 1. Description of business—This describes the business
of the company, who and what the company does, what

subsidiaries it owns, and what markets it operates in. It may
also include recent events, competition, regulations, and labor
issues. Other topics in this section may include special
operating costs, seasonal factors, or insurance matters.
· Item 1A. Risk factor—Here, the company lays out anything
that could go wrong, likely external effects, possible future
failures to meet obligations, and other risks in order to
adequately warn investors and potential investors.
· Item 1B. Unresolved staff comments
· Item 2. Description of properties—This section lays out the
significant properties, or physical assets, of the company. This
only includes physical types of property, not intellectual or
intangible property.
· Item 3. Legal proceedings—Here, the company discloses any
significant pending lawsuit or other legal proceeding.
References to these proceedings could also be disclosed in the
Risks section or other parts of the report.
· Item 4. Mine safety disclosures—This section requires some
companies to provide information about mine safety violations
or other regulatory matters.
Part II
· Item 5. Market for registrant’s common equity, related
stockholder matters and issuer purchases of equity securities—
Gives highs and lows of stock in a simple statement.
· Item 6. Selected financial data—This section contains
financial data showing consolidated records for the legal entity
as well as subsidiary companies.
· Item 7. Management’s discussion and analysis of financial
condition and results of operations—Here, management
discusses the operations of the company in detail by usually
comparing the current period versus prior period. These
comparisons provide a reader an overview of the operational
issues of what causes such increases or decreases in the
business.
· Item 7A. Quantitative and qualitative disclosures about market
risk

· Item 8. Financial statements and supplementary data
· Item 9. Changes in and disagreements With accountants on
accounting and financial disclosure
· Item 9A(T). Controls and procedures
· Item 9B. Other information
Part III
· Item 10. Directors, executive officers and corporate
governance
· Item 11. Executive compensation
· Item 12. Security ownership of certain beneficial owners and
management and related stockholder matters
· Item 13. Certain relationships and related transactions, and
director independence
· Item 14. Principal accounting fees and services
Part IV
· Item 15. Exhibits, financial statement schedules, and
signatures
Events Triggering Disclosure
Events that trigger disclosure should be based on an
accountant’s assessment of materiality.
Consistency generally requires that a company use the same
accounting principles and reporting practices through time. This
concept prohibits indiscriminate switching of accounting
principles or methods, such as changing inventory methods
every year. However, consistency does not prohibit a change in
accounting principles if the information needs of financial
statement users are better served by the change. When a
company makes a change in accounting principles, it must make
the following disclosures in the financial statements (in the
Notes to the Financial Statements):
· nature of the change
· reasons for the change
· effect of the change on current net income, if significant
· cumulative effect of the change on past income
Another event that can trigger a disclosure is prior period
adjustments. Events that trigger disclosure should be based on

an accountant’s assessment of materiality, especially when
facing decisions related to the full disclosure principle.
Disclosures will normally include details to materiality
decisions in the notes to financial statements.
Voluntary Disclosure
Voluntary disclosure in accounting is the provision of
information by a company’s management beyond requirements
such as generally accepted accounting principles and SEC rules,
where the information is believed to be relevant to the decision-
making of users of the company’s annual reports.
Voluntary disclosures can include strategic information such as
company characteristics and strategy, nonfinancial information
such socially responsible practices, and financial information
such as stock price information.
FASB classified voluntary disclosures into six categories below:
1. business data—breakdown of market share growth and
information on new products
2. analysis of business data—trend analysis and comparisons
with competitors
3. forward-looking information—sales forecast breakdown and
plans for expansion
4. information about management and shareholders—
information on stockholders and creditors and shareholding
breakdown
5. company background—product description and long-term
objectives
6. information about intangible assets—research and
development and customer relations
Meek, Roberts, and Gray (1995) classified voluntary disclosures
into three major groups: strategic, nonfinancial, and financial
information.
The determinants of the extent and type of voluntary disclosures
of firms have been explored in the financial reporting literature.
Meek, Roberts, and Gray found that the extent and type of
voluntary disclosure differs by geographic region, industry, and
company size, and other research has found that the extent of

voluntary disclosure is affected by the firm’s corporate
governance structure and ownership structure.
Current Issues in Reporting and Disclosure
Accountants must stay up to date with current issues in
reporting and disclosures related to standards set by regulatory
agencies.
Mark-to-Market or Fair Value Accounting
Mark-to-market or fair-value accounting refers to accounting
for the fair value of an asset or liability based on the current
market price, for similar assets and liabilities, or based on
another objectively assessed fair value. Fair value accounting
has been a part of GAAP in the United States since the early
1990s and used increasingly since then.
Mark-to-market accounting can change values on the balance
sheet as market conditions change. In contrast, historical cost
accounting, based on the past transactions, is simpler, more
stable, and easier to perform, but does not reflect current fair
value. Instead, it summarizes past transactions. Mark-to-market
accounting can become inaccurate if market prices change
unpredictably. Buyers and sellers may claim a number of
specific instances when this is the case, including inability to
both accurately and collectively value the future income and
expenses, often due to unreliable information and over
optimistic and over pessimistic expectations.
SFAS No. 157
In September 2006, the US Financial Accounting Standards
Board (FASB) issued Statement of Financial Accounting
Standards 157: Fair Value Measurement, which “defines fair
value, establishes a framework for measuring fair value in
generally accepted accounting principles (GAAP), and expands
disclosures about fair value measurements.” This statement is
effective for financial reporting fiscal periods commencing after
November 15, 2007, and the interim periods applicable.
Fair Value GAAP vs. IFRS
Under GAAP, there is only one measurement model for fair
value (with limited exceptions). GAAP defines fair value as the

price that would be received to sell an asset or paid to transfer a
liability (at the measurement date). Note that fair value is an
exit price, which may differ from the transaction (entry) price.
Various IFRS standards use slightly varying wording to define
fair value. Under IAS 39, fair value is defined as the amount for
which an asset could be exchanged, or a liability settled,
between knowledgeable, willing parties in an arm’s length
transaction. At inception, transaction (entry) price generally is
considered fair value.
Sarbanes-Oxley Act
Following the Enron scandal, changes were made to mark to
market via the Sarbanes-Oxley Act in 2002. Sarbanes-Oxley
affected mark to market by forcing companies to implement
stricter accounting standards. These included more transparency
in financial reporting and stronger internal controls to prevent
and identify fraud and auditor independence. Also, the Public
Company Accounting Oversight Board (PCAOB) was created by
the SEC for the purpose of overseeing audits. This act also
implemented harsher penalties for fraud, such as enhanced
prison sentences and fines for committing fraud. Although the
law was created to restore investor confidence, the cost of
implementing the regulations caused many companies to avoid
registering on US stock exchanges.
Internal Revenue Code Section 475 contains the mark-to-market
accounting method rule for taxation. It provides that qualified
security dealers who elect mark to market treatment shall
recognize gain or loss as if the property were sold for its fair
market value on the last business day of the year, and any gain
or loss shall be taken into account in that year. The section also
provides that commodities dealers can elect mark to market
treatment for any commodity (or their derivatives) which is
actively traded (i.e., for which there is an established financial
market providing a reasonable basis to determine fair market
value by disseminating price quotes from brokers/dealers or
actual prices from recent transactions).
Stock Option Expensing

Stock option expensing is a method of accounting for the value
of share options, distributed as incentives to employees, within
the profit and loss reporting of a listed business. On the income
statement, balance sheet, and cash flow statement it should say
that the loss from the exercise is accounted for by noting the
difference between the market price (if one exists) of the shares
and the cash received, the exercise price, for issuing those
shares through the option.
Opponents of considering options as an expense say that the
real loss—due to the difference between the exercise price and
the market price of the shares—is already stated on the cash
flow statement. They would also point out that a separate loss in
earnings per share (due to the existence of more shares
outstanding) is also recorded on the balance sheet by noting the
dilution of shares outstanding. Simply, accounting for this on
the income statement is believed to be redundant.
Currently, the future appreciation of all shares issued are not
accounted for on the income statement but can be noted upon
examination of the balance sheet and cash flow statement.
The two methods to calculate the expense associated with stock
options are the intrinsic value method and the fair-value
method. Only the fair-value method is currently US GAAP. The
intrinsic value method, associated with Accounting Principles
Board Opinion 25, calculates the intrinsic value as the
difference between the market value of the stock and the
exercise price of the option at the date the option is issued (the
grant date). Since companies generally issue stock options with
exercise prices which are equal to the market price, the expense
under this method is generally zero.
In 2002, another method was suggested—expensing the options
as the difference between the market price and the strike price
when the options are exercised, and not expensing options
which are not exercised, and reflecting the unexercised options
as a liability on the balance sheet. This method, which defers
the expense, also was requested by companies.
FASB has moved against Opinion 25, which left it open to

businesses to monetize options according to their intrinsic
value, rather than their fair value. The preference for fair value
appears to be motivated by its voluntary adoption by several
major listed businesses and the need for a common standard of
accounting.
Governance and Accountability
Who Owns the Corporation? The Legal Debate
Do shareholders own the company? To most people, this idea is
so axiomatic that the question hardly seems worth asking.
However, the long-simmering debate about the age-old
argument over the board's responsibilities to shareholders
versus the rights of all company stakeholders flared up again
recently, drawing attention once again to that central question
(Bernstein, 2008).
In the latest round of this debate, two leading corporate
governance experts—Lucian Bebchuk, Harvard Law School
professor and ardent shareholder-rights proponent, and Martin
Lipton, founding partner of Wachtell, Lipton, Rosen & Katz and
a stalwart defender of the view that management's prerogative is
to act in the best interest of the corporation—squared off in the
pages of the Virginia Law Review (see Bebchuk, 2007, p. 675;
Lipton & Savitt, 2007, p. 733). The central issue in this debate
is whether directors of a public company owe their primary
fiduciary duty to its shareholders, as Bebchuk insists, or if they
have to consider the prerogatives of all the stakeholders, as
Lipton maintains.
Bebchuk (2007) cites a widely quoted 1988 ruling by the
Delaware courts that "the shareholder franchise is the
ideological underpinning upon which the legitimacy of
directorial power rests" and points out that corporate law gives
boards the authority to hire and fire management and set the
company's overall direction. Next, he argues that since directors
are expected to serve as the shareholders' guardians,
shareholders must have the power to replace them. Thus, the

fear of being replaced is supposed to make directors
accountable and provide them with incentives to serve
shareholder interests.
He continues by noting just how infrequently US directors are
actually challenged, much less removed, and concludes that
shareholder power to replace directors in the United States is
largely a myth. To make shareholder power real, he supports the
proposal that directors be elected by a secret ballot open to rival
candidates nominated by shareholders. To put them on an equal
footing with the slate proposed by the board's nominating
committee (usually with management input), he suggests that
challengers be reimbursed by the corporation if they receive a
threshold number of votes.
Taking the opposing view and challenging the widely accepted
argument that a company's primary goal is to maximize
shareholder value, Lipton challenges the very notion that
corporations are the private property of stockholders.
"Shareholders do not own corporations," he says. "They own
securities—shares of stock—which entitle them to very limited
electoral rights and the right to share in the financial returns
produced by the corporation's business operations" (Lipton &
Savitt, 2007, p. 733). Directors, he argues, are not merely
representatives of shareholders who have a legal responsibility
to put investor interests first. Instead, the role of the board is
simply and dutifully to seek what is best for the company itself,
which means balancing the interests of shareholders as well as
other stakeholders, such as management and employees,
creditors, regulators, suppliers, and consumers. He concludes
that Bebchuk's notion that a board's primary fiduciary
obligation is to shareholders is a myth of corporate law.
Focus of US Governance Law: Conduct or Accountability?
Governance in the United States has evolved as a medley of
federal law—including not only corporation law but also tax
and labor law—state law, and a series of codes of various self-
regulating authorities ranging from the NYSE to the accounting
industry. State law has traditionally been the ultimate arbiter of

governance issues. In contrast, in the United Kingdom,
corporate reform can be affected simply through an act of
Parliament.
This unusual history of governance law in the United States has
created an opening to support different interpretations of a
variety of its provisions. For example, the law not only
identifies shareholders as the owners of the corporation but also
defines them as investors who receive ownership in the
corporation in return for money or assets they invest. It
stipulates that shareholders are responsible for electing a board
of directors, the operators of the corporation who have overall
responsibility for the business of the corporation, but it does not
meaningfully address the implementation of this statute. It also
specifies that the board of directors, rather than its
shareholders, directs a company's business and affairs.
Additional guidance about a board's fiduciary role is contained
in statutes governing the role and conduct of individual board
members. Specifically those defining a director's obligation in
terms of such principles as the duty of care, duty of loyalty, and
the business judgment rule. The duty of care requires directors
to be informed, prior to making a business decision, of all
material information reasonably available to them in the
exercise of their management of the affairs of a corporation.
The duty of loyalty protects the corporation and its
shareholders. It requires directors to act in good faith and in the
best interests of the corporation and its shareholders. The
prevalent legal standard is that the duty of loyalty requires that
the director be "disinterested," such that he or she "neither
appears on both sides of a transaction nor expects to derive any
personal financial benefit from it," and his or her decision must
be "based on the corporate merits of the subject before the
board rather than extraneous considerations or influences" (The
American Law Institute, 1994, p. 61). The business judgment
rule protects directors from liability for action taken by them if
they act on an informed basis in good faith and in a manner they
reasonably believe to be in the best interests of the corporation's

shareholders. The business judgment rule does not apply in
cases of fraud, bad faith, or self-dealing.
As long as these principles are adhered to and as long as
directors are careful and loyal to corporate and shareholder
interests, they have wide discretion to exercise their business
judgment as they see fit. None of these principles provide clear
guidance to the central question of who owns the corporation.
Corporate Purpose: A Societal Perspective
One reason that US governance law is sometimes indeterminate
is that the enormous differences between the two legal views
described above reflect a broader, philosophical debate on the
role and purpose of corporations in society. Indeed, opposing
views on the purpose and accountability of the corporation—
shareholders versus stakeholders, or private (property) versus
public (social and political entity) conceptions of the
corporation—have been part of the governance debate for well
over 100 years.
Shareholder capitalism, until recently prevalent mainly in the
United States and the United Kingdom, holds that a company is
the private property of its owners. From a legal perspective, the
Anglo-American corporation is essentially a capital market
institution, primarily accountable to shareholders, charged with
creating wealth by exploiting market opportunities. Stakeholder
capitalism, on the other hand, embodies a more organic view of
the corporation in which companies have broader obligations
that balance the interests of shareholders with those of other
stakeholders, notably employees but also including suppliers,
distributors, customers, and the community at large. Under this
set of beliefs, the corporation is seen as an institution with a
continuing purpose, and therefore, with a life of its own.
Shareholders and wealth creation for owners do not dictate its
priorities. Rather, a deep concern for employees, suppliers, and
customers, and implicitly for its own continued existence,
defines the corporate mission.
Stakeholder capitalism can take different forms, reflecting the
degree of commitment to different stakeholders. Germany's

legal system, for example, makes it clear that firms do not have
a sole duty to pursue the interests of shareholders. Under
Germany's system of codetermination, employees and
shareholders in large companies hold an equal number of seats
on the companies' supervisory boards, and the interests of both
parties must be taken into account in decision making. In
Denmark, employees in firms with more than 35 workers elect
one-third of the firm's board members, with a minimum of two.
In Sweden, companies with more than 25 employees must have
two labor representatives appointed to the board. These
employee board members have all the rights and duties of other
board members.
The situation differs somewhat in France. French firms with
more than 50 workers have employee representatives at board
meetings, but they do not have the right to vote. More
conventional codetermination systems exist for former public-
sector French firms that have been privatized. These systems
can be introduced voluntarily by companies. In Finland,
companies can also voluntarily adopt employee representatives
on the board. Across the European Union (EU) as a whole,
another type of worker participation in decision making is the
works council, a group that has a say in such issues as layoffs
and plant closures. A corporation with at least 1,000 employees,
of which there are 150 or more in at least two EU countries,
must have a European Works Council.
Japanese firms also differ from those in the United States and
the United Kingdom. Japanese executives do not have a
fiduciary responsibility to stockholders, but they can be liable
for gross negligence in performing their duties. At the same
time, it is accepted practice in Japan that managers align their
priorities with the interests of a variety of stakeholders. For
example, a recent survey revealed that if Japanese executives
feel that the company is going through a tough period
financially, keeping their employees on the job is much more
important than maintaining dividends to shareholders.
Specifically, only 3 percent of Japanese managers said

companies should maintain dividend payments to stockholders
under such circumstances. This compares with 41 percent in
Germany, 40 percent in France, and 89 percent in both the
United States and the United Kingdom.
In the United States, these issues also continue to be debated.
Some time ago Reason (2005) magazine featured a spirited
debate featuring the late Milton Friedman, former senior
research fellow at the Hoover Institution and Paul Snowden
Russell Distinguished Service Professor of Economics at the
University of Chicago; John Mackey, founder and CEO of
Whole Foods Market; and others, on the purpose of the
corporation. Friedman, a Nobel laureate in economics and the
author of a famous 1970 New York Times Magazine article
titled "The Social Responsibility of Business Is to Increase Its
Profits," had no patience with capitalists who claimed that
"business is not concerned 'merely' with profit but also with
promoting desirable 'social' ends; that business has a 'social
conscience' and takes seriously its responsibilities for providing
employment, eliminating discrimination, avoiding pollution, and
whatever else may be the catchwords of the contemporary crop
of reformers" (Friedman, 1970).
He wrote that such people are "preaching pure and
unadulterated socialism. Businessmen who talk this way are
unwitting puppets of the intellectual forces that have been
undermining the basis of a free society these past decades."
Mackey disagreed vehemently with Friedman. A self-described
ardent libertarian who likes to quote Ludwig von Mises on
Austrian economics and Abraham Maslow on humanistic
psychology, and is a student of astrology, Mackey believes
Friedman's view of business is too narrow and underestimates
the humanitarian potential of capitalism. Selected portions of
this debate are reprinted below, beginning with Mackey's
passionate, personal vision of the social responsibility of
business.
In 1970 Milton Friedman wrote that "there is one and only one
social responsibility of business—to use its resources and

engage in activities designed to increase its profits so long as it
stays within the rules of the game, which is to say, engages in
open and free competition without deception or fraud." That's
the orthodox view among free market economists—that the only
social responsibility a law-abiding business has is to maximize
profits for the shareholders.
I strongly disagree. I'm a businessman and a free market
libertarian, but I believe that the enlightened corporation should
try to create value for all of its constituencies. From an
investor's perspective, the purpose of the business is to
maximize profits. But that's not the purpose for other
stakeholders—for customers, employees, suppliers, and the
community. Each of those groups will define the purpose of the
business in terms of its own needs and desires, and each
perspective is valid and legitimate. (Friedman, Mackey, &
Rodgers, 2005)
Mackey continues, "We have not achieved our tremendous
increase in shareholder value by making shareholder value the
primary purpose of our business…the most successful
businesses put the customer first, ahead of the investors. In the
profit-centered business, customer happiness is merely a means
to an end: maximizing profits. In the customer-centered
business, customer happiness is an end in itself, and will be
pursued with greater interest, passion, and empathy than the
profit-centered business is capable of."
Not surprisingly, Friedman respected Whole Foods' success but
took issue with its business philosophy.
"Maximizing profits is an end from the private point of view,"
he wrote. "It is a means from the social point of view. A system
based on private property and free markets is a sophisticated
means of enabling people to cooperate in their economic
activities without compulsion; it enables separated knowledge
to assure that each resource is used for its most valued use, and
is combined with other resources in the most efficient way."
Mackey replied, "While Friedman believes that taking care of
customers, employees, and business philanthropy are means to

the end of increasing investor profits, I take the exact opposite
view: Making high profits is the means to the end of fulfilling
Whole Foods' core business mission. We want to improve the
health and well-being of everyone on the planet through higher-
quality foods and better nutrition, and we can't fulfill this
mission unless we are highly profitable. High profits are
necessary to fuel our growth across the United States and the
world. Just as people cannot live without eating, so a business
cannot live without profits. But most people don't live to eat,
and neither must a business live just to make profits"
(Friedman, Mackey, & Rodgers, 2005).
Mackey's logic was perhaps most effectively first articulated by
Peter Drucker in 1974 in his famous book Management: Tasks,
Responsibilities and Practices. "The purpose of a business is not
to make a profit," Drucker wrote. "Profit is a necessity and a
social responsibility. A business, regardless of the economic
and legal arrangements of society, must produce enough profit
to cover the risks of committing today's economic resources to
the uncertainties of the future; to produce the capital for the
jobs of tomorrow; and to pay for all the non-economic needs
and satisfactions of society from defense and the administration
of justice to the schools and the hospitals, and from the
museums to the boy scouts. But profit is not the purpose of
business. Rather a business exists and gets paid for its economic
contribution. Its purpose is to create a customer" (Drucker,
1974, p. 67).
This discussion raises questions that transcend the legal debate
on fiduciary obligations. It asks us to consider questions, such
as, What does society want from corporations? What are the
moral obligations and responsibilities of business? Who has the
right to make such decisions in a public company? Is
shareholder wealth maximization the right objective? What
obligations does a company have to other stakeholders, such as
employees or suppliers, and the community at large? Are these
objectives necessarily in conflict with each other? If so, how
should trade-offs be made? Furthermore, the discussion suggests

that to be consistent and effective, directors and boards should
have ready answers to many, if not all, of the questions and
know where they agree or disagree. As we shall see, regrettably,
this is not true. Not only has the United States, as a society,
changed its perspective on this issue several times, but also,
today, the majority of directors remain confused, sometimes
intimidated, by the law and often are unwilling or unable to
debate these issues openly.
The Primacy of Shareholder Interests: A Historical Perspective
During the first part of the nineteenth century, the corporation
was viewed as a social instrument for the state to carry out its
public policy goals, and each instance of incorporation required
a special act of the state legislature. The function of the law
was to protect stakeholders by making sure corporations would
not pursue activities beyond their original charter or state of
incorporation. By the end of the nineteenth century, states
began to allow general incorporation, which fueled an explosive
growth in the creation of companies for private business
purposes. In its aftermath, concern for stakeholder welfare gave
way to the concept of managing the corporation for
shareholders' profits. This section draws on Sundaram and
Inkpen (2004).
In 1919 the primacy of shareholder value maximization was
affirmed in a ruling by the Michigan State Supreme Court
in Dodge vs. Ford Motor Company. Henry Ford wanted to invest
Ford Motor Company's considerable retained earnings in the
company rather than distribute it to shareholders. The Dodge
brothers, minority shareholders in Ford Motor Company,
brought suit against Ford, alleging that his intention to benefit
employees and consumers was at the expense of shareholders. In
their ruling, the Michigan court agreed with the Dodge brothers:
A business corporation is organized and carried on primarily for
the profit of the stockholders. The powers of the directors are to
be employed for that end. The discretion of directors is to be
exercised in the choice of means to attain that end, and does not
extend to a change in the end itself, to the reduction of profits,

or to the non-distribution of profits among stockholders in order
to devote them to other purposes (Dodge v. Ford Motor Co.,
1919).
In The Modern Corporation and Private Property, published in
1932, Adolph Berle and Gardiner Means provided important
intellectual support for the shareholder value norm. In this now
classic book, the authors called attention to a new phenomenon
affecting corporations in the United States at the time. They
noted that ownership of capital had become widely dispersed
among many small shareholders, yet control was concentrated in
the hands of just a few managers. Berle and Means warned that
the separation of ownership and control would destroy the very
foundation of the existing economic order and argued that
managing on behalf of the shareholders was the sine qua non of
managerial decision making because shareholders were property
owners.
Following the 1929 stock market crash and the Great
Depression, stakeholder concerns were being voiced once again.
If the corporation is an entity separate from its shareholders, it
was argued, it has citizenship responsibilities (Dodd, 1932, p.
1145–1163). According to this point of view, rather than being
an agent for shareholders, the role of management is that of a
trustee with citizenship responsibilities on behalf of all
constituencies, even if it means a reduction in shareholder
value. In the following years, states adopted a number of
stakeholder statutes reflecting this new sense of corporate
responsibility toward nonshareholding constituencies, such as
labor, consumers, and the natural environment.
By the end of the twentieth century, however, despite state-level
legislative efforts to the contrary, American-style market-driven
capitalism had prevailed and the pendulum swung back to the
shareholder. Friedman's (1970) view that the "sole social
responsibility of business is to increase profits" energized a
push back on corporate social responsibility. In the meantime,
agency theory emerged. Agency theory is directed at the
dilemma in which one party (the shareholder as the principal)

delegates work to another (management as the agent) who
performs that work. Agency theory is concerned with resolving
two problems that can occur in such a relationship. The first is
the agency problem that arises when (1) the desires or goals of
the principal and agent conflict and (2) it is difficult or
expensive for the principal to verify what the agent is actually
doing. The issue here is that the principal cannot verify that the
agent has behaved appropriately. The second is the problem of
risk sharing that arises when the principal and agent have
different attitudes toward risk. In this situation, the principle
and the agent may prefer different actions because of the
different risk preferences and the concept of the corporation as
a nexus of contracts (Easterbrook & Fischel, 1991). The nexus
of contracts theory views the firm not as an entity but as an
aggregate of various inputs brought together to produce goods
or services. Employees provide labor. Creditors provide debt
capital. Shareholders initially provide equity capital and
subsequently bear the risk of losses and monitor the
performance of management. Management monitors the
performance of employees and coordinates the activities of all
the firm's inputs. The firm is seen as simply a web of explicit
and implicit contracts establishing rights and obligations among
the various inputs making up the firm.
To protect the interests of other stakeholders, 30 states in the
United States enacted stakeholder statutes that allowed directors
to consider the interests of nonshareholder constituencies in
corporate decisions. Thus, the law gave boards latitude in
determining what is in the best long-term interests of the
corporation and how to take the interests of other stakeholders
into account. Nevertheless, the mainstream US corporate law
remains committed to the principle of shareholder wealth
maximization.
Governance Without a Shared Purpose?
The lack of a clear, shared consensus about why a company
exists, to whom directors are accountable, and what criteria they
should use to make decisions—in the law as well as in society

at large—is a significant obstacle to increasing the effectiveness
of the corporate governance function. When boards operate with
tacit assumptions about their objectives and loyalties, they may
hide potential disagreements among their members and sacrifice
effectiveness. Such hidden disagreements make it difficult to
get consensus on complex issues, such as what qualifications a
CEO should have, whether or not to outsource parts of the value
chain, or how to evaluate and compensate top management.
Lorsch (1989) first identified the confusion among directors
about their accountabilities. Based on their beliefs, he
categorized directors as belonging to one of three groups:
traditionalists, rationalizers, or broad constructionists. Each has
a different vision of what the modern corporation's fundamental
purpose is and, therefore, to whom and for what a board should
be held accountable.
Traditionalists see themselves as accountable to shareholders
only. For them, there is no need to debate the fundamental
purpose of the modern corporation—it is and always has been
the maximization of shareholder value. They do not believe
there is a conflict between putting the shareholder first and
responding to the needs of other constituencies, and therefore
experience little role ambiguity or conflict. Members of this
group find support for their position in a narrow interpretation
of current state and federal law. They also tend to view the
highly publicized abuses at Enron, WorldCom, Vivendi, and
other companies as anomalies made possible by imperfections in
the current system, rather than as indicators of more systemic
problems.
A second, larger group—the rationalizers—experiences more
anxiety about their role as directors. They recognize that, in
today's complex, global economy, real tensions can occur
between the interests of different constituencies and that not all
decisions can be reduced to the simple formula that assumes
what is good for the shareholder is good for everyone else.
Examples include whether or not to close a domestic plant in
favor of manufacturing in a low-cost, foreign location; whether

or not to outsource production to lower cost suppliers; or how to
respond to pressures for greener operations.
The final group, which Lorsch labels the broad constructionists,
recognizes specific responsibilities to constituencies other than
shareholders and is willing to act on its convictions. Directors
belonging to this group constantly struggle to balance their
views with the more traditional view of a director's
accountabilities and—to stay within the boundaries of the law—
frame their decisions in terms of what is in the best long-term
interest of the corporation as a whole.
Lorsch summarized his findings stating, "Thus we found the
majority of directors felt trapped in a dilemma between their
traditional legal responsibility to shareholders, whom they
consider too interested in short-term payout, and their beliefs
about what is best, in the long run, for the health of the
company." He further observed that in many boards a group
norm had evolved, prohibiting open discussion of a board's true
purpose and that a lot of directors were unaware of recent
rulings in the evolving legal context that grant them the latitude
to consider constituencies other than shareholders.
In recent years the issue of a board's primary role and
accountability has, if anything, become even more confusing.
Despite strong rhetoric from many quarters advocating
maximization of shareholder value as a company's primary goal,
there is a growing recognition that a company and the board
have broader responsibilities. This trend reflects the fact that
real—that is, economic and psychological rather than legal—
ownership of the corporation is moving from shareholders to
employees, customers, and other stakeholders that make up the
human capital of the firm.
This trend has created problems for directors. As Carter &
Lorsch (2004) note, "Boards have a real challenge in deciding to
whom they are really responsible and where their commitments
ultimately lie. Directors must think about and discuss among
themselves the constituencies and the time horizons they have
in mind as they think about the board's responsibilities. Many

boards have skirted discussion of these complex issues. They
seem too abstract, and reaching a consensus among board
members about them can take more of that most precious
commodity—time—than directors want to devote."
Is Shareholder Value Maximization the Right Objective?
In their widely cited book The Value Imperative—Managing for
Superior Shareholder Returns, McTaggart, Kontes, and Mankins
(1994) write, "Maximizing shareholder value is not an abstract,
shortsighted, impractical, or even, some might think, sinister
objective. On the contrary, it is a concrete, future-oriented,
pragmatic, and worthy objective, the pursuit of which motivates
and enables managers to make substantially better strategic and
organizational decisions than they would in pursuit of any other
goal. And its accomplishment is essential to the welfare of all
the company's stakeholders, for it is only when wealth is
created that customers will continue to enjoy a flow of new,
better, and cheaper products and the world's economies will see
new jobs created and old ones improved."
Implicit in this statement are three important assumptions, all of
which can be challenged:
· Shareholder value is the best measure of wealth creation for
the firm.
· Shareholder value maximization produces the greatest
competitiveness.
· Shareholder value maximization fairly serves the interests of
the company's other stakeholders.
With respect to the first assumption, it can be argued that firm
value, which also includes the values to all other financial
claimants, such as creditors, debt holders, and preferred
shareholders, is a better indicator of wealth. The importance of
distinguishing between firm value and shareholder value lies in
the fact that managers and boards can make decisions that
transfer value from debt holders to shareholders and decrease
total firm and social value while increasing shareholder value.
The second assumption—that shareholder value maximization
produces the greatest long-term competitiveness—can also be

challenged. An increasingly influential group of critics, which
also includes a substantial number of CEOs, thinks product-
market rather than capital-market objectives should guide
corporate decision making. They worry that companies that
adopt shareholder value maximization as their primary purpose
lose sight of producing or delivering a product or service as
their central mission, and that shareholder value maximization
creates a gap between the mission of the corporation and the
motivations, desires, and capabilities of the company's
employees who only have direct control over real, current,
corporate performance. They note that shareholder value
maximization is simply not inspiring for employees, even
though they often share in some of the gains through benefit,
bonus, or option plans. To many of them, shareholders are
nameless and faceless, under no obligation to hold their shares
for any length of time, never satisfied, and always asking,
"What will you do for me next?" Worse, they say, not only does
shareholder-value appreciation fail to inspire employees, it may
encourage them to view maximizing one's financial well-being
as a legitimate or even the only goal. Instead, they want
companies to create a moral purpose that not only provides a
clear focus on creating competitive advantage for the company
but also unites its purpose, strategy, goals, and shared values
into one overall, coherent management framework that has the
power to motivate constituents and the legitimacy of the
corporation's actions in society (Ellsworth, 2002, p. 6).
The third assumption—that shareholder maximization is
congruent with fairly serving the interests is the firm's other
stakeholders—is perhaps most controversial. Proponents of
shareholder value maximization—including many economists
and finance theorists—are adamant that maximizing shareholder
value is not only superior as a fiduciary standard or
management objective but also as a societal norm. Jensen
(2001), for example, writes, "Two-hundred years of research in
economics and finance have produced the result that if our
objective is to maximize the efficiency with which society

utilizes its resources (that is to avoid waste and to maximize the
size of the pie), then the proper and unique objective for each
company in the society is to maximize the long-run total value
of the firm. Firm value will not be maximized, of course, with
unhappy customers and employees or with poor products.
Therefore, consistent with stakeholder theory value-maximizing
firms will be concerned about relations with all their
constituencies. A firm cannot maximize value if it ignores the
interest of its stakeholders."
McTaggart et al. (1994) also believe shareholder value
maximization allows managers and boards to resolve any
conflicts to everyone's long-term benefit. Consider, for
example, their prescription for resolving trade-offs between
customer- and shareholder-focused investments. "As long as
management invests in higher levels of customer satisfaction
that will enable shareholders to earn an adequate return on their
investment, there is no conflict between maximizing shareholder
value and maximizing customer satisfaction. If, however, there
is insufficient financial benefit to shareholders from attempts to
increase customer satisfaction, the conflict should be resolved
for the benefit of shareholders to avoid diminishing both the
financial health and long-term competitiveness of the business."
Not surprisingly, stakeholder theorists take a different point of
view. They argue that shareholders are but one of a number of
important stakeholder groups and that, like customers,
suppliers, employees, and local communities, have a stake in
and are affected by the firm's success or failure. To stakeholder
theory advocates, an exclusive focus on maximizing stockholder
wealth is both unwise and ethically wrong. Instead, the firm and
its managers have special obligations to ensure that the
shareholders receive a fair return on their investment. But the
firm also has special obligations to other stakeholders, which go
above and beyond those required by law (Freeman, 1984, p. 17).
More recently, Ian Davis, managing director of McKinsey,
criticized the shareholder value maximization doctrine on
altogether different grounds. He observed that, in today's global

business environment, the concept of shareholder value is
rapidly losing relevance in the face of the larger role played by
government and society in shaping business and industry
elsewhere in the world. "In much of the world," he wrote,
"government, labor and other social forces have a greater
impact on business than in the U.S. or other more free-market
Western societies. In China, for example, government is often
an owner. If you're talking in China about shareholder value,
you will get blank looks. Maximization of shareholder value is
in danger of becoming irrelevant (Davis, 2006).
Finally, a growing number of parties, including CEOs, while not
questioning that shareholder value maximization is the right
objective, are concerned about its implementation. They worry
that the stock market has a bias toward short-term results and
that stock price, the most common gauge of shareholder wealth,
does not reflect the true long-term value of a company. Lucent
Technologies CEO Henry Schacht, for example, has stated,
"What has happened to us is that our execution and processes
have broken down under the white-hot heat of driving for
quarterly revenue growth" (Loomis, 2003).
Stakeholder Theory: A Viable Alternative?
Although the recognition of stakeholder obligations has been
with us since the birth of the modern corporate form, the
development of a coherent stakeholder theory awaited a shift in
legal thinking from a perspective on shareholders as owners to
one of investors, more on a par with providers of other inputs
that a company needs to produce goods or services. Whereas the
ownership perspective, rooted in property law, provides a
natural basis for the primacy of shareholder rights, the view of
the corporation as a bundle of contracts permits a different view
of the fiduciary obligations of corporate managers. According to
Freeman and McVea (2001), "The stakeholder framework does
not rely on a single overriding management objective for all
decisions. As such it provides no rival to the traditional aim of
'maximizing shareholder wealth.' To the contrary, a stakeholder
approach rejects the very idea of maximizing a single-objective

function as a useful way of thinking about management strategy.
Rather, stakeholder management is a never ending task of
balancing and integrating multiple relationships and multiple
objectives.
To pragmatists, the rejection of a single criterion for making
corporate decisions is problematic. Directors occasionally face
situations in which it is impossible to advance the interests of
one set of stakeholders and simultaneously protect those of
others. Whose interests should they pursue when there is an
irreconcilable conflict? Consider the decision whether or not to
close down an obsolete plant. The closing will harm the plant's
workers and the local community but will benefit shareholders,
creditors, employees working at a more modern plant to which
the work previously performed at the old plant is transferred,
and communities around the modern plant. Without a single
guiding decision criterion, how should the board decide?
The problem is not just one of uncertainty or unpredictability.
Ultimately, the stakeholder model is flawed because of its
failure to account adequately for what Bainbridge (1993) calls
"managerial sin." The absence of a single decision-making
criterion allows management to freely pursue its own self-
interest by playing shareholders off against nonshareholders.
When management's interests coincide with those of
shareholders, management can justify its decision by saying that
shareholder interests prevailed in this instance, and vice versa.
The plant closing decision described above provides a useful
example: Shareholders and some nonshareholder constituents
benefit if the plant is closed, but other nonshareholder
constituents lose. If management's compensation is tied to firm
size, we can expect it to resist any downsizing of the firm. The
plant likely will stay open, with the decision being justified by
the impact of a closing on the plant's workers and the local
community. In contrast, if management's compensation is linked
to firm profitability, the plant will likely close, with the
decision being justified by management's concern for the firm's
shareholders, creditors, and other constituencies that benefit

from the closure decision.
It has been argued that shareholders, in fact, are more
vulnerable to management misconduct than nonshareholder
constituencies. Legally, shareholders have essentially no power
to initiate corporate action and, moreover, are entitled to vote
on only very few corporate actions. Under the Delaware code,
shareholder voting rights are essentially limited to the election
of directors and the approval of charter or bylaw amendments,
mergers, sales of substantially all of the corporation's assets,
and voluntary dissolutions. As a formal matter, only the election
of directors and the amendment of the bylaws do not require
board approval before shareholder action is possible.
In practice, of course, even the election of directors, absent a
proxy contest, is predetermined by the existing board
nominating the following year's board. Rather, formal decision-
making power resides mainly with the board of directors. As a
practical matter, of course, the sheer mechanics of undertaking
collective action by thousands of shareholders preclude them
from meaningfully affecting management decisions. In effect,
shareholders, just like nonshareholder constituencies, have but a
single mechanism by which they can negotiate with
management—withholding their inputs (capital). But
withholding inputs may be a more effective tool for
nonshareholders than it is for shareholders. Some firms go for
years without seeking equity investments. If the management
groups in these firms disregard shareholder interests, the
shareholders have no option other than to sell out at prices that
will reflect management's lack of concern for shareholder
wealth. In contrast, few firms can survive for long without
regular infusions of new employees and new debt financing. As
a result, few management groups can prosper while ignoring
nonshareholder interests. Nonshareholder constituencies often
also are more effective in protecting themselves through the
political process. Shareholders—especially individuals—
typically have no meaningful political voice. In contrast, many
nonshareholder constituencies are represented by cohesive,

politically powerful interest groups. Unions, for example,
played a major role in passing state antitakeover laws.
Environmental concerns are increasingly a factor in regulatory
actions. From this point of view, it can be argued that an
explicit focus on balancing stakeholder interests is not only
impractical but also unnecessary because nonshareholder
constituencies already have adequate mechanisms to protect
themselves from management misconduct.
Resolving the Conflict: Toward Enlightened Value
Maximization?
Jensen (2001) believes the inherent conflict between the
doctrine of shareholder value maximization and the objectives
of stakeholder theory can be resolved by melding together
"enlightened" versions of these two philosophies:
Enlightened value maximization recognizes that communication
with and motivation of an organization's managers, employees,
and partners is extremely difficult. What this means in practice
is that if we simply tell all participants in an organization that
its sole purpose is to maximize value, we will not get maximum
value for the organization. Value maximization is not a vision
or a strategy or even a purpose; it is the scorecard for the
organization. We must give people enough structure to
understand what maximizing value means so that they can be
guided by it and therefore have a chance to actually achieve it.
They must be turned on by the vision or the strategy in the
sense that it taps into some human desire or passion of their
own—for example, a desire to build the world's best automobile
or to create a film or play that will move people for centuries.
All this can be not only consistent with value seeking, but a
major contributor to it.
Indeed, it is a basic principle of enlightened value maximization
that we cannot maximize the long-term market value of an
organization if we ignore or mistreat any important
constituency. We cannot create value without good relations
with customers, employees, financial backers, suppliers,
regulators, and communities. But having said that, we can now

use the value criterion for choosing among those competing
interests. I say "competing" interests because no constituency
can be given full satisfaction if the firm is to flourish and
survive. Moreover, we can be sure—again, apart from the
possibility of externalities and monopoly power—that using this
value criterion will result in making society as well off as it can
be. (Jensen, 2001, p. 16)
Thus, Jensen defines "enlightened" stakeholder theory simply as
stakeholder theory with the specification that maximizing the
firm's total long-term market value is the right objective
function. The words "long-term" are key here. As Jensen notes,
"In this way, enlightened stakeholder theorists can see that
although stockholders are not some special constituency that
ranks above all others, long-term stock value is an important
determinant (along with the value of debt and other instruments)
of total long-term firm value. They would recognize that value
creation gives management a way to assess the tradeoffs that
must be made among competing constituencies, and that it
allows for principled decision making independent of the
personal preferences of managers and directors (Jensen, 2001,
p. 17).
Even though shareholder value maximization is increasingly
being challenged on pragmatic as well as moral grounds, its
roots in private property law, however—a profound element in
the American ethos—guarantee that it will continue to dominate
the US approach to corporate law for the foreseeable future. As
a practical matter, the courts have given boards increasing
latitude in determining what is in the best long-term interests of
the corporation and how to take the interests of other
stakeholders into account. This latitude makes it imperative that
directors openly and fully discuss these issues and agree on a
clear, unambiguous statement of purpose for the corporation.
Glossary
agency theory
a theory that attempts to reconcile the relationship between
shareholders and the agent of the shareholders (for example, the

corporation's managers)
board of directors
an elected group of business individuals who have overall
responsibility for the business of the corporation
broad constructionists
directors who recognize and are willing to act on
responsibilities to constituencies other than shareholders
business judgment rule
a rule that protects directors from liability if they act on an
informed basis in good faith and in a manner they reasonably
believe to be in the best interests of the corporation's
shareholders. This does not apply in cases of fraud, bad faith, or
self-dealing
duty of care
a statute that requires directors, before making a business
decision, to be informed of all material information reasonably
available to them in exercising their management of the
corporation's affairs
duty of loyalty
a statute that protects a corporation and its shareholders by
requiring directors to act in good faith and in the corporation's
and shareholders' best interests
enlightened stakeholder theory
a theory that corporate value cannot be maximized unless the
corporation concerns itself with all its constituent stakeholders,
with the specification that maximizing the corporation's long-
term market value is the right goal
enlightened value maximization
a theory that recognizes that corporate decision-makers need to
be more sensitive to nonshareholder constituencies, that
maximizing shareholder value does not produce the most value
for the organization
management
executives who act in a trustee manner toward a corporation's
nonshareholders, including labor, consumers, and the
environment

rationalizers
directors who recognize the tensions that occur in the interests
among different constituencies but who nevertheless act
primarily for the sake of shareholders
shareholder capitalism
an economic system of capitalism that holds that a company is
the private property of its owners
shareholder value
the value of profit that a corporation earns for employees,
suppliers, and other creditors
shareholder value maximization
a doctrine that holds that a company's ultimate success can be
measured by the extent to which shareholders' wealth and stock
value are increased
stakeholder capitalism
an economic system of capitalism that holds that companies
balance the interests of shareholders with those of other
stakeholders, primarily employees but also suppliers,
distributors, customers, and the community at large; holds the
view that companies have a broader obligation than shareholder
capitalism
stakeholder theory
a theory that corporate value cannot be maximized unless the
corporation concerns itself with all its constituent stakeholders
strategy
a method for guiding management's choices about where to
compete--which customers to serve, with what products and
services, and how to deliver those products to customers
effectively and profitably
traditionalists
directors who see themselves as being accountable only to
shareholders
value maximization
the maximization of a corporation's common stock by increasing
the wealth of that corporation's shareholders

Key Elements of Web Analytics
In order to test the success of your website, you need to
remember the TAO of conversion optimization: track, analyze,
optimize.
A number is just a number until you can interpret it. Typically,
it is not the raw figures that you will be looking at, but what
they tell you about how your users are interacting with your
website. Because your web analytics package will never be able
to provide you with completely accurate results, you need to
analyze trends and changes over time to understand your
brand’s performance.
Avinash Kaushik, author of Web Analytics: An Hour a Day,
recommends a three-pronged approach to web analytics (2007):
1. Analyzing data about behavior infers the intent of a website’s
visitors. Why are people visiting the website?
2. Analyzing outcomes metrics shows how many visitors
performed the goal actions on a website. Are visitors
completing the goals we want them to?
3. A wide range of data tells us about the user experience. What
are the patterns of user behavior? How can we influence them
so that we achieve our objectives?
Behavior
Web users’ behavior can indicate a lot about their intent.
Looking at referral URLs and search terms used to find the
website can tell you a great deal about what problems visitors
are expecting your site to solve.
Some methods to gauge the intent of your visitors include the
following:
· click density analysis—Looking at a heatmap to see where
people are clicking on the site and if there are any noteworthy
clumps of clicks (such as many people clicking on a page
element that is not actually a button or link).
· segmentation—Selecting a smaller group of visitors to analyze
based on a shared characteristic (for example, only new visitors,
only visitors from France, or only visitors who arrived on the

site by clicking on a display advert). This lets you see if
particular types of visitors behave differently.
· behavior and content metrics—Analyzing data around user
behaviors (e.g., time spent on site, number of pages viewed) can
give a lot of insight into how engaging and valuable your
website is. Looking at content metrics will show you which
pages are the most popular, which pages users leave from most
often and more. This data provides excellent insight for your
content marketing strategy and helps uncover what your
audience is really interested in.
A crucial, often-overlooked part of this analysis is internal
search. Internal search refers to the searches of the website’s
content that users perform on the website. While a great deal of
time is spent analyzing and optimizing external search—using
search engines to reach the website in question—analyzing
internal search goes a long way to exposing weaknesses in site
navigation, determining how effectively a website is delivering
solutions to visitors, and finding gaps in inventory on which a
website can capitalize.
For example, consider the keywords a user may use when
searching for a hotel website, and keywords they may use when
on the website. Keywords to search for a hotel website may
be Cape Town hotel or bed and breakfast Cape Town. Once on
the website, the user may use the site search function to find out
more. Keywords they may use include Table Mountain, pets,
or babysitting service. Analytics tools can show what keywords
users search for, what pages they visit after searching, and, of
course, whether they search again or convert.
Outcomes
At the end of the day, you want people who visit your website
to perform an action that increases your revenue. Analyzing
goals and key performance indicators (KPIs) demonstrates
where there is room for improvement. Look at user intent to
establish if your website meets the users’ goals and if these
match with the website goals. Look at user experience to
determine how outcomes can be influenced.

Website Performance
Reviewing conversion paths can give you insight into improving
your website.
In the figure above, after performing a search, one hundred
visitors land on the homepage of a website. From there, 80
visitors visit the first page toward the goal. This event has an 80
percent conversion rate. Twenty visitors take the next step. This
event has a 25 percent conversion rate. Ten visitors convert into
paying customers. This event has a 50 percent conversion rate.
The conversion rate of all visitors who performed the search is
10 percent, but breaking this up into events lets us analyze and
improve the conversion rate of each event.
User experience
In order to determine the factors that influence user experience,
you must test and determine the patterns of user behavior.
Understanding why users behave in a certain way on your
website will show you how that behavior can be influenced to
improve your outcomes.
References
Kaushik, A. (2007). Web analytics: An hour a day. San
Francisco, CA: Sybex.
Licen
Project 5—Final Report Template
Memo: Please use this template
1. Title page
· states the client organization, selected country, the client's
product, type of legal structure, and the alliance partner
· date submitted
· your name
· course title, course and section number
· professor’s name
2. Table of contents

· page numbers for each major section
3. Executive summary
· summarizes the results of your analysis and how you arrived at
the recommendation
· belongs on a separate page from the introduction to the report
· Start your executive summary as follows: “Business Plan for
[selected client organization] to enter [selected country] $(size
of market in US Dollars) market for [product/service] through a
[type of legal structure] with [selected alliance partner].”
4. Introduction (first page of report body)
· states the purpose of the report
· explains what the report will do
· introduces the industry, country, and client's name
5. Marketing strategy
· market analysis
· characteristics of potential customers in the country
· use of web networks and social media for e-marketing
6. Governance and CSR
7. Financial projections
8. Strategy implementation
9. Conclusion
· Summary of the recommendations and rationale
10. Reference
· APA-style reference page
11. Appendices
· if needed
Management, Strategies, Tools, and Practices in eMarketing
Sirous Tabrizi University of Windsor, Windsor, Canada
Mohammad Kabirnejat Islamic Azad University, Hashtrood
Branch, Iran Abstract Globalization has resulted in significant
changes in the way business is conducted all over the world. For
instance, outsourcing specialist jobs, alliances among large
multinational companies, and high degree of government
involvement in markets have all forced companies to adjust

their structures, practices, and policies. For marketers, two
major changes have influenced their practices: increasingly
global demographic and deeper customer engagement. Since
“push” advertising is becoming increasingly irrelevant,
companies need to do more outside the traditional marketing
approaches. emarketing is one of the new approaches towards
marketing that shows significant promise, especially given the
increasingly dominant role played by the Internet in society and
popular culture. This article discusses some of the changes
necessary to take an e-marketing approach in a business, and
focus specifically on several important instruments (the
SOSTAC and SMART frameworks) that can help develop
consistent strategies. Some conjectured examples are presented
to help understand the main argument. Keywords:
Globalization, eMarketing, SOSTAC, SMART, branding,
marketing mix, emarketing management style 70 Tabrizi and
Kabirnejat: eMarketing Introduction Globalization has resulted
in significant changes in the way business is conducted all over
the world. For instance, numerous companies including such as
IBM, Microsoft, and Philips have started outsourcing specialists
from various parts of the world, enabling global movement of
people for jobs and requiring structural changes to the company
(Engardio, Bernstein, & Kripalani, 2003). In addition ,
globalization has had a positive effect on the economic situation
of many developing countries, such as China, India and
Bangladesh. However, companies all over the world have to
take the practical marketing strategies to give better services to
customers. Philip Kotler, who is considered as the father of
modern marketing, by many, defines marketing as “the science
and art of exploring, creating, and delivering value to satisfy
the needs of a target market at a profit. Marketing identifies
unfulfilled needs and desires. It defines, measures, and
quantifies the size of the identified market and the profit
potential. It pinpoints which segments the company is capable
of serving best and it designs and promotes the appropriate
products and services” (Kotler, 2005; p.10). In the specific case

of e-marketing , a more comprehensive and practical definition
is provided by specialists at CISCO: “Electronic Marketing (E-
Marketing) is a generic term utilized for a wide range of
activities -advertising, customer communications, branding,
fidelity programs etc. - using the internet” (Otlacan, 2007). In
other words, E-Marketing is the process of finding, attracting,
winning, and retaining customers through electronic means
(Stokes, 2008). Primarily this is accomplished through the
Internet but also through e-mail, social networking, and various
forms of wireless media. Hence, it is not just producing a
website but through facilitating online dialog between
consumers and the company (Stokes, 2008). “E-Marketing is
also known as Internet Marketing, Web Marketing, Digital
Marketing, and Online Marketing” (Levinson & Neitlich, 2011,
p. 89). It includes both direct response marketing and indirect
marketing elements, and is a continual process rather than
something which is executed only once. The messages and 71
Journal of Knowledge Globalization, Volume 8, Number 2, 2015
stories developed through traditional marketing can be
improved through technology and electronic means in a variety
of ways. eMarketing adds new dimensions and meaning to
traditional marketing. Such as reach, scope, interactivity,
immediacy, demographic, supply chain, value chain, and
financial chain. Reach: Due to the nature of the Internet, E-
Marketing can have a global reach and access potential
customers from all over the world. This can also be performed
on a much smaller budget than what was normally necessary for
a comparable reach (Dann & Dann, 2011). Scope: E-Marketing
allows a variety of methods for reaching customers and enables
a wide range of products and services that can be offered.
Therefore, the marketing of a product is combined with other
areas such as brand formation, public relations, customer
service, and information management in a way that was
traditionally not possible (Dann & Dann, 2011). Interactivity:
Since E-Marketing is a dialog between customers and
companies, there is a degree of interaction between the two that

does not exist in traditional marketing. Companies can use the
responses, complaints, and commendations of customers to
further develop their brands and better their own image
(Krishnamurthy, 2006). On the other hand, customers feel more
engaged with the company and can become empowered to
promote the product through their own actions and discussions.
The marketing landscape thus becomes more dynamic, adaptive,
and capable of achieving faster and deeper growth. Immediacy:
The Internet, being pervasive and always accessible, provides a
constant and continual means through which customers can be
engaged and view and buy products. E-Marketing effectively
closes the gap between providing information, advertising, and
buy opportunities and eliciting a reaction from customers
(Krishnamurthy, 2006; Dann & Dann, 2011). 72 Tabrizi and
Kabirnejat: eMarketing Demographics: Generally speaking,
Internet users have a significant buying power, as they are
skewed towards the middle-classes, and are often capable of
organizing themselves into focused groupings and sub-
populations (Krishnamurthy, 2006; Dann & Dann, 2011). As
such, savvy marketers can find access to desired niche markets
in addition to being able to easily and effective target such
groups (Parsons, & Maclaran, 2009). Literature From the very
beginning, marketing in the 21st century has been different.
Marketers today have a greater number and variety of choices in
support, media opportunities, and methods of communications
but they also face increasing competition due to the Internet
facilitating virtual competition (Andreasen, 2006). E-marketing
is the application of marketing techniques, principles, and
practices using electronic media, especially the Internet (Pride
& Ferrell, 2011). It encompasses all the activities which a
company conducts through the Internet so as to attract new
business, retain current business, or develop its brand identity.
In an analysis of e-business components and accepted marketing
concepts, Albert and Sanders (2003) developed this definition:
“E-business marketing is a concept and process of adapting the
relevant and current technologies to the philosophy of

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