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Creative Accounting, Fraud and International Accounting Scandals by Michael John Jones

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Chapter 20

Bank Failures and Accounting During the Financial Crisis of 2008–2009

Simon D. Norton

20.1 INTRODUCTION

Jensen and Meckling (1976, p. 9) observed that ‘[t]he firm is not an individual. It is a legal fiction which serves as a focus for a complex process in which the conflicting objectives of individuals … are brought into equilibrium within a framework of contractual relations.’ Agency theory suggests that management will be self-serving and where information is asymmetrical, this will be exploited to the detriment of the uninformed owner (Schipper, 1989). Creative accounting may be viewed as a technique or form of behaviour whereby management attempts to exploit information or limit its disclosure to maintain its superiority of bargaining power vis-à-vis the owner. Definitions of creative accounting, as we saw in Chapter 1, tend to focus upon the manipulation of levels of earnings in a way which affects reported income but which, in most scenarios, makes no genuine contribution to the economic well-being of the organisation (Merchant and Rockness, 1994).

In the context of the financial markets, creative accounting may occur for complex reasons which significantly exceed the relatively simplistic objective of earnings manipulation derived from traditional agency theory (Kothari, 2001). Owners (shareholders) or investors (for example, bondholders) or lenders in the interbank markets invariably have access to risk evaluation models as well as the ability to exit when management ...

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