A study by Watts and Zimmerman that explored the question of how corporate management responds to new standards proposed by the FASB was discussed in the text. Answer the following questions related to that study. a. What was the hypothesis of the study? b. Describe the study and discuss its findings. c. Was the study inductive or deductive? Explain. d. Discuss the criticisms that have been directed at the study and the implications of those criticisms.

Question

What will be an ideal response?

Answer 1

ANSWER:
a. Watts and Zimmerman hypothesized that management has more incentive to favor standards that lower reported net income when the firm is subject to political pressures, such as antitrust action or regulation because of their dominant market position.

b. Watts and Zimmerman examined responses to the FASB’s exposure draft requiring general price-level adjusted income calculations in corporate annual reports. They found that the proposal was supported by larger firms that would have lower income as a result of general price-level adjustment. Larger firms that would have higher income using general price-level adjustment tended to be against the proposal. These findings supported their hypothesis.

c. The study was inductive because it tested actual data (responses to the exposure draft) from a sample of firms and made inferences about the relevant population.

d. Solomons stated that Watts and Zimmerman’s evidence is rather flimsy because it involves a relatively small number of firms, a single accounting issue, and a single point in time. He also noted that many of the firms that lobbied in favor of general price-level adjustments were not using already available techniques, such as accelerated depreciation and LIFO, which would have reduced reported income. Also, several large firms that would have had lower general price-level-adjusted income relative to historical cost income lobbied against the proposed standard. This implies that the premise of the study, that large firms would be in favor of standards that decrease income, would be applicable only to a very small handful of very large firms. These criticisms show that empirical research in an area involving human behavior is subject to many interpretations and must be used carefully if inferences relative to the standard-setting process are to be drawn from the research.