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Thoughts on the divide between

theoretical and empirical research in accounting

Qi Chen
Fuqua School of Business
Duke University

Joseph Gerakos
Tuck School of Business
Dartmouth College

Vincent Glode
The Wharton School
University of Pennsylvania

Daniel Taylor
The Wharton School
University of Pennsylvania

September 19, 2016

Abstract

What is the relation between theoretical and empirical research in accounting? What should be
the relation? As a mix of individuals with experience in both theory and empirical research, we
offered our perspectives on these issues during a lively panel discussion at the 2015 Junior
Accounting Theory Conference. This paper highlights key themes from our discussion.

_________________________
*
This paper is adapted from a panel session at the 2015 Junior Accounting Theory Conference where Chen,
Gerakos, and Glode were invited to serve as panelists and Taylor was invited to serve as moderator. Taylors
remarks draw heavily on the material in Bertomeu et al., (2016). We thank the conference organizers for inviting us
to serve on the panel, the conference participants for comments and encouragement to formalize our remarks, and
the editors for providing the opportunity to combine our remarks into this paper.

Electronic copy available at: http://ssrn.com/abstract=2841276


INTRODUCTION

What is the relation between theoretical and empirical research in accounting? What

should be the relation? Accounting researchers have struggled with these questions since the

economics revolution in the accounting literature in the early 1970s. During that period, path-

breaking empirical research on the information content of accounting disclosures coincided with

path-breaking theoretical research on capital markets and the efficiency of alternative

information systems. 1

Almost five decades later, a vast and growing divide separates theoretical and empirical

research in accounting. This divide, and the need to bridge it, was the topic of our panel

discussion at the 2015 Junior Accounting Theory Conference. In this paper, we highlight key

themes from this discussion with the hope that they will be useful for future generations of

theory-oriented empiricists and empirical-oriented theoristsfuture generations of accounting

researchers interested in bridging the divide.

Before turning to the panel discussion, it is useful to reflect on the state of affairs in

accounting research as it concerns the relation between theory and empirical work. While

concerns about the divide between theory and empirical work are not new (e.g., Ball and Foster,

1982), we are concerned that the divide has grown to the point thatwithin the next 10 years

theory will no longer be viewed as an important methodology within accounting research. 2

To provide some hard evidence on the matter, we collect data on the number of theory

papers published each year between 2001 and 2014 in the top four journals in accounting: The

Accounting Review (TAR), Journal of Accounting and Economics (JAE), Journal of Accounting

1
See Ball and Foster (1982), Jensen (1982), and Verrecchia (1982) for excellent commentary on this early literature,
especially as it relates to the relation between theory and empirical work.
2
When reading an earlier draft of the manuscript, a well-respected theory colleague commented that this view was
too optimisticthat theory in accounting was already dead.

Electronic copy available at: http://ssrn.com/abstract=2841276


Research (JAR), and Review of Accounting Studies (RAST). Panel A of the appendix shows a

striking downward trend in the number of theory papers (as a fraction of total papers) published

in leading accounting journals. While there is no apparent time trend in theory papers published

in TAR, there are pronounced downward trends in the number of theory published in the JAR,

JAE, and RAST. Over the 20012005 (20102014) period, theory papers comprised 26% (10%)

of papers published in RAST, 18% (11%) of papers published in JAR, 12% (10%) of papers

published in TAR, and 9% (4%) of papers published in JAE. Collectively, these changes

constitute a 44% reduction in the fraction of theory papers published in top journals.

To examine whether this pronounced downward trend is unique to accounting, or

indicative of a more general trend away from theory in the related social sciences, Panel B of the

appendix presents similar data for the top three journals in finance: Journal of Finance (JF),

Journal of Financial Economics (JFE), and Review of Financial Studies (RFS). With the

exception of RFS, there is not a pronounced downward trend in theory papers in finance. While

JF and JFE remain flat around 30% and 24%, RFS moves from 48% in the 20012005 period to

37% in the 20102014 period.

Notably, RAST and RFS were created with the explicit intention of catering to theory

work and elevating the role of theory within their respective fields. For example, in the first five

years of RAST (i.e., 1996-2000), theory papers comprised 42% of published papers. Given this

intention, it is striking that 15 years later theory papers consistently comprise only 10% of papers

in RAST.

The vast divide between theory and empirical work also manifests in the training of

future generations of accounting researchers. While every top research university offers theory

seminars in finance and economics, it is not the case for accounting. The number of accounting

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researchers with sufficient quantitative training to produce first-rate theory work is too few to go

around. Hence, theorists are concentrated in only a few schools. As a direct consequence, the

vast majority of accounting doctoral students are not exposed to a theory course in their field of

study. In the absence of exposure and training, it is difficult to imagine theory guiding or

enriching the work of future generations of empirical accounting researchers.

Perhaps as a result of these fundamental differences in training, few theorists have a

grasp on empirical work, and few empiricists have a grasp of theory work. While individual

researchers may have incentives to specialize in either empirics or theory, it is far clear that such

incentives serve the profession. A key feature of the scientific process is the complementarity

between theory and data. However, our sense is that complementarities between theory and

empirical work are valued less in accounting than in related fields, and that the value of these

complementarities has declined over time.

Assuming for the moment that theory-empirical complementarities are valuable in related

fields, why are such complementarities less valuable within accounting? Is it training? Are

features of accounting research topics less amenable to formal modeling than in related fields?

Are theory models in accounting less amenable to empirical testing than in related fields? These

are not easy questions to answer, but attempting to answer these questions helps illuminate our

own biases, the institutional forces that shape our profession, and the unique features of

accounting topics.

The remainder of the document offers a commentary on several thought provoking

questions, with responses broken out by panelist. Each of Sections 2 through 8 corresponds to a

different question. Section 9 concludes and summarizes.

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WHAT ARE THE PRIMARY BARRIERS TO DOING THEORY WORK IN ACCOUNTING?

Daniel Taylor (moderator):

Is this just an issue of training? Of mathematical prowess? My sense is that to make a

theoretical contribution, nowadays you really have to impress people with your mathematical

horsepower. Simple models that make a simple point are no longer welcomeeven if directly

relevant to an institutional setting or set of empirical findings. Instead you need an impressive

display of analytical pyrotechnics that is often inaccessible to a broad empirical audience; math

for the sake of math will get you farther than a simple point targeted at an empirical audience. It

seems, empirical relevance is neither necessary nor sufficient. I know many theorists who

unabashed profess not to care that their work is not accessible by empiricists.

Vincent Glode (panelist):

I disagree with Dan. I think this is how we, junior people, view the profession, that is,

theoretical contributions must be highly technical nowadays. However, I am know a few current

and former editors at top finance journals very well and not a single one of them seems to believe

that simplicity is not better than complexity. I have also been involved in the review process for

my papers and many others that I refereed and there clearly is a concern for simplicity from

journal editors. Editors have a long-term view and care about impact, so they probably want to

minimize the barriers to understanding your contribution. But bear in mind that we, junior

people, do play a role in creating this problem when we act as referees and discussants. The

discussants who tend to ask me to complicate my models are rarely the senior ones, they are

more often the junior ones. And if as referees we do the same thing or we complain that simple

models are perhaps not robust, without really knowing, or we confuse simplicity with

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obviousness, we are contributing to making simple models harder to publish, despite perhaps

what the editors think is best for the profession.

Qi Chen (panelist):

I agree with Vincent that good economic insights do not necessarily need to be proven or

stated using complex models (Modigliani-Miller Theorem is a good example). Dan raised an

important point about training. Information economics is a difficult field and is still being

developed. A solid training in economics and quantitative methods is a pre-requisite for doing

good theory work. However, the average applicant to PhD programs in accounting is ill-prepared

for quantitative training in economics, mathematics, and statisticsespecially when compared to

the average applicant to PhD programs in economics, finance, and other quantitatively oriented

social sciences. This situation is not helped by the fact that most PhD programs in accounting

require only Introductory Microeconomics and Introductory Econometrics courses in their PhD

curriculum and do not have any faculty who do theoretical research. So yes, training is a big

hurdle.

Unfortunately I do not see any urgency by our profession to change the situation. This is

dangerous and damaging to the long-run success of helping accounting academia to be a

respectful research field, as theoretical research is the ultimate source of rigorous new insights

and methodologies. Lack of theory training not only reduces the number of theory researchers, it

also reduces the number of well-trained empiricists capable of absorbing, disseminating, and

testing economic models. Insufficient theory training results in deficient empirical research

empirical research that cannot challenge existing paradigms and inspire new theoretical research.

Instead, published empirical research tends to gravitate towards the theories (or verbal

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conjectures) most recognized by referees and editors (e.g., Jensen and Meckling, 1976) at the

expense of new alternative theories that have the potential to challenge conventional wisdom and

generate significant new empirical predictions.

One example is the issue of whether accounting conservatism is desirable for debt

contracting. The conventional view is that accounting conservatism is desirable for debt

contracting, although the argument is made in a rather ad hoc manner. Perhaps because the

argument is intuitive, and is made by well-known and well-respected scholars in the field (e.g.,

Watts, 2003), the profession has gathered volumes of empirical correlations that appear to

confirm the validity of the argument. Meanwhile, Gigler et al. (2009) provide a rigorous

theoretical analysis of the argument and show that the argument is based on tenuous

assumptions. Nonetheless, it seems that many have already taken the desirability of conservatism

in debt contracting as a truism and any evidence to the contrary must be false.

Should accessibility to empiricists, empirical relevance, or empirically testability be

sufficient or necessary condition for theory papers? The answer depends. Accessibility is perhaps

the most tenuous of all. Even empirical research is not accessible without sufficient training. My

view is that good theories should always have empirical relevance and/or policy implications,

although the distance between a particular paper and its ultimate empirical relevance and

testability depends on the nature of the question being addressed. For example, Arrow-Debreu

general equilibrium theories are perhaps inaccessible to the average researcher, have no direct

testable predictions, but they set up the foundation for future theories that can speak directly to

empirical work. Cynics may also dismiss the Modigliani-Miller Theorem on the grounds that the

assumptions are unrealistic. But it is nevertheless empirically relevant because it formalizes the

necessary assumptions that one has to make in order to generate empirical predictions.

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WHAT ROLE DO EMPIRICAL FINDINGS PLAY IN INFORMING THEORY WORK?

Vincent Glode (panelist):

I think the role played by empirical work in informing theory greatly depends on the

ultimate contribution of the paper. As an applied finance theorist, many of my papers are written

in response to a puzzling empirical fact. This is how I was taught at Carnegie-Mellon --- you

find an empirical fact that appears puzzling and that needs to be explained and you build a model

to explain it. So without empirical facts, there is no paper like that. Other papers are written

around a theoretical insight that I find interesting, even without thinking about the implications

of that insight for the real world. But even these papers end up making a link with empirical

facts because I still want to convince many readers of the economic importance of my insights.

Sometimes, I calibrate the model to show that the mechanism is important quantitatively and can

match some empirical quantities.

I should note that when I submit my papers to finance and economics journals, the

assigned editors tend to be theorists, sometimes they are what we could call pure theorists, yet

they still ask for a good empirical motivation for my models. I suspect that it comes from the

fact that a paper can make a much broader impact if it speaks both to theorists and empiricists

rather than to only one of these groups. You can speak to empiricists by linking your insights to

facts that are already documented but you can also speak to empiricists by linking your insights

to tests that could be implemented in the future.

Qi Chen (panelist):

Empirical research should play a significant role in informing theory work and in

challenging existing theories. Many good theory papers in accounting are motivated by empirical

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findings. For example, empirical regularities about how stock prices (returns) relate to

accounting numbers are the main motivation for a significant amount of theoretical research.

These papers address the role of accounting information in different contexts, for example, its

role in communicating information about firm production (e.g., Kanodia and Mukherji 1996;

Kanodia and Lee 1998; Kanodia, Singh and Spero, 2005), its role in addressing incentive

misalignment, i.e., stewardship role (e.g., Gigler and Hemmer, 1998, 2001), its role in helping

traders forecast future cash flows/dividends (e.g., Verrecchia 1982), and its role in properly

representing value dollar-by-dollar (e.g., Ohlson, 1995).

In each of these contexts, in order to focus on the key issues and gain sharper insights,

researchers often need to turn off key features of other contexts. For example, Ohlson (1995) is

concerned about accounting numbers ability to represent value. Therefore, it starts with a model

where firms dividends are exogenously determined, and focuses on how key accounting

institutional features (book value, earnings, clean surplus relation) can produce a theoretically

correct number (in dollar terms) for the value of the dividend stream. In doing so, it suppresses

investors need for information (e.g., to learn about future dividends) and therefore has limited

value in assessing the usefulness of accounting in settings where investors have incomplete

information (e.g., Holthausen and Watts, 2001). Models dealing with the role of accounting

information in secondary trading markets (e.g., Verrecchia, 1982) address investors need for

information to learn about future dividends, at the expense of suppressing institutional features of

accounting (e.g., balance sheet is not explicitly modeled in these types of trading models). Both

models take a firms future cash flows as given, that is, they focus on the exchange/consumption

side of the economy, suppressing the production side.

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Models on accountings stewardship role have the production side in the background. In

contrast to the pure-exchange type of models where information disclosure does not affect the

underlying fundamentals (e.g., future cash flows) that the disclosure is about, these models

highlight how information system is designed can also alter the fundamentals. In addition to

highlight the importance of accounting measurement, it also shows that it is difficult, and

perhaps not meaningful, to attempt to separate business fundamental quality from accounting

measurement quality as they are intrinsically related.

Kanodia and Mukherji (1996), Kanodia and Lee (1998) and Kanodia, Singh and Spero

(2005) directly address the production side, and contain some of the most significant and

promising insights in recent accounting theory. Unlike most of the agency-based models, this

line of works directly model the separate reporting of firm decisions vs. the outputs of these

decisions, and therefore brings theory closer to capture institutional reality: accounting reports

both balance sheet and income statements, and the measurement issues are related to both the

reporting of decisions (e.g., assets) and of outputs (e.g., earnings). As such, these works have the

potential to shed light on the desirability of key accounting institutional properties, including for

example, the role of accruals, and the role of measurement of firm assets and earnings (see

Kanodia and Sapra (2016) for a review of this literature). Yet, little, if any, empirical research

has assessed the empirical validity and implications of this line of work. This is unfortunate, as

the role of accounting for communicating production related information is no less important

than its stewardship role, or its role in secondary trading markets. It is true that models in this

literature are more mathematically complicated, but certainly not for the sake of mathiness. The

situations they study are inherently more complex and the ideas more sophisticated. Nonetheless,

the fact that the majority of empiricists do not seem to be aware or understand these papers

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means the payoff to a theorist from investing time to learn and absorb their insights is not

immediate.

WHY DO YOU THINK THERE IS VERY LITTLE COLLABORATION


BETWEEN THEORISTS AND EMPIRICISTS?

Qi Chen (panelist):

Mutual misunderstanding contributes to the lack of cooperation. Each focuses on what

the other cannot do. The ironic part is that their criticism for each other is really the same

criticism: theorists think it is impossible to conclude with certainty from a regression of Y on X

that X affects Y (when they believe so many other things in reality could also affect Y);

empiricists think theories cannot really say anything useful when the models are so stylized and

abstract. Lack of training is the key factor: theorists should gain better appreciation for how

empirical studies actually work; and empiricists should improve their understanding of how to

evaluate a model and to draw proper empirical implications from theory.

Joseph Gerakos (panelist):

From a junior empiricists perspective, the primary barrier to collaboration is the fear of

getting rejected by a journal. Unfortunately, this is a healthy fear. It is relatively straightforward

to write a paint-by-numbers empirical paper and push it through a top-tier accounting journal.

When I say paint-by-numbers, I mean, for example, that there are a bunch of studies that

correlate X with A, B, C, and D, so I am going to correlate X with E. The primary objective of

such papers is to document interesting new descriptive facts rather than to develop and test

formal theory. When providing such descriptive evidence, validity threats are few, and ex post

such threats can often be converted into interesting findings to be explored in future research.

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In contrast, consider a joint theory-empirical project. For projects that combine theorists

and empiricists, both parties need to learn how to communicate and collaborate together. This is

non-trivial; empiricists likely lack in-depth theory training and theorists likely lack in-depth

empirical training. Both types of authors will have to learn an entirely different vocabulary and

set of tools. Hence, the joint theory-empirical approach inherently takes longer. Moreover, by its

very nature, the depth of analysismeasured along a single dimensiondoes not match that of

either a pure theory paper or a pure empirical paper. Such a studys contribution relies on

complementarities between theoretical and empirical approaches. Moreover, it is harder to ex

post rationalize results in a joint theory-empirical paper.

Unfortunately, and perhaps due to a deficiency in training, joint theory-empirical papers

do not appear to be valued by many in the profession, thereby leading to a higher likelihood of

rejection by a journal. In terms of incentives, tenure clocks are short. Rationally anticipating the

resistance to joint theory-empirical projects, many faculty opt for the path of least resistance

write pure empirical papers. 3 At the same time, however, the status quo provides opportunities

for researchers who are willing to take risks.

Vincent Glode (panelist):

As Qi and Joseph mentioned, there is a lot of specialization. With short tenure clocks, it

is hard diversify your training, your expertise, and your research. And I think the optimal degree

of specialization may differ from an individuals perspective and from a social perspective. I also

think the concerns that empiricists have when they worry about perfect identification are almost

opposite to the concerns that theorists have when they build a model. Empiricists need to know

3
See Hopwood (2007) and Waymire (2012) for greater discussion of these incentive problems and how they
manifest in our research.

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all the institutional details in order to build a convincing test that shows causalityassuming

causality is the goal. Theorists abstract away all the possible interferences and build models that

focus on one possible mechanism. So in one case, you want to rule out alternative channels, in

the other case, you simply omit them.

I think it is important to understand that the two types of research are trying to play very

different roles. Theorists are not trying to identify all causal channels. Usually, they propose and

explain just one channel. Then empiricists can look for evidence for or against the conjectured

channel.

Daniel Taylor (moderator):

As an empiricist, I think it is important to keep in mind that some of the better theory

papers use simple mathematical models as a tool for illustrating very general economic intuition.

The purpose of such papers is not to model the real world, or to show X causes Y, but to explain

why X might cause Y in a particular setting. Empiricists can then look at the results and ask: (1)

To what extent do the theoretical assumptions comport with the real world? (2) To what extent

do violations of the assumptions alter the intuition that I learned from the theory (i.e., To what

extent is the intuition generalizable)? And ultimately, (3) To what extent do the forces present in

the model manifest in the data? My own sense is that there is very little collaboration between

empiricists and theorists because, when evaluating theory, many empiricists stop at the first

question.

AS AN EMPIRICIST, WHY SHOULD I CARE ABOUT FORMAL THEORY?

Daniel Taylor (moderator):

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To frame the discussion, it will be useful to differentiate between verbal theory and

formal theory as it is applicable to empirical papers. Define verbal theory as using words to

describe ones intuition and using this intuition to develop hypotheses, and define formal theory

as using mathematical expressions to formalize ones intuition and develop hypotheses (e.g.,

Kahn and Whited, 2016).

When it comes to the role of formal theory in informing empirical work, I have heard

many empirical researchers espouse variations on the following sentiments: (1) Why do I need a

formal theory if I can describe it in words? and more extreme, (2) I do not understand the role

of formal theory work in accounting research. If the results are consistent with the data, then I

did not need the theory. If the results are not consistent with the data, then the theory is wrong.

In an empirical paper, what advantages does invoking formal theory to motivate hypotheses and

tests have over invoking verbal theory? Disadvantages?

Joseph Gerakos (panelist):

Theory is important because it forces us to be careful when interpreting conditional

correlations, which is basically all that we do as empiricists. Theory forces a researcher to be

explicit about assumptions that underlie these interpretations. Theory does not, however, require

math. For example, the Coase Theorem is important in law and economics, but the math is

trivial. Nevertheless, it is important to differentiate theory from story-telling. Too much of the

accounting empirical literature is along the lines of I have some intuition, I lay out some broad

predictions that conform with this intuition, and then regress away.

It is important to push back against this approach and force empirical researchers to

rigorously state the assumptions that underlie their predictions, analysis, and interpretations.

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Assumptions and predictions should be laid out in primitives such as supply, demand, costs, and

benefits. I am not saying that you have to use math. Logical calculus can be written out with

words. In fact, I recommend all doctoral students take a class in formal logic. In your research,

be explicit about your assumptions and make sure that they are internally consistent. In

workshops and seminars, force presenters to be clear and open about their assumptions and push

them if those assumptions are opaque or internally inconsistent.

Vincent Glode (panelist):

Whenever I write a theoretical paper, my goal is to change the readers priors. I want to

surprise people. I have an intuition that I consider original, yet relevant, and I start building a

model to illustrate this intuition. As I formalize the intuition, often I derive the specific

conditions under which my intuition works. These conditions inform us about when we should

expect our verbal theory to work and when it should not work. And going back to the quote, I

think that models may contribute to the literature even when their predictions are later rejected

by empiricists. In many cases, it is important to rule out specific mechanisms and we cannot rule

them out empirically if nobody has developed the relevant theory first.

Qi Chen (panelist):

When the hypothetical empiricist starts to look at data, s/he must have some idea on what

to look for. These ideas are usually intuitive conjectures and hypotheses, not theory. Intuition

should not be confused with formal theory. Take the Modigliani-Miller Theory for an example.

Prior to Modigliani-Miller, a reasonable conjecture would be that paying more dividends would

increase equity value. You can see why it is easily confused as a theory, because it appears

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logically consistent: investors like getting dividends, thus equity values of dividend paying firms

must be higher. A hypothetical empiricist might observe a positive stock price reaction to

dividend increases and interpret this as empirical evidence in favor of the theory. However,

under this theory, one would reach the absurd recommendation that it is good for managers to

borrow money or to sacrifice valuable investment opportunities to pay dividends! Formal theory

does not reach this logical absurdity and instead forces researchers to develop new theories (e.g.,

signaling theory) to understand how and why prices change upon dividend announcements.

Intuition is by its very nature incomplete, formal theory can help complete ones intuition.

An accounting example is the Positive Accounting Theory, which is an intuitive

conjecture: it conjectures that observed accounting practices are chosen by self-interested parties.

The conjecture was formed and stated under reasonable logical steps. Under this conjecture,

incentives play a role in explaining observed accounting practices. This conjecture suggests the

need to control for incentive-related variables in an analysis of accounting choices. Without

diminishing its role in the development of accounting profession as a research field, it is perhaps

time to ask is this the only theory that explains accounting practices? Have we exhausted all

alternatives? If the answer is yes, then the obvious next step is that we should quit calling

ourselves researchers because we have identified not just a theory, but a truism that explains

everything. If the answer is no, then what are the alternatives? Why havent we developed a

credible alternative over the last 30 years?

Daniel Taylor (moderator):

To summarize and expand, while it is true that verbal theory is useful for motivating

empirical analysescertainly much of my own work relies on verbal theorymy own sense is

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that there are two key disadvantages. First, because it is by definition based on intuitive

reasoning, verbal theories are limited by the depth of the researchers intuition. While verbal

theory is well-suited for articulating predictions that are intuitive, I would argue thatby

definitionverbal theory cannot generate a prediction that is counterintuitive. This would seem

to highlight the necessity of grounding empirical work in formal theory. Consider a world in

which all empirical predictions are based solely on authors intuitionthen as a field, it would

seem our research would only be as deep as our intuition. And if our research is only as deep as

our intuition, are we really a field of scientific inquiry?

In stark contrast, formal theory can offer predictions that are counterintuitive and can also

be useful for extending ones intuition in directions that would not have otherwise been apparent.

The Capital Asset Pricing Model (CAPM) stands as a prominent example. In the absence of a

formal model, would intuition suggest not only that the covariance between a firms stock return

and the market return is a measure of risk, but the only risk that is priced by the market?

Second, because verbal theories lack mathematical formalism, assumptions and

constructs are often not well-defined. As a result, verbal theory is often much more difficult to

falsify than formal theory. In this regard, formal theory can be viewed as enumerating a set of

conditions (or assumptions) under which a particular result is definitively true. Here too, the

CAPM serves as an excellent example. The assumptions necessary for the CAPM to hold are

generally well understood. In the presence of explicit assumptions, researchers can test the

assumptions and extend the theory. The cycle can then continue. This would seem to epitomize

the scientific process. It is not clear to me that the scientific process can function effectively in a

setting where assumptions and constructs are not well-defined.

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Go back to the example Qi gave on debt contracting and conservatism. A growing

number of empirical studies report correlations that seem to suggest accounting conservatism is

desirable for debt contracting. As scientists, we must be prepared to admithowever unlikely

that it is possible these correlations are collectively spurious. Mathematically formalizing the

argument that accounting conservatism is desirable for debt contracting adds credibility to the

reported correlations because it defines the world (or set of assumptions) under which

conservatism facilitates debt contracting. In other words, it proves existencethat there exists a

world in which conservatism is desirable for debt contracting. One can then ask whether this

hypothetical world and associated assumptions are a reasonable approximation to reality. If the

assumptions are reasonable, the model adds credibility to how researchers are interpreting the

correlations. If the assumptions are unreasonable, the model would seem to cast doubt on the

interpretation.

So to summarize the discussion to this point, I think it is important to bear in mind that

while formal theory is certainly not a precondition for conducting interesting empirical analyses,

it is important to recognize that formal theory can help enrich and guide empirical work in ways

that verbal theory cannot. In other words, motivating empirical work based on formal theory

should be considered value-added.

HOW DOES ONE DECIDE THE PROPER MIX OF THEORY AND EMPIRICAL WORK
WITHIN A GIVEN PAPER?

Daniel Taylor (moderator):

To frame the question, imagine the following scale for the extent to which theory is

integrated into an empirical paper:

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FIGURE 1
Extent to which theory is integrated into an empirical paper

No Full
Integration Integration

(a) (b) (c) (d) (e)


Descriptive Paper that tests Paper that tests Paper that combines Paper that combines
paper predictions predictions both formal theory both formal theory
derived from derived from and reduced-form and structural tests
verbal theory formal theory tests of comparative of comparative
statics statics

Type (a) represents a descriptive paper that reports various correlations without any attempt to

ground those results in theory, verbal or formal, (b) represents a standard empirical paper that

tests predictions motivated by verbal theory, (c) represents a standard empirical paper that tests

predictions motivated by formal theory, (d) represents a paper that contains both formal theory

and reduced-form empirical tests of comparative statics, and (e) represents a paper that contains

both formal theory and structural, or functional form, tests of comparative statics. A key

distinction between reduced-form and structural tests is that the former tests the sign of a

comparative static, e.g., y x > 0 , whereas the latter tests the functional form of the

comparative static, e.g., y x = 2 / N . Papers that feature reduced-form tests often assume a

linear data generating process and estimate regressions where variables of interest are motivated

using formal theory and controls variables are motivated using verbal theory or different formal

theories. Papers that feature structural tests often involve non-linear estimation of the data

generating process, and require not only that all variables are motivated by formal theory, but the

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same formal theory. When is a particular type appropriate/inappropriate? Should every empirical

paper have a formal theory model associated with it?

Qi Chen (panelist):

It depends on the professions current stock of knowledge on the matter. Fama and

French (1993) can be viewed as pure descriptive, but it saves the profession some trouble in

trying to attack/address 10 anomalies at a time. Li (2008) is descriptive, but it discovers and

opens up a whole new subfield for accounting researchers to explore, at least data-wise. These

papers do not need models because their contribution lies in documenting useful empirical

regularities or discovering intriguing new facts.

A better question to ask is whether you have an idea/insight that can make meaningful

contribution. The decision on the mix of theory and empirics should be secondary to the idea that

you want to pursue, and depends on what is the best approach to communicate your idea and

help establish your desired contribution in the best possible way. For example, Bushman et al.

(2004) does not have a formal model, and the empirical specification is ad hoc. It was, however,

among the first empirical analysis on the real consequences of the properties of accounting

information, specifically the asymmetric timeliness in loss recognition (it was published in 2004,

but the first draft was circulated around 1999). Before then, under the joint forces of Positive

Theory of Accounting and efficient market hypothesis, accountants had always regressed

properties of the accounting system (e.g. earnings management) on something else. Given the

amount of empirical papers published in the last ten years relating different variables to proxies

of asymmetric timeliness, it is difficult to establish significant contribution without

theories/models to help develop more precise mechanisms. Another example is Chen et al.

19
(2007), which is among the first to test the idea that managers learn from prices. Evidence

supporting the learning channel highlights the role of stock markets on the real economy, and has

implications for evaluating the efficiency of market designs. Before then, it is believed by many

that managers never needed to learn anything from the market because they know more about

their firms than investors. There is no model in the published version although the empirical

specification can be derived from an analytical structure. In both cases, the referees and the

editors appreciated the potential implications of the ideas behind the results; they greenlighted

the papers so the rest of the profession can explore and debate about these issues.

Vincent Glode (panelist):

I agree with Qi: it greatly depends on the contribution you are trying to make to the

literature. If you are the first person to ever look at a specific phenomenon, (a) is probably fine.

But as more people work on the topic and more information becomes available about the topic,

you want to start exploring the potential mechanisms that drive this finding. That is usually when

you start seeing papers that use insights from formal theories developed by others. Finally, once

we have identified a few channels that qualitatively help explain a phenomenon, we might want

to have a better understanding of their interactions and their relative importance through the use

of (e).

Joseph Gerakos (panelist):

All of these approaches are relevant. As Qi points out, sometimes a purely descriptive

piece can spur future theory work, which can then inform subsequent empirical work.

Unfortunately, while many recognize the value of papers on one extreme, (a), my sense is that

20
few people recognize the value of papers on the other extreme, (e). I often hear researchers state

that all models are wrong so why are researchers testing models. Of course, all models are

wrong. Nonetheless, some models are useful for developing intuition and it is worth seeing how

these models comport with the data.

Consider (c) or (d), a reduced-form paper that uses a differences-in-differences design

around a quasi-natural experiment. Such approaches can be useful to test formal theory. Reduced

form is great for estimating the direction of an effect, but less so for estimating the magnitudes of

primitives. Every paper does not need to have a formal theory, but we need to see more papers

that incorporate formal theory. Finally, I think that it is worthwhile for an empirical researcher to

try multiple approaches to research. Why would you want all of your papers to look the same?

WHAT ROLE CAN STRUCTURAL MODELING PLAY, IF ANY?

Daniel Taylor (moderator):

Consider papers, or hypothetical papers, in the most extreme right tail of the above scale:

structural models. From my perspective, the primary benefit of structural estimation is that it

allows us to formalize our assumptions and estimate latent variables that we would not otherwise

observe. For example, Bertomeu et al., (2016) point out that empiricists use structural estimates

all the time without even realizing it. For example, from the CAPM, Kyles , and Easley and

OHaras PIN, are all estimates of structural parameters that appear in seminal theory models,

and are widely used in empirical research to measure systematic risk and information

asymmetry, respectively. Structural modeling gives meaning to certain correlations in the data;

meanings that might not otherwise be apparent in the absence of formal theory. In many cases,

the explicit assumptions that underlie various formal theory models are known to be violated

21
(e.g., the CAPM assumptions). Nevertheless, structural estimates of parameters in these models

(e.g., ) continue to guide and inform empirical work. Thus, it is important to recognize that

while a formal theory model may not literally hold, structural estimates based on these models

can still help guide empirical research.

Given that empirical researchers regularly use structural estimates in their reduced-form

regressions, and given the prevalence of structural modeling in economics and finance, why are

structural models so rare in accounting? Is it simply an issue of inadequate training? Of some

unique feature of accounting data? Is there a benefit to structural modeling that many are

missing?

Qi Chen (panelist):

I agree with Dan. A related issue is how to quantify and measure information, where

formal models and structural estimation can really help, as the quantity/flow of information itself

is not directly observable and measurable. It would be helpful for our profession to establish

proper perspective on the pros and cons of these different approaches and structural models

specifically. They are tools. None of them is perfect. Each has its own advantage in dealing with

a specific question.

I do not know if structural modeling has a bad rap in accounting. My two cents is that the

profession has never really developed the culture (and ability) to practice it. Some of the issues

brought up earlier on the training of PhD students have a lot to do with this.

Joseph Gerakos (panelist):

22
While training undoubtedly plays a major role, at the same time, accounting structural

researchers need to make the benefits of structural more transparent. The main benefit of a

structural approach is not identification. In fact, a good structural paper goes through all of the

identification exercises that a good reduced form paper goes through and then layers on

structure. I do not understand comments such as I am identifying based on my model. How do

I know that you have the right model? You have infinite degrees of freedom. Good structural

papers take a long time because you have to combine identification with structure.

The benefit of the structural approach is the estimation of economic primitives that can be

used in counterfactuals. Anytime we are interested in magnitudes (as opposed to directions),

more structure is the way to go. For example, Gerakos and Syverson (2015) estimate changes in

consumer surplus in the audit market under various market structures. We were interested in

magnitudes so we had to estimate economic primitives, namely client preferences for the

characteristics of the Big 4 firms and the marginal utility of income. We could not have done this

with a reduced form approach. Nonetheless, we followed the same identification steps as in a

reduced form approach.

There is currently a debate in accounting about whether natural experiments or structural

modeling is the best approach. I think that this debate is a deadweight loss. Each approach has

its use. Other fields have gone through this debate and nothing came of it. The approaches are

not mutual exclusive. For example, why not combine a natural experiment with a structural

model?

Qi Chen (panelist):

23
Heckman (2000) and Heckman and Vytlacil (2007) offer excellent perspectives on the

pros and cons of various empirical paradigms. Natural experiments cannot identify structural

parameters. An exogenous loss of analyst coverage may indeed cause an ex post observable loss

in firms equity value. But a natural follow-up question is: Why? This relates to the relevance of

mechanisms, and the magnitude of each mechanism. These are questions that theory-based work

and structural estimation are best suited to examine.

WHAT CAN WE DO ABOUT THE DIVIDE BETWEEN THEORY AND EMPIRICAL WORK?

Vincent Glode (panelist):

I think that people in this room can play a big role in improving the situation. Becoming

more rounded as researchers should make us better referees and we all know that referees can

make a big difference in how the game is played.

Joseph Gerakos (panelist):

Work with the Ph.D. students and be proactive in the review process. Give editors

feedback. Make a point of highlighting the importance of theory in your recommendations to the

editorboth positive and negative. It is easy to grouse about the state of affairsthe hard part is

to effect change. If you see an empirical paper that is devoid of theory, or runs in the face of

extant theory, do not be afraid to raise this point. We need to be direct in order to effect change.

Qi Chen (panelist):

Journal editors could help by encouraging the submissions and the publications of

theoretical papers, taking the long-term view that an academic profession without theoretical

24
foundations of its own is unlikely to stay strong in the long run (when was the last time any

major accounting journal designates a special issue to the latest advances in theoretical studies in

accounting?).

Given the importance of referees, it is imperative that referees are open to new ideas.

Ohlson (1995) and related works were often viewed by the mainstream theorists as not really a

theory but rather a statistical tautology. Yet, it had a large impact on empirical research. Perhaps

instead of dismissing it, those who are not happy with it can pick up the good part (which in my

view relates to institutional features about accounting) and improve it by incorporating some

economics. A good example is Zhang (2000), but these sorts of papers do not appear to generate

sufficient attention from mainstream theorists. The lack of attention may be due to the fact that

they do not address any agency or information asymmetry problemswhich appear to be a pre-

requisite for many theorists. There are many difficult and interesting problems other than dealing

with a self-interested manager who manages earnings to shirk, and to hide private information.

Perhaps it is time for the accounting profession, both theorists and empiricists, to jump out of the

mindset that agency problems are the only interesting problems.

In this regard, it would be helpful if accounting theorists learn to be nicer to each other,

to appreciate different perspectives; at the same time, to challenge each other in a healthy

manner, creating a learning environment. Theorists need to believe in their own models and try

to put themselves in empiricists shoes (what are the real empirical implications that I would

spend time to pursue, if I were the empiricist). Empiricists need to think like theorists: what are

the new ideas that this theory conveys that are different from what my priors? How does it

change how I should examine the data?

25
CONCLUSION

We emphasize the value of a close link between theoretical and empirical research, and

encourage authors, referees, and editors to do the same. Until complementarities between

theoretical and empirical research are recognized and valueduntil formal theory grounded in

empirical observation is valued higher than theory that is not, and empirical research grounded in

formal theory is valued higher than empirical research that is notthe divide between theory and

empirical research will remain.

We close the panel discussion on an optimistic note. Several observations suggest a new

generation of accounting researchers is interested in bridging the divide between theory and

empirical work. For example, an increasing number of junior researchers have started using

structural models to examine economic phenomenon related to earnings management (Gerakos

and Kovrijnykh, 2013; Beyer et al., 2014; Zakolyukina, 2014; Terry, 2015), voluntary disclosure

(Bertomeu et al., 2014; Cheynel and Liu-Watts, 2015; Zhou, 2015), analysts forecasts (Xiao,

2015), and the audit market (Gerakos and Syverson, 2015); the organizers of the Junior

Accounting Theory Conference recognize the benefit from integrating theory-minded empirical

researchers into their meetings; and importantly, the fields newest journal has taken the

initiative to facilitate the conversation between theory and empirical researchers.

26
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28
Appendix. Time-Series of theory papers in leading accounting and finance journals

Panel A presents the number of formal theory papers published in leading accounting journals: The Accounting Review (TAR), Journal
of Accounting and Economics (JAE), Journal of Accounting Research (JAR), and Review of Accounting Studies (RAS). Panel B
presents the number of formal theory papers published in leading finance journals: Journal of Finance (JF), Journal of Financial
Economics (JFE), and Review of Financial Studies (RFS). We cumulate theory papers over rolling five-year intervals and scale by the
total number of papers published in the journal over the interval. For example, the observation for journal j in year t is computed as the
number of formal theory papers published in journal j from t4 to t scaled by the total number of papers published in journal j from t
4 to t. We identify formal theory papers by searching the text for one of the following words, Proposition 1, Theorem 1, or
Lemma. The search algorithm is not case-sensitive and does not distinguish between formal theory papers with or without
accompanying empirical analyses, and does not distinguish between regular research papers, discussion papers, or review papers. The
scale in Panel A ranges from 0% to 30% in increments of 5%, and scale in Panel B ranges from 0% to 60% in increments of 10%.

Panel A. Accounting Journals. Panel B. Finance Journals.

30% 60%
RAST JAR TAR JAE RFS JF JFE
total published papers over the past 5 yrs

total published papers over the past 5 yrs


Published theory papers as a fraction of

Published theory papers as a fraction of


25% 50%

20% 40%

15% 30%

10% 20%

5% 10%

0% 0%
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Year Year

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