Abstract
This historical review article draws upon two theoretical models to compare state regulatory innovations pertaining to business and accounting practices in two contrasting periods: the Colbert Period, a period of absolutism under Louis XIV in seventeenth-century France; and the period of liberal democracy in the United States in the early twentieth century, during which the US federal government sought to expand its power over the regulation of unregulated capitalist activity. These two contrasting periods of state intervention in business and accounting practices can be characterized as innovations whose underlying design was conditioned by contemporary circumstances. The theoretical models employed include that of Miller (1990), who maintained that a primary “reason of state” (i.e. “political rationality”) justifying intervention in business and accounting practices during the Colbert period was “military competition” between France and other European powers. The second theoretical model employed is based on Clarke (2004), who argued that there is cyclicality to reasons of state focusing on “restoring economic stability” in the face of economic crises. This article identifies innovations in the regulation of business and accounting practices that have helped states to obtain the economic resources necessary for the exercise of sovereignty while maintaining social order within their national boundaries.
Introduction
In this historical review article, two contrasting periods have been chosen to illustrate innovations in the regulation of business and accounting practices, one in seventeenth-century France under Louis XIV, which has been characterized as a period of absolutism. The second period focuses on the United States, in the early twentieth century, during which time the US federal government sought to control the expansion of capitalist activity through regulation of business and accounting practices. Even though distant in time, these two historical periods can be compared in a relevant manner since they both involved “reasons of state” (i.e. “political rationalities”) pertaining tocentralizing the power of the state, military competition, and restoring economic stability. Standardization of accounting practices was present in both of these periods as an important tool of control over business and accounting practices. Far from being anachronistic, the comparison of these two periods more than two centuries apart is justified by the fact that both illustrate the growth of central power, even if this centralizing process was carried out in a monarchical state in the one instance and a democratic context in the other.
The theoretical models employed in this article include that of Miller (1990) who maintained that the principal “reason of state” (i.e. “political rationality” in Miller’s terminology) for intervention in business and accounting practices during the Colbert period was “military competition” between France and other European powers. We have extended Miller’s theoretical model to illustrate two additional reasons why the French state intervened in business and accounting practices during the Colbert period. These two additional reasons were: (1) the need to restore economic stability after the French civil war known as the Fronde; and (2) the efforts by Louis XIV to centralize the power of the state under his absolute authority. The “need to stabilize the economy” is supported by Clarke (2004), who argues that there is cyclicality to state interventions in business and accounting practices in response to periodic crises in economic affairs. We illustrate these three reasons of state through various historical and other bibliographic references (Bovigny, et al., 1999; Clément, 1846; Geant, 1931; Kimmel, 1988).
We have also extended the work of Miller (1990) and Clarke (2004) to the United States in the early twentieth century. The “military competition” rationale for state intervention in economic activity was present in the years preceding and during the First World War. The “need to restore economic stability” was also present following the stock market crash of 1929. In addition, “centralization of the power of the state” emerged during the New Deal Period of the early 1930s. Thus, there are similarities between the reasons of state pertaining to regulatory interventions in business and accounting practices in the two historical periods, even though they are clearly distinct in time, place, and in the nature of the state.
The principal contribution of our article is to illustrate innovations in the regulation of business and accounting practices that have helped states to obtain the economic resources necessary for the exercise of sovereignty while maintaining social order within their national boundaries. In effect, whether to appropriate resources directly or to draw upon the energy of private entrepreneurs to achieve their ends, states require material means not only to maintain and strengthen their power, but also to play the role of arbiter to maintain the cohesion and social order that form the basis of their legitimacy. This legitimacy was virtually unchallenged under the Ancien Regime in France when the monarchy and the social hierarchy were frozen in a moral and religious order which could endure a certain degree of arbitrariness. In contrast, the question of legitimacy has been a constant theme in liberal democracies, where new rights for citizens have been obtained and maintained within a complex set of social regulations and growing egalitarian legislation. In other words, if in the first instance, the monarchy was able to issue edicts and decrees without any significant constraints in order to achieve its reasons of state, in more democratic states the government has needed, in the interests of legitimacy, to employ the economic and social arbitration that is necessary for its survival.
The remainder of this article is organized into three sections. The first section reviews some of the relevant literature that has looked at state regulation of business and accounting practices. The second section compares the Colbert Period in France during the late seventeenth century with the United States in late nineteenth and early twentieth centuries. A final section discusses and concludes the article.
Review of prior literature
In pursuing this historical review article, it is important to define “government” and to distinguish the idea of “government” from the idea of the “state” and also from “arts of government”, both of which have been addressed by Miller (1990). The definition of the “state” employed by Miller was derived from certain lectures on Governmentality given by Michel Foucault at the College of France in the 1980s (subsequently published in Foucault, 1994). According to Lascoumes (2004), Foucault rejected an essentialist approach to the definition of the “state” and therefore he did not provide a specific definition. Foucault’s anti-essentialist perspective led him to an approach which describes certain practices (“arts of government”), including “political rationalities” (i.e. the reasons “why” a state does what it does) and “technologies” (i.e. “what” the state does when it intervenes). Foucault was less interested in ideologies than in the actual procedures and practices pertaining to the governing of populations (Lascoumes, 2004: 3). In the absence of a specific definition, we agree with Miller (1990: 317), that the state comprises: “an assemblage of practices, techniques, programmes, knowledges, rationales and interventions that are at most provided with a temporary unity and individuality”. In this article, we nevertheless use the term “state”, to evoke the exercise of sovereignty over a particular territory for the purpose of maintaining a social order linked to a specific political regime (e.g. absolute monarchy, liberal democracy). Thus, the use that we make of the word “state” is more specific way than the relatively generic definition provided by Miller (1990: 317).
From another perspective, Miller (1990) indicates that the social science literature has articulated several distinct concepts of the “state”, including a functional model, a radical model, and an external model. A functional model focuses on the idea that states come into existence in order to govern a particular territory (Lindblom, 1982). In contrast, a radical model defines the state as an expression of the interests of the ruling class in a particular society rather than the governing authority per se (Tinker, 1984). From a third perspective, an external model seeks to identify reasons for the existence of states, with a focus on reasons related to “military competition”. Miller (1990) argues that “military competition” among geopolitical entities has resulted in large, well organized states which contend for territorial dominance and control of natural resources. Pursuant to this external model, accounting regulations, and in particular, those related to taxation and public finance, are “what” the state does in order to achieve its ends. In other words, according to Miller (1990) one of the primary reasons for intervention by the French state in business and accounting practices during the Colbert period was “military competition” with other nation states. Accounting regulations were introduced by Colbert to promote standardization which would lead to economic development for the purpose of supporting military forces in order to defend and protect the territory of the state.
We have extended Miller’s (1990) theoretical model by demonstrating that during the Colbert period there were two additional reasons “why” the French state intervened in business and accounting practices. The first of these reasons was to “restore economic stability” after the Fronde (a civil war for control of the French state), and the second was to “centralize the power” of the French king.
We also extend Miller’s theoretical model by illustrating state regulatory innovations introduced by the US federal government in the early years of the twentieth century. “Military competition” was present as a reason of state in the years prior to the entry of the United States into the First World War in 1917. This was a period of significant growth in the military capabilities of the United States, including the creation of a world-class naval force that could compete with other nation states. While this focus on military completion subsided after the First World War, the economic crisis of 1929 led to an additional reason for state intervention by the federal government focusing on “restoring economic stability”. Clarke (2004) maintains that state regulation of economic activity is cyclical and that such regulation is related to economic crises and reforms. Regulation of economic activity increases during periods marked by business failures and economic crisis, thereby leading to reforms of the regulatory system. Among the state regulatory innovations introduced after the crisis of 1929 were various aspects of the New Deal legislation which served to “centralize the power” of the federal government in the 1930s.
In summary, innovations in state regulation of business and accounting practices derive from “reasons of state” (i.e. “political rationalities”) involving “military competition”, “restoring economic stability”, and “centralization of power”. These reasons of state are based on the premise that a stable economy requires the existence of a secure sovereign government and an administrative apparatus that is sufficiently well developed to maintain that sovereignty. This often leads to military competition with other states. An efficient and well-developed system of taxation helps to maintain control over a given territory and protect the financial resources of the state. In contexts where sovereignty is challenged or threatened by external conflict, the direct or indirect control of financial resources becomes a matter of strategic importance, in that control of resources facilitates the provisioning of requisite military forces. Accounting in this context becomes a technology for the centralization 1 of the power of the state in order to achieve greater control over economic resources. This centralizing function, to which may be added a general increase in credit and lending activities, contributes to the emergence of regulations to harmonize accounting practices. The transition from an artisanal to an industrial economy and the development of an efficient tax collection administration leads to the creation of enterprises whose innovations and economic importance are such that they become strategic engines of wealth creation through the tax receipts that they generate. Following this logic, the state attempts to encourage economic development in order to restore and maintain economic stability, for reasons of military competition, and to centralize the power of the state. The following sections illustrate innovations in state regulation of accounting and business practices related to these three “reasons of state” in two contrasting historical periods.
Innovations in state regulation of business and accounting practices
This section is divided into two sub-sections, each focusing on distinctly different periods of innovation in the regulation of business and accounting practices. In developing these sub-sections, we have identified prior accounting literature that has focused on the regulation of business and accounting practices. We first consider how an Absolutist royal government introduced innovations in regulation through the issuance of edicts and decrees specifying the nature and form of accounting records.
Innovations in state regulation of business and accounting practices in a period of absolutism
This sub-section illustrates state regulatory innovations during the Colbert period in seventeenth-century France. As argued by Miller (1990), one the primary reasons for state intervention in business and accounting practices in seventeenth-century France was military competition with other major European powers. We extend Miller’s argument to illustrate that there were two additional reasons why the French state intervened in business and accounting practices during the Colbert period. These two additional reasons were: (1) the need to restore economic stability after the Fronde; and (2) the efforts by Louis XIV to centralize the power of the state under his absolute authority. The “need to stabilize the economy” is supported theoretically by Clarke (2004), who argued that there is cyclicality to state interventions in business and accounting practices in response to periodic crises in economic affairs. We illustrate these two additional historical reasons for state regulatory intervention through various bibliographic references (Bovigny et al., 1999; Clément, 1846; Geant, 1931; Kimmel, 1988).
Economic instability in the aftermath of the Fronde
The first half of the seventeenth century in France was a period of political, economic and social turmoil. Henri IV (1553–1610) was assassinated in the aftermath of the Wars of Religion between Catholics and Huguenot Protestants. The death of his son Louis XIII at an early age from tuberculosis led to a civil war between factions of the aristocracy ranged against Cardinal Mazarin and the Queen Regent during the minority of Louis XIV (1638–1643). This civil war is known as the Fronde. The Fronde led to economic instability in which the royal government was in frequent economic and financial difficulty due to an inability to tax the aristocracy. As a result, the government was faced with revolt when it attempted to raise tax revenues (Kimmel, 1988: 15). Ultimately, it was through the financial and accounting acumen of Jean-Baptiste Colbert (1619–1683) that Louis XIV was able to introduce significant innovations in the regulation of business and accounting practices leading to the restoration of economic stability in France.
The rise of Colbert
Colbert was born into a family of wealthy merchants in the city of Reims and he was apprenticed at an early age in an international banking and trading enterprise in Lyon. Thereafter he went on to take a clerkship at the Parisian accounting house, “l’étude Chappelain” and at the law firm of Biterne, where he learned financial law (Soll, 2014: 34). Working in merchant houses and accounting firms provided specific sorts of training, including ars mercatoria, or mechanics of running a firm. These methods had not changed significantly since the Middle Ages even though the use of double-entry book-keeping had become more prevalent and formed the basis of financial and mercantile management. In order to manage a trading house, the merchant needed to be constantly aware of the inventory stock and currencies on hand. This meant diligent record-keeping. Successful trading also required a mastery not only of merchandise – from cloth, metals, plants, and spices to slaves – but also their valuation and measurement. Colbert was particularly skilled in handling the laws and regulations related to exchange and trade, and administrative record-keeping and archiving. Colbert’s accounting, legal and merchant training opened the way to his purchase in 1639 of a position under Cardinal Richelieu during the reign of Louis XIII as a commissary (commissaire ordinaire des guerres). In this position he traveled across France, writing administrative reports and dealing with military finances. In 1650, the army minister, Michel Le Tellier assigned Colbert to be his representative under Cardinal Mazarin who had become the prime minister after the death of Cardinal Richelieu (Soll, 2009: 35).
The meeting of Colbert and Mazarin brought together two complementary spirits. Mazarin had amassed a large fortune through various financial schemes, but he did not have the accounting and financial expertise to manage it. Colbert, on the other hand, had trained in accounting, law and financial management. Mazarin did not know how much wealth he had, or how much he could raise to fund his armies. Mazarin recognized that he needed a good accountant like Colbert not only to put his finances in order, but also to raise money to support the armies necessary for military conflict and competition. During the period from 1650 until Mazarin’s death in 1661, Colbert worked diligently to manage Mazarin’s fortune, which was increased over four times. Upon Mazarin’s death this fortune passed to the King (Soll, 2009: 35).
The period after the Fronde was also a period of economic corruption epitomized by the Superintendent of Finances Nicolas Fouquet (1615–1680), who enriched himself enormously in a way that angered Louis XIV. The wars in which France had engaged during the seventeenth century against other European powers such as Spain, England and the Holy Roman Empire, led to deficits in the royal treasury as well as disorder in the royal accounting records and inefficiency in the calculation and collection of tax revenues. This disorder in the accounts was made worse by fraud, which was ultimately revealed, resulting in Fouquet’s arrest in 1661 and eventual death in prison (Kimmel, 1988). Colbert was instrumental in perpetuating the downfall of Fouquet, and he insisted on the need for secrecy in the arrest of Fouquet and the acquisition of his secret papers which revealed the extent of his corruption.
After the death of Mazarin in 1661, Louis XIV decided not to appoint a prime minister. According to Soll (2009: 50), the reason for this was because: “Colbert was Louis’s most important confidant and the keeper of his secrets”. 2 In his role as Minister of Finances, Colbert became centrally involved in restoring the French economy to financial stability after the economic instability caused by the Fronde and the financial corruption of Nicholas Fouquet under Mazarin. Colbert was able to create a balanced budget and promote a favorable balance of trade. His market reforms included the foundation of the Manufacture royale de glaces de miroirs in 1665 to compete with the importation of Venetian glass. He also founded the royal tapestry works at Gobelins. Colbert also worked to protect the domestic economy by raising tariffs and by encouraging public works projects. During his period as Minister of Finances Colbert issued more than 150 edicts and ordinances to regulate business and accounting practices, including the Ordonnance 1673, also known at Le Code Savary which required merchants and bankers to keep written records in books of account that were required to be signed by a public official (Ames, 1996).
The importance of military competition
It is important to note that throughout Louis XIV’s reign, France was a leading European military power, engaging in three major wars and two minor conflicts. Thus, an important reason why the French State introduced innovations in the regulation of business and accounting practices was related to military competition with other European powers (Church, 1972; Lossky, 1994). The French army in the latter part of the seventeenth century was estimated to number between 350,000 to 400,000 men and its annual cost was more than 55 million livres per year out of a total state budget of 165 million livres (Beik, 2000: 104). 3
To support the costs of military competition, the King had two primary sources of revenue: “ordinary” and “extraordinary”. “Ordinary” revenues were received from properties belonging to the King, while “extraordinary” revenues were derived from taxes. During the reign of Louis XIV, “extraordinary” revenues constituted the primary source of revenues for the royal government (Beik, 2000). Among the tax revenues were: La gabelle (tax on the royal salt monopoly); La taille (an annual tax partitioned out among 32 tax jurisdictions based on the revenue requirements of the royal government); and La capitation (a direct tax created in 1695 assessed per person and based on revenues) (Bovigny et al., 1999). The average annual tax revenues received by the King between 1683 and 1687 were about 105.1 million livres, of which an annual average of 42.5 million livres came from the taille, 55.5 million livres came from the gabelle, and the remainder (7.1 million livres) came primarily from the sale of the rights to collect the gabelle (Beik, 2000: 90).
The taille was a considered to be a burdensome and oppressive tax by the French middle and lower classes, in that the nobility, clergy, court, and government officials were exempt from the tax. In certain parts of the France, referred to as pays d’élection, the amount of tax was fixed by the Intendants and divided among the tax districts. The tax was collected by prominent local persons, who were responsible for the full payment. In other parts of the Kingdom, called the pays d’état, the taxes were referred to as a don gratuit (or “benevolence”). In these areas, the taille was not as heavy a burden and it did not discourage industry and agriculture. While, the amount of the tax was fixed by the Intendants the provincial authorities had some influence in its division among districts and individuals.
Colbert introduced innovations in the method of calculating the taille and its division among the various tax jurisdictions. He scrutinized all claims to exemption, and reinstated properties that had avoided taxation under various pretexts. He also developed a more careful supervision of the collection of the taille by urging Intendants to control the tax collectors; he gave rewards to those who collected the tax with the least amount of cost, and punished the most wasteful.
Miller (1990) indicates that Intendants became very important during the Colbert period as multi-functioned administrators who operated as general representatives and agents of the King. The post of Intendant was held through a royal appointment and not through purchase. Intendants were granted wide powers of investigation in various areas such as administration of justice, police and finances, including tax administration (Miller, 1990: 326). Thus, whether it was a question of revenue derived from royal domains or from tax collection, the regulatory innovations introduced by Colbert in the areas of administration and tax collection created a need for formalization of accounting practices which was gradually extended to all merchants and traders (Miller, 1990). 4 The idea of accounting standardization derived from the effort to centralize the absolute power of the French state. According to Soll (2009: 50): “Louis and Colbert worked to transform the culture of statecraft, making archival and managerial cultures from accounting central to kingship”. 5 Following this logic, and according to Soll (2009: 64): “In spite of the fact that true double-entry bookkeeping was not done at an official level, the verifications of the États de la Dépense et Recette du Trésor (1662–81) show that a sophisticated form of state accounting emerged during the ministry of Colbert”.
Innovations in the regulation of accounting practices under Colbert
In his discussion of the Colbert period, Miller (1990) illustrates Foucault’s (1991: 96–97) argument that, in the seventeenth century, the “arts of government” crystalized around “reasons of state” (i.e. “political rationalities”) and “edicts and decrees” (i.e. “technologies”) which were directed towards the standardization of accounting practices. A prime example was the Ordonnance 1673, also known as Le Code Savary because Jacques Savary, a Paris merchant, was asked by Colbert to draft the ordinance which appeared in 1673.
The Code Savary was the first codification of the laws applicable to accounting regulation in France. The Code simplified and clarified previous customary law, and it was intended to apply throughout France. The Code required every merchant and banker to keep written records of transactions in a book signed by a public official. The merchants and bankers were also required to prepare semi-annual inventories of their fixed and movable assets as well as their accounts receivable and debts payable. Through this regulation of accounting practices, the Code Savary was intended to present a clear view of the merchant’s ability to pay his debts out of existing assets in the case of bankruptcy. If a merchant did not keep authenticated records, the bankruptcy was considered to be fraudulent and the merchant could be subjected to the death penalty. The Code Savary also authorized the formation of limited liability partnerships 6 (Chatfield, 1996).
Discussion
While the innovations in state regulation of accounting practices pertaining to taxation and merchant accounting introduced by Colbert can be considered to have had a central role in facilitating the centralization of the French state and achieving economic stability after the Fronde, it is also important to consider Soll’s (2014) argument that Colbert’s innovations were doomed to failure because they did not promote transparency in economic affairs. During his period of his service as Minister of Finance to Louis XIV, Colbert created miniature double-entry account books for the King, showing expenditures and revenues. For the King, who wanted to change France in significant ways, while simultaneously waging costly wars, this information was useful in the arts of governing. However, when Colbert died, Louis reverted to centralizing absolute control and secrecy. One of the paradoxes of accounting can therefore be expressed: clear and transparent accounting is a necessary prerequisite for political and economic success but it also implies accountability. Ultimately it was threatening for an absolute monarch to be forced to respond to the reality of accounting numbers (Soll, 2014). Consequently, the innovations introduced by Colbert benefited primarily a monarch who recognized the power of accounting knowledge. The information developed, however, was not shared, thus contributing to uncertainty about economic affairs that had the effect of stultifying growth and eventually led to the demise of the Ancien Régime.
Soll (2014) also argues that the quest for centralization and absolutism through control of information was not limited to accounting. Colbert created great libraries to gather and monopolize information and knowledge that would enhance the power of the monarchy. Again, the problem was not the development of knowledge resources but rather the secrecy surrounding its access and use. As Soll (2014) indicates, the purpose of knowledge was not only to fight wars, it was also vital in centralizing the power of the state. 7 In contrast to liberal democracies, the centralized information monopoly created by Colbert was designed to centralize royal power rather than to arbitrate and to regulate relations between economic agents.
In summary then, Miller (1990) indicates that the late seventeenth century was a significant time of innovation in state regulation of business and accounting practices, in particular, with respect to the “arts of government”. He has also argued that rules and regulations were utilized to achieve “reasons of state” (i.e. “political rationalities”) focused on “military competition” with other nation states and the concomitant need to raise sufficient tax revenues to maintain a large standing army. Colbert employed “technologies of government”, including rules and regulations pertaining to accounting, in order to achieve economic development and stability. In this way, accounting rules and regulations and reasons of state were linked. In other words, the creation of economic stability and a unified set of accounting regulations allowed economic prosperity, which enhanced the military power of the state.
Innovations in business and accounting regulation in a period of liberal democracy
This sub-section discusses innovations in the regulation of business and accounting practices in a period of liberal democracy. In this sub-section we extend the work of both Miller (1990) and Clarke (2004) to the United States in the early twentieth century. The “military competition” rationale for state intervention in business and accounting practices appeared in the years preceding and during the First World War. The “need to restore economic stability” was also present following the stock market crash of 1929 in which Clarke’s (2004) theories regarding cyclical regulation of economic activity were also pertinent. In addition, “centralization of the power of the state” appeared in both the Progressive era and New Deal periods. Thus there are similarities between the reasons for state interventions in business and accounting practices in the Colbert period in France and the early twentieth century in the United States, even though these two periods are distinct in time and place, as well as in the nature of the state.
Innovations in state regulation of business and accounting practices prior to the First World War
In contrast to many European countries where there is a unified set of laws throughout the territory of the state, in the United States there are multiple jurisdictions divided among the federal government and the 50 state governments. Pursuant to the US Constitution, business and accounting regulation has typically been a matter for the state governments; the federal government played virtually no role in business or accounting regulation prior to the end of the nineteenth century. This lack of power over regulation of business and accounting practices by the US federal government began to change in the late nineteenth and early twentieth centuries as a result of the rise of a political movement known as the Progressive movement (Buenker et al., 1986). Followers of the Progressive movement argued for federal regulation of business and accounting practices in order to reduce corruption, enhance economic competition and limit the power of monopolistic capitalist interests. While this reason of state was not directly related to restoring economic stability, it was motivated by a political economic rationale in that it sought to enhance economic competition. For example, the federal government enacted a law regulating railroads in 1887 (the Interstate Commerce Act), and one preventing large companies from controlling a single industry in 1890 (the Sherman Antitrust Act). These laws were not rigorously enforced until the years between 1900 and 1920, when Republican President Theodore Roosevelt (1901–1909), Democratic President Woodrow Wilson (1913–1921), and others sympathetic to the views of the Progressive movement came to power. Thus, the Progressive movement was responsible for the introduction of various legal and accounting regulatory technologies which were focused on reasons of state pertaining to political economy (Buenker et al., 1986).
Military competition as a reason of state prior to the First World War
With reference to the First World War, Stevenson (2004: 179) has indicated that there was a “self-reinforcing cycle of heightened military preparedness which was an essential element in the conjuncture that led to disaster. The armaments race was a necessary precondition for the outbreak of hostilities [in World War I]”. From the perspective of the United States, participation in the First World War was made feasible by an accounting technology; namely the passage of the United States Revenue Act of 1913 which incorporated an income tax. Prior to the passage of the Revenue Act of 1913, income taxation was prohibited in the United States pursuant to the US Constitution. The 1913 Revenue Act became law in October 1913 because the US Constitution had been amended in February 1913 as a result of political pressures exerted by the Progressive movement to allow income taxation. It is questionable whether the Unites States government would have been able to obtain the economic resources necessary to enter World War I without the tax revenues provided by the Revenue Act of 1913 (Thorndike, 2015).
In the first full year of the Revenue Act of 1913, tax revenues were only $28 million. The preparations for the entry into World War I greatly increased the need for tax revenue and the federal government responded by passing the 1916 Revenue Act. The 1916 Act raised the lowest tax rate from 1 percent to 2 percent and raised the top rate to 15 percent on taxpayers with incomes in excess of $1.5 million. The 1916 Act also imposed taxes on estates and business profits. Driven by the First World War and primarily funded by income tax revenues, in 1917 the US federal budget was almost equal to the total budgets for all the years between 1791 and 1916. Needing still more tax revenue, the War Revenue Act of 1917 lowered exemptions and greatly increased tax rates. Another revenue act was passed in 1918, which raised tax rates once again, this time raising the bottom rate to 6 percent and the top rate to 77 percent. These changes increased revenue from $761 million in 1916 to $3.6 billion in 1918, which represented approximately 25 percent of Gross Domestic Product (GDP). Thus, a primary “reason of state” related to “military competition” led to an innovation in state regulation of business and accounting practices through the accounting technology of income taxation (Thorndike, 2015).
Innovations in rate of return regulation
Rate of return regulation was introduced by the US federal government during the Progressive era as a way of regulating large concentrations of economic power and monopolistic practices. This type of regulation was related to the state focusing on restoring and maintaining economic stability. As an example, the Interstate Commerce Commission (ICC) was created by the federal government pursuant to the Interstate Commerce Act of 1887 for the purpose of regulating railroad tariffs. The ICC was given the power to set maximum rate tariffs and to eliminate price discrimination. The regulatory power of the ICC was subsequently expanded when the federal government enacted new legislation, including: the 1893 Railroad Safety Appliance Act pertaining to regulation of railroad safety; the Elkins Act (1903) which increased penalties for rate fixing; and the Hepburn Act (1906) which authorized the ICC to set maximum railroad rates based on accounting rate of return on invested capital (Stone, 1991).
The Hepburn Act authorized the ICC to set “fair and reasonable” rail tariffs and rates and to develop uniform accounting regulations for railroads in the United States. The ICC issued accounting rules and regulations for all railroads that came under its jurisdiction (i.e. those operating in interstate commerce). The accounting rules and regulations were similar to the ones that had been issued in 1894, but those rules had not been previously enforced. In the more progressive era of the early twentieth century, railroads were now compelled by the Hepburn Act to recognize depreciation expense and a corresponding reserve (i.e. accumulated depreciation) for their “non-permanent” fixed assets (i.e. rail equipment). The railroads resisted this new theory of “economic depreciation”, because they preferred their traditional method of “betterment” accounting whereby the cost of new equipment was charged to operating expense rather than recording depreciation expense on existing equipment. While this debate between the US federal government and the railroad industry over an accounting technology increased the ICC’s authority to issue and require accounting rules and regulations, the ICC eventually compromised and allowed “betterment” accounting for track and railway structures, a compromise that would result in divergent accounting treatments of depreciation expense among railroads and other companies in the United States for over 70 years (Heier, 2006).
Securities regulation
After the First World War, the United States entered a period of economic prosperity in the 1920s. As Clarke (2004) points out, there was a cyclical pattern of regulation in which Progressive movement attempts to control capitalism were relaxed or not enforced. Thus, it was not until the Stock Market Crash of 1929 and the start of the Great Depression that an increase in the cyclical pattern of economic regulation of economic activity developed in the New Deal legislation of the early 1930s.
One of the most significant innovations in the regulation of business and accounting practices in the United States was the federal Securities Act of the 1930s. The Securities Acts were based on the regulatory perspective of the drafters of the legislation, which were heavily influenced by Professor Felix Frankfurter of Harvard Law School (Parrish, 1970). This perspective focused on centralized control of American capitalism by the federal government and restoring economic stability. Given this perspective, and the Roosevelt administration’s commitment to encourage private investment as the key to economic recovery, there was an emphasis on cooperation with the financial community and self-enforcement by private sector entities (Braeman, 1972). The specialized knowledge possessed by professional accountants was considered to be important for the efficient functioning of capital markets. Hence, the primary objective of the legislation was the preservation of American capitalism through the restoration of economic stability (Parrish, 1970: 93).
The first of the New Deal’s measures, the Securities Act of 1933, required issuers of securities to file accurate and complete information about their companies with the Federal Trade Commission. The Securities Act of 1933 passed Congress without a major struggle. This act also specified that securities offered for sale to the public must include financial statements prepared in accordance with generally accepted accounting principles and audited by independent accountants. Material misstatements of financial information or failure to include material financial information would be considered fraud. However, the penalties were not rigorous and the defense of “lack of intent to defraud” was relatively easy to prove.
The continuing public anger over the 1929 Wall Street collapse and the revelations of financial misconduct produced by Congressional hearings in 1933 resulted in a second securities law in 1934 which was much more encompassing and strict in its regulatory intent. This legislation was described as imposing drastic organizational changes for the financial community (Parrish, 1970). The legislation’s high margin requirements threatened brokers and bankers with reduced volume. The Securities and Exchange Act of 1934 also created the Securities and Exchange Commission (SEC), with authority to prescribe the accounting standards (i.e. Generally Accepted Accounting Standards) that were required to be followed in the preparation of financial reports (Douglas and Bates, 1933). Many business enterprises were against the requirement to file an annual financial statement with the SEC which would include public disclosure of the financial affairs of listed corporations and audited financial statements prepared in accordance with specific accounting standards. However from its inception, the SEC became highly influential in the creation of accounting standards, primarily by working closely with the New York Stock Exchange and the American Institute of Certified Public Accountants. As an example of the SEC’s continuing influence on the establishment of accounting standards, for most of the twentieth century it prevented any attempts to move away from historical cost accounting in financial statements. This position was a reaction to the speculative trading and financial scandals of the 1920s (before federal regulation) whereby listed companies would revalue their assets upward, often based on questionable evidence of market value. The abuse of this accounting practice, especially in the electrical utility field, misled investors during the financial crisis of 1929. The SEC was determined to prevent a repetition of this accounting abuse (Zeff, 2005).
The innovations in regulation of business and accounting practices introduced by the Securities Acts of the 1930s fundamentally changed the relationship between shareholders, boards of directors and corporate management. Clarke’s (2004) argument about cyclical patterns of regulation and reform are clearly illustrated by the 1929 crash and the reforms enacted through the Securities Acts of the 1930s. One important provision of the 1934 Act was the anti-fraud provision, which specifies that it is “unlawful for any person, directly or indirectly, to use or employ, in connection with the purchase or sale of any security registered on a national securities exchange any manipulative or deceptive device or contrivance”. This provision allows the US government, through the SEC, to pursue corporate fraud wherever it occurs (Cox et al., 2009).
Innovations in public utility regulation
One of the major accounting scandals of the 1920s involved electric public utility companies. By the late 1920s, the electricity generating industry in the United States had become highly concentrated due to mergers between companies, leading to what were referred to as “public utility holding companies”. The federal Public Utilities Holding Company Act of 1935 (PUCHA) introduced federal regulation of the public utility industry by restricting the operations of such companies to a single state, and also subjecting these companies to rate of return regulation based on a maximum accounting rate of return on invested capital. 8 In addition, no electric generating company could engage in other types of businesses. This led to the dismantlement of the public utility holding companies in the United States (McCraw, 1971).
The regulatory approach of the Roosevelt administration with respect to the public utilities industry was very different from the type of regulation imposed on the investment banking industry by the Securities Acts of 1933 and 1934 (Parrish, 1970). The PUCHA law specified that all public utility holding companies would be dissolved by 1940 except those whose existence was necessary for the operation of a geographically and economically integrated system. This represented the complete elimination of a private sector industry through federal government regulation which was a completely unprecedented event in United States history. A number of factors combined to make the electric power companies politically vulnerable. A study of the electric power industry by the Federal Trade Commission revealed the accounting abuses of the public utility holding companies with respect to transferring funds from operating companies, over-stating accounting for fixed assets as a basis for excessive rates, and manipulating the securities market, as well as their failure to provide geographical integration or efficient utilization of existing power resources and a lack of regulation by the federal or state governments. There was considerable political opposition to the Roosevelt administration’s efforts to dismantle the electric power industry, but eventually the legislation was approved in the United States Congress by a close vote (Braeman, 1972). The legislative and political struggle over the Public Utility Holding Company Act of 1935 demonstrated the difficulties faced by the federal government in introducing innovations in the regulation of business and accounting practices that threatened entrenched economic power (Parrish, 1970); however, ultimately the federal government prevailed in this political dispute and the public utilities industry was dismantled with a long-lasting impact on electricity generating in the United States that remains to this day.
Discussion
One of the primary questions in the United States with respect to regulation of business and accounting practices is “what is the general purpose of regulation?”. It can be seen from the examples presented in the previous sections that “military competition”, “restoring economic stability” and “centralizing the power of the state” were present in the early years of the twentieth century as reasons of state leading to regulatory interventions in business and accounting practices. Centralizing the power of the state was justified by a political reason for regulating business monopolies in the public interest. In this context the US federal government used accounting technologies to regulate market forces by specifying maximum tariffs and maximum accounting rates of return on capital investments. In order to introduce this type of regulation the federal government needed to rely heavily on accounting regulatory technologies. This reliance ultimately led to the standardization of accounting practices through the mandating of uniform accounting methods for business entities.
The second reason of state related to centralization of state power involved the protection of public safety by reducing hazards inherent in defective products, food or drugs. This reason of state also had an economic dimension related to the state’s involvement in protecting the investing public by establishing accounting rules and regulations to improve the reliability and timely production of information essential to the operation of capital markets. The reasons of state related to centralizing the power of the state distinguished the mission of the ICC from that of the SEC. Although the ICC sought to provide information for investors, its main task was to regulate prices using accounting rules and regulations. In contrast, the SEC concentrated on assuring high quality accounting information and transparency for investors. Thus, in contrast to the Colbert Period in France, where the emphasis was on secrecy, the move towards increased state regulation of business and accounting practices in the United States in the early twentieth century was characterized by greater transparency and accountability through the establishment of standardized accounting rules and regulations.
Conclusion
In this historical review article we have illustrated various innovations in the regulation of business and accounting practices in two contrasting periods. We first looked at edicts and decrees issued during the Colbert Period in France which involved the regulation of the system of taxation and the issuance of regulations regarding the nature and format of accounting records. These edicts and decrees were based on reasons of state (i.e. “political rationalities”), which Miller argues were principally related to military competition among major European powers. However, as Clarke (2004) points out, innovations in the regulation of business and accounting practices have often occurred during periods of economic crisis, thus requiring state intervention to restore economic stability. Economic instability was present in mid-seventeenth-century France as a result of the Fronde and the political corruption under Cardinal Mazarin. It was not until innovations in the regulation of business and accounting practices were introduced by Colbert that economic stability was restored. However, because Colbert insisted on the secrecy and centralization of the power of the state, this system of state regulation failed to sustain the primary reasons of state pertaining to military competition and economic stability. After the death of Colbert, Louis XIV reverted to centralizing the absolute power of the state.
In contrast, in the United States in the early twentieth century there were confrontations among the federal government and capitalist interests for control of the state. In order to control unregulated capitalist interests, the federal government introduced innovations in the regulation of business and accounting practices. The purpose was to both restore economic stability and to create protections against rapacious business practices, but the result was much greater centralization of the power of the US federal government.
The state regulatory innovations of business and accounting practices described in this article occurred in two distinct historical periods during which there was an increasing centralization of royal power in seventeenth-century France, and a strengthening of federal power in the United States in the early twentieth century. An important distinction can be made between these two historical periods in that the centralization of royal power in seventeenth-century France was bounded by secrecy which ultimately led to the downfall of the Ancien Régime, while the primary reason for federal regulation of business and accounting practices in the early twentieth century in the United States was greater transparency and accountability of business activity to the public interest.
Through our extension of Miller (1990), who primarily focused on the Colbert period, to the United States in the early twentieth century, we illustrate how the past can be used to explain a later historical period. The primary argument underlying Miller (1990) was with regard to the central importance of “military competition” during the Colbert period. We have extended Miller (1990) to illustrate two additional reasons of state (i.e. “political rationalities”), namely the “centralization of the power of the state” and the “stabilization of the economy”. Taken together, these three “reasons of state” are important for the maintenance of an organized state and therefore they represent the expression of an intentional political policy. From this perspective, “reasons of state” are not random, but instead respond to a certain political logic. The function of economic regulation may have been somewhat different under Louis XIV than it was in the early twentieth century in the United States where a set of relatively sophisticated institutions were created to control the economy. Our reliance on the theoretical perspective of Clarke (2004) however, is pertinent, in that economic instability and financial crises have led to corrective “technologies” (e.g. laws and regulations). Thus, the three reasons of state (i.e. military competition, centralization of power, and restoring economic stability) can be said to be based on political rationality and political intent. Otherwise, there would be little reason for the existence of interventions by the state in the regulation of business and accounting practices.
Footnotes
Funding
This research received no specific grant from any funding agency in the public, commercial, or not-for-profit sectors.