The Enlightenment’s connections to two US accounting-based regulatory models

Introduction

The eighteenth-century Enlightenment engendered new patterns of social thought that still affect contemporary perspectives. New beliefs about the virtue of individual liberty and the pursuit of material betterment challenged traditional absolutist notions about the ordering of political and religious life. These changes in outlook became linked to a growing desire for the expansion of knowledge, especially to those fields of understanding of a practical nature which could improve humankind’s material lot.

These trends created the need of new definitions involving the proper relationship of the individual to the broader socioeconomic context. The idea of a social contract, first advanced by Thomas Hobbes in the seventeenth century and amplified in the following century by John Locke, Jean-Jacques Rousseau, and others, became particularly important to the leaders who transformed America and France in their rejection of monarchy and proposal of new republican forms of government. While the Enlightenment encompasses the late seventeenth century through early nineteenth century, this article concentrates on American Enlightenment writers of the late eighteenth century. The men now known as the United States’ founding fathers (Benjamin Franklin, John Adams, Thomas Jefferson, James Madison, Alexander Hamilton) ¹ were highly attuned to a changing intellectual dynamic. Although generally agreeing about broad principles relating to life, liberty, and the pursuit of happiness, two different models emerged about the nature of the relationship between the individual, the state, and the economy. One, championed by Thomas Jefferson, contemplated a polity composed primarily of small farmers and businesspeople operating without substantial direct governmental oversight. Jefferson’s framework, extended in the nineteenth century by Andrew Jackson, favored greater devolution of power over economic affairs to localities. In a largely agrarian society centered in dispersed small towns, this encouraged the resolution of important public issues through the collaborative efforts of cooperative private groups and associations. The alternate system favored by Alexander Hamilton envisioned a strong, activist federal government with two primary purposes: (1) to promote a national economic agenda and (2) to ensure that the commonweal did not suffer from selfish pursuit of individual advantage. This Jeffersonian–Hamiltonian dialectic played a central role in shaping the ways that accounting evolved as a mechanism of social governance and control.

Many researchers have investigated how accounting affected key products of Enlightenment thinking, namely, capitalism and republicanism. German historicists such as Max Weber, Werner Sombart, and Joseph Schumpeter argued that accounting was a critical prerequisite for the rise of Western capitalism which provided the material basis for the extension of Enlightenment thought, a view subsequently challenged by Basil Yamey and Sidney Pollard (see Carruthers and Espeland, 1991; Tribe, 1995). Both Goldthwaite (2015) and Lane (1953) have emphasized the accounting role in ordering affairs in the Florentine and Venetian republics. Lane (1966) also argued that the flourishing of Renaissance capitalism actually depended on the emergence of the proto-republican ideals cherished by the Enlightenment thinkers. Mepham (1988a) has linked the rise of the accounting profession directly to prominent Scottish Enlightenment thinkers; others have discussed ways in which governments employed accounting to embed Enlightenment ideals (Galhofer and Haslam, 1994a, 1994b; Sanchez-Matamoros et al., 2005). Lemarchand (1999) and Soll (2009) both document the French government’s eighteenth-century extension of accounting’s scope to facilitate state finance and taxation. Napier (2001) finds that accounting’s constant evolution echoes an Enlightenment legacy in the belief of perfectible progress.

We contend that the Enlightenment ideals, which found expression in the writings of Jefferson and Hamilton, have had a strong impact on shaping a national outlook about government possibilities and in that way informed modern accounting regulation. We do this by exploring the different ways that the federal government used accounting knowledge, including measures of profitability, efficiency, and liquidity to ensure the probity of corporate reporting. This occurred initially in the late 1880s through the Interstate Commerce Commission’s (ICC) attempts to control the monopolistic railroads, and later, in the 1930s, efforts to ensure the viability of the nation’s financial markets through the Securities and Exchange Commission (SEC). The following section analyzes the writings of Jefferson and Hamilton to expose what they believed to be the proper relationship between citizens and their republic. In the third and fourth sections, we examine the influence of these differing perspectives on the use of accounting knowledge in advancing the regulatory missions of the ICC and SEC. The “Conclusion” section evaluates what this experience tells us about the role of specialized knowledge in ordering a society, which evolved from its early base in agriculture and small, disperse localities to a more complex and interdependent one based in industry and populous urban centers.

Enlightened ideas and American perspectives

While the term Enlightenment encompasses many intellectual perspectives, a general characterization of the movement would include a rejection of a worldview framed by religious enthusiasm and zealotry in favor of scientific investigation and attempts to apply knowledge to practical matters (Staloff, 2005: 30). Enlightenment thinkers expressed a belief in progress and individual liberty and were intent on disseminating knowledge to a wide audience beyond educated elite groups, through such channels in democratic societies as a free press, education, libraries and publishing (Commager, 1977: 37–43; Staloff, 2005: 18). Enlightenment thinkers, in particular John Locke, also emphasized the importance of individual civil and political rights (Fraser, 1999: 69). Government, whether explicitly or implicitly, was seen as deriving legitimacy from the governed, as Hamilton (1775) stated, “…. the origin of all civil government, justly established, must be a voluntary compact.”

Governments could exercise power to impose regulations and sanctions to curtail individual interests. In addition, both formal and informal groups, often with state support, sought to extend authority over particular societal functions. State-chartered guilds and corporations regulated various economic affairs. Intellectuals sought to advance understanding in their special fields through learned societies, universities, and political associations.

In Europe, Enlightenment writers looked with favor on commerce because a thriving economy and the creation of wealth had the potential to produce benefits for many people. Governments sought to enhance their power through varied economic policies. This was especially true in America where Enlightenment leaders were both politicians and businessmen (Commager, 1977: 16). They saw the nation in terms of competitive groups that contributed to the national economy: skilled laborers or urban merchants, holders of both large and small lands, as well as residents of small or large states. They believed in the power of commerce and recognized that their nation drew strength from the involvement of diverse groups (McCraw, 2012: 5). Enlightenment ideals eventually fostered revolution and the formation of an independent republic. The new nation’s founders recognized they had the unique opportunity to devise a beneficent society that could protect individual rights while inspiring communal activity and commerce. The only problem was related to the details of achieving such a society.

As reflected in The Federalist Papers, ² the debates about government formation originally involved questions about whether individual states or a federal authority should predominate. There was also the question of how to ensure that large states did not overwhelm the interests of the small ones. The Articles of the US Confederation, ratified in 1781, gave primacy to the individual states. The following US Constitutional government in 1789 centralized power but allocated it among three equal branches of government: executive, judicial, and legislative. The role of states’ rights versus the central government, however, remained unsettled until the American Civil War. These issues echoed an abiding foundational dispute: should government be solely informed by the will of the people, or would a strong central government be needed to ensure the persistence of an effective union?

Two schools of thought in this area were articulated by Hamilton and Jefferson. Both men believed that institutions could be devised to promote liberty and material betterment, and Jefferson was optimistic about individuals’ potential to jointly act in the society’s best interest. In contrast, Hamilton did not believe that the innate good character of the elite was sufficient to foreswear selfish interests in pursuit of the common good. Instead, he believed an entity needed to exist outside the reach of individual interests to force compromise and adherence to strictures beneficial to the commonweal. This unifying structure would ensure that the union as a whole could continue in the face of irreconcilable differences between interest groups (McCraw, 2012: 51).

Hamilton’s solution to the problem of self-interest (i.e. a strong, central government) echoed in some ways beliefs advocated by two very different pre-Enlightenment characters, Jean-Baptiste Colbert and Thomas Hobbes. Colbert was the seventeenth-century minister to Louis XIV of France, who developed many methods of knowledge classification, which were then embraced by Enlightenment scholars in the following century (Soll, 2009: 5). Colbert, however, was a strong monarchist and nationalist. Accounting, as employed by Colbert, “was not simply about good administration; (i)t was also a tool of power and repression” (Soll, 2014: 77). Under Louis XIV, France used accounting to order and direct a mercantilist society. Colbert believed that commerce, guided by central state authority, should be promoted to create wealth which would benefit the nation (Soll, 2009: 5–11). Hamilton’s (1782) outlook was sharpened by observing the benefits to France’s economy from Colbert’s organizational efforts. In a similar vein, Hamilton (1782) felt the economic progress in sixteenth- and seventeenth-century England could be “in a great measure ascribed to the fostering care of the government.” Hamilton believed that one of the first priorities of any effective government was to enhance the country’s economy. To do this, government also had to protect against “the avarice of individuals” who would operate in a manner “prejudicial to the balance” (Hamilton, 1782).

Hamilton’s outlook aligned with the thinking of Thomas Hobbes, another pre-Enlightenment thinker and monarchist, through a shared belief in the necessity of a social contract. Hobbes saw rational individuals as consenting to live under a government in exchange for protection against a dangerous state of Nature, a comprehensive phase that encompassed the risks inherent in the physical and social environments. From Hobbes, Hamilton took a sense that man needed external restraint to maintain civil society. Like Hobbes, Hamilton believed that untrammeled self-interest presented a potentially dangerous threat, saying, “the only enemy which Republicanism has to fear in this Country is in the Spirit of faction and anarchy” (Hamilton, 1792a). Recognizing a tension between individual liberty and the centrifugal forces they can unleash, Hamilton envisioned society’s fall into anarchy without a strong government to constrain individual passions. The federal government, as the center, needed to exert control over the states, effectively assuming all powers not expressly granted to the individual states. To this end, he advocated the federal assumption of state debts arguing that assumption would “. . .consolidate the finances of the country and …. avoid the collisions of thirteen different and independent systems. . .” (Hamilton, 1792b). Similarly, he promoted the benefits of a national bank to foster national unity and creditworthiness (Hamilton, 1781).

Hobbes’ thinking also influenced Jefferson, though he drew different conclusions than Hamilton. Jefferson emphasized individual rights as propounded by Thomas Paine, ³ who, in his turn, reflected the views of that Enlightenment champion John Locke. Locke derived his sense of innate rights in part from the work of Hobbes, extending Hobbes’ social contract by establishing the doctrine of inherent rights of the individual, which endowed civil society with the freedom to choose its form of government (Fraser, 1999: 69). Jefferson’s view of America’s future encompassed much more than one where the rights of the individual were upheld, however; he pictured a particular type of America.

Jefferson’s ideology differed from Hamilton’s in the vision of America as a nation of small landowners, saying, “those who labor in the earth are the chosen people of God …. while we have land to labor, then, let us never wish to see our citizens occupied at a workbench” (Jefferson, 1832: 160). These landowners constituted an elite whose endowment of talent and ability was the source of their higher social status and demonstrated by their frequent accrual of great wealth. Because of their superior abilities, the nation would benefit from their leadership. Jefferson (1813) noted,

the natural aristocracy I consider as the most precious gift of nature, for the instruction, the trusts, and government of society …. that form of government is the best that provides most effectual(ly) for a pure selection of these aristoi [aristocracy] into the offices of government.

Jefferson thought that capable individuals could rise from all levels of society. ⁴ Moreover, the removal of primogeniture and entail would work against the social dominance of a permanent aristocracy whose status derived from inherited wealth rather than individual ability and dynamism (Katz, 1976; Staloff, 2005: 301). Such propertied men, Jefferson felt, were the ones to entrust with governing society because their patriotism and status would guarantee their public interest. Jefferson’s main concern was that a strong central government would act in ways that stultified the creativity and beneficial initiatives of those whose elitarian status came about from their successful endeavor. As he wrote to the US Congress, he hoped that the states would “prove their attachment unaltered to limited government ….” (Jefferson, 1798).

The social chasm that separated the elite and the many had important implications for the early American definition of democracy. Initially, only the US state of Pennsylvania extended suffrage to all free White males; the other states had various property requirements for the vote, with stiffer requirements for officeholders (Beard, 1935: 189). Jefferson and his compatriots did not feel that protection of the rights of the individual required active participation in the governing system by all citizens. Democracy meant that the opportunity to succeed would be open to all, but only those successful, as proved by a property qualification, could be trusted to govern, to create and maintain the laws of a just society (Katz, 1976).

Jefferson’s position on decentralized power reflected his optimistic belief in the positive power of rationality and humanity’s innate goodness. He believed that laws could be promulgated that would serve as a foundation for a just society (Valsania, 2004). Moreover, not only was the democratic will of the people to be trusted, but it was also efficient: checks and balances were actually shackles that impeded the suppression of freedom. While individuals were imperfect, as a whole their collective activities needed little restraint to create a more perfect society (Staloff, 2005: 57–58, 334).

Later, Andrew Jackson and his followers incorporated and modified the Jeffersonian mode of thought, maintaining a distrust of concentrated and geographically distant power while transferring idealization of Jefferson’s landed gentry to one of the “common man” (Murphy, 2013). Their continuing fear of too much power in the hands of the central government became manifest in Jackson’s successful campaign to destroy the Bank of the United States in 1836 (McCraw, 2012: 332). At the same time, the conception of democracy evolved. During the first half of the nineteenth century, suffrage was gradually extended so that by 1856 all free White men could vote in all states (Engerman and Sokoloff, 2005). Jeffersonian and Jacksonian conceptions of the relationship between the individual citizen and government evolved over the next half-century and into the twentieth century. This transition was first realized through the party system and later through the emergence of interest groups. In spite of all modifications, however, this tradition maintained a perspective where individual citizens or their local representatives dictated to the central government, and not vice versa. Party and later interest group leadership helped inform governmental responses to socioeconomic difficulties. By relying on the acumen and support of such groups, government continued to operate as a Jeffersonian democracy.

The next two sections discuss how these viewpoints affected the application of accounting knowledge to advance the policies of the ICC and the SEC. Ultimately, the ICC employed a more Hamiltonian approach, while the SEC followed a more Jeffersonian path, though each agency experimented with both approaches. Some, like political scientist Skowronek (1982), argue that the organizational demands of industrialization required that Americans “alter course and shed already well-articulated governing arrangements” (p. 4) effectively moving from a Jeffersonian model of limited government to a bureaucratic, statist model. However, we argue that both models continued to influence the US regulatory experience. Our argument qualifies Skowronek’s (1982) thesis by placing the creation of the regulatory agencies in the continuum of American responses to changing economic and social conditions; the bureaucracies that were born varied in the degree to which they followed a Hamiltonian or Jeffersonian approach. Environmental factors helped determine which model was followed.

Hamiltonianism and the ICC

Although the ideas of the Enlightenment had long been expressed in terms of the individual, their practical implementation steadily assumed a more organizational aspect as the United States became larger and their social structure became more complex and interdependent starting during the last quarter of the nineteenth century. At the beginning of this transition, the federal government was relatively small and reflected a Jeffersonian predilection. The largest executive agency, except during wartime, ⁵ was the US Post Office. Writing as an academic, Wilson (1885) persuasively argued that the most important branch of the nation’s triune structure of national governance was the Congress. This perspective began to change in 1887 during the presidency of Grover Cleveland with the passage of the Act to Regulate Commerce (ARC hereafter, or Interstate Commerce Act) which authorized the formation of the ICC to regulate the nation’s first giant business enterprise, the railroads. This all-weather transportation industry, continental in scope and encompassing 193,000 miles of track by 1900, made possible the rise of a new urban, industrial society (Chandler, 2009; ICC, 1901: 12–16; Wiebe, 1967). The interstate character of the industry proved a challenge at the state level, where most regulatory action originated in the nineteenth century, prompting calls for action at the federal level.

The ICC was an independent agency whose board members were nominated by the President and approved by the Senate, and whose policies were implemented through a bureaucratic staff that initially had a budget of US$113,000 and 11 employees. The agency steadily grew, reaching 2,407 employees in 1931 with a budget of US$8.9 million (Sharfman, [1931] 1937: 65–68). Implementation of a Hamiltonian model of governance was initially impeded by limited resources, legal challenges, and a need for sharper definition of its scope of authority. However, an overview of the agency’s powers testifies to its gradual movement toward a Hamiltonian character.

At its inception in 1887, the agency exerted control over market competition by enforcing rules against rebating, pooling, unreasonable rates, and rate discrimination between customers. The federal body mandated the filing of accounting reports employing uniform forms and measurement methods as well as statistical reports relating to employment, wages, accidents, and types of equipment and safety devices. By 1906, the ICC was authorized to inspect the accounting records of railroads, to require management certifications of corporate financial reports and to compel sworn testimony from rail employees. In 1906, it also received authority to determine maximum service rates, and the ability to set minimums in 1910. The federal body was empowered in 1920 to approve all railroad financing, and it imposed limits for a time on the maximum profits that railroads could earn. To ensure compliance with its decisions, it also controlled the issuance of certificates of convenience required by railroads to initiate changes in organization, operation, or financing (Sharfman, [1931]1937).

Federal involvement in rail regulation represented a furtherance of earlier local-level initiatives. State governments sought to reconcile the competing interests of important socioeconomic groups by focusing on two broad sets of problems whose remediation required access to detailed accounting and statistical information. The first was corporate financial transparency that, although useful for shippers, primarily benefited the nation’s growing investor community. As early as 1859, Henry Varnum Poor sought to assist investors through the compilation of industry information and financial data in American Railroad Journal (Chandler, 1995). Leading investment banking houses such as the House of Morgan and Kuhn, Loeb & Co. in New York, and Lee Higginson and Kidder Peabody in Boston specialized in floating railroad securities in both the United States and Europe (Carosso, 1970, 1987; Johnson and Supple, 1967)

However, there was a concern among some investors about the reliability of many corporate reports. One major concern was the problem of “watered stock” which was the overstatement of asset and equity values (Cleveland and Powell, 1919: 322–353; Giffen, 1872: 12–16; Ripley, 1911, 1915: 227–280; AP Turner & Co, 1885: 1–6, 12–14; Van Oss, 1893: 52–54, 132–135). This was an increasingly pressing problem as the total par value of rail stocks and bonds grew to over US$10.2 billion by 1900 (ICC, 1901: 52–64). Overstatements could result from several causes, including the fraudulent issuance of securities, paying too much for rail construction or property acquisition, paying greenmail to speculators to acquire competing but redundant lines, selling securities at a discount from par values, and the excessive issuance of stock dividends (Van Oss, 1893: 125).

To address the growing need for information, the US state of Massachusetts in 1869 had passed a “sunshine law” that mandated that intrastate railroads file periodic financial statements (McCraw, 1984: 17–25). One of the architects of the new legislation (soon followed by several other Eastern states) was Charles Francis Adams, Jr., a great-grandson of President John Adams and grandson of President John Quincy Adams. Charles Francis Adams (1879) was sensitive to the notions of Hamiltonian and Jeffersonian governance although he used different terms to describe these alternatives. In his view, there were two basic models for oversight (pp. 115–116). The first, consistent with Jeffersonianism, was “legislative” or “parliamentary,” characteristic of the laissez-faire approaches to railroad development in this period in both Britain and the United States. The alternative, consistent with the Hamiltonian tenets, was “executive” or “administrative” that involved strong direct state intervention over railroad affairs as followed in Germany and France. In crafting the Massachusetts law, Adams and his associates followed the legislative approach that was broadly Jeffersonian in nature. Adams believed that public opinion, informed through transparency facilitated by mandating the use of uniform accounting forms and practices, could induce the railroads to operate in the public interest. In addition, the state would reduce investment risk by mandating that total corporate debt should not exceed equity and avoid over building by controlling the scope of railroad expansion.

The second broad regulatory policy objective for which the states relied on accounting information was the control of rates for railroad service. Although dependent on legislative action, intervention in rate setting made the agencies more administrative-executive, to use Charles Francis Adams’ terms, and thus Hamiltonian. Interestingly, Adams did not favor this alternative believing that the states would experience great difficulty in sustaining the administrative capacities needed to support such a policy and in funding costly legal contests in the courts against powerful railroad adversaries. In the East, shippers represented by a host of local chambers of commerce, businessmen’s associations, farmers, and trade groups like the New York Cheap Transportation League militated for lower freight tariffs (Benson, 1955). In the West and South, farmers (usually operating through the Grange, their national representative association) succeeded in passage of state laws controlling intrastate rail traffic charges (Buck, 1963; Miller, 1971). The power of the states to intervene in these matters was affirmed by the Supreme Court in its “Munn v. Illinois” (1876) decision. However, the scope of state laws soon proved insufficient as new regional railroads emerged during the 1880s. The efforts of the state of Illinois to address the changing structure of industry by extending its control over interstate commerce were prevented by the Supreme Court in its “Wabash St. Louis and Pacific Railway v. Illinois” decision in 1886. This finding provided the impetus for federal activism and the formation of the ICC the next year. By transferring power to a federal body, Adams’ argument that the states lacked the resources to administer rate setting became moot.

While strongly supported by farmers and shippers, many railroads also favorably inclined toward the new federal legislation because it stabilized markets. The new rules seemed potentially effective in diminishing cutthroat pricing that threatened railroad profitability and sustainability. It also blocked the type of secret rebates that John D. Rockefeller’s Standard Oil Company extracted from the Pennsylvania railroad in 1877 that disadvantaged competing oil refiners and railroads (Chandler and Tedlow, 1985: 354–355; Tarbell, 1913).

Beyond the experience of the individual states, a third factor influencing the implementation of regulation at the federal level came from the new ideas espoused by influential governmental adherents to the German historical school of economics. This trend of thought was evident in the outlook of Henry Carter Adams, a professor at the University of Michigan (unrelated to Charles Francis Adams). Henry Carter Adams was recruited to the ICC by its first chairman, Thomas M. Cooley, who had been his mentor at Johns Hopkins and a colleague at Michigan. Adams served as head of the ICC’s Bureau of Statistics and Accounts and acted as an advisor on economic policy matters during its first 24 years of activity. The son of a Congregationalist minister who grew up in Dubuque, Iowa, Henry Carter Adams’ deep Christian beliefs contributed sensitivity to questions of social justice particularly as it related to the distribution of society’s economic surplus (Furner, 1975: 49–52). He witnessed firsthand the advocacy of the local Granger movement for state intervention over railroad rate setting, and his ability to apply knowledge of accounting and economics to address these matters was furthered through postgraduate study in Germany after receiving the first doctorate granted by the Johns Hopkins University in 1879 (Furner, 1975: 49–52, 128–132). In Berlin, he participated in the seminar of Professor Ernst Engel, a pioneer in welfare economics who headed the Prussian state and railroads statistical bureaus (Desrosieres, 1998: 180–187). Consistent with German historicism, Henry Carter Adams rejected the laissez-faire conceptions of classical economic thought that held great sway in the United States at that time. Instead, he embraced the view that the national state, guided by ethical values and expert knowledge, should play an active role in establishing national economic policies. In this view, the national state had a moral responsibility for maintaining social welfare (Furner, 1975: 48). Henry Carter Adams (1884, 1898) established a reputation as an expert in taxation and public finance through the publication of “Taxation in the United States, 1789-1816” and later “The Science of Finance.” He believed that the great disparities in wealth and income that stemmed from industrialization were best addressed via redistribution, accomplished through income and estate taxation. These ideas influenced his thinking about national railroad policy, as Henry Carter Adams believed that freight and passenger tariffs acted as a tax for transportation services. Under this view, the transportation cost burden should be allocated in ways that would help to achieve what was believed to be the most equitable distribution of the nation’s economic surplus (Furner, 1975: 100–105, 130–135). He mixed reliance upon a strong federal bureaucracy, however, with reliance upon the skills of professionals. He believed that an administrative agency like the ICC, staffed by specialists in law, transportation, and economics, was better equipped to make judgments about railroad matters than the courts. Moreover, Adams thought that such an administrative agency could better protect the interest of consumers against powerful railroads that had the resources to defeat their economically weaker adversaries through the appeal process.

A major lesson that Henry Carter Adams apparently learned in Ernst Engel’s Berlin seminar was the critical importance of accounting as a means for implementing public policy. Rules could be set and compliance assessed through the application of accounting. Use of accounting as a device for monitoring, controlling, and ordering activity in the industry was reflected in a letter to ICC Commissioner Wheelock G. Veazey that explained how accounting could function as a mechanism of control:

Now the easiest way, indeed the only way, by which uniformity of management can be secured is to establish uniformity in accounting and to take from railway managers the right of adjusting them in an arbitrary manner. Accounts, if they be honest, are true records of administration, and he who controls accounts can, in large measure, control the policy of management. Should the form of book-keeping be determined by the Commission and all railways been obliged to adjust their accounting to a uniform rule, the Commission would be in a position to impose its ideas on the management of the roads. And more than this, uniformity of accounts and strict supervision over them, which may be secured through the agency of the statistical bureau, provide a new way of testing the compliance of carriers with the rules of the Commission. Statistics properly used and adequately guided are the surest means of detecting any departure from the established rules of management. (Adams, 1893)

In the accounting system that Adams envisioned, uniformity of reporting formats and measurement methods was critical for several reasons. First, Adams believed that accounting uniformity, like all dimensions of the national railroad system including track gauges and traffic documentation, would assure maximum efficiency (Adams, 1918: 4–9). Second, the homogeneity of accounting and statistical information was a prerequisite for making valid inter-period or inter-corporate comparisons (Adams, 1918: 4–9). To achieve these objectives, Henry Carter Adams initially followed a Jeffersonian path by eliciting the support and assistance from two specialist groups. The first was the Association of American Railroad Accounting Officers (AARAO hereafter), a representative body comprised of accounting officers from railroads, organized with the assistance of the ICC in 1888 (Adams, 1918: iii). The AARAO provided guidance on standardizing financial statement design and accounting practice. The second group, also formed through the ICC’s sponsorship, was the National Association of State Railroad and Utility Commissioners (NASRUC hereafter) whose members had decades of experience in applying accounting information to the problems of railroad regulation (Smykay, 1955). As these groups arose with ICC support, however, and not organically, it is debatable, the degree to which they reflected the Jeffersonian ideals of cooperative association and self-determination.

Henry Carter Adams’ work in informing regulatory processes with relevant accounting and statistical data helped the ICC’s efforts to assure reasonable and equitable rates for service and to prevent unfair discrimination between consumers. Such data facilitated the monitoring of corporate activity and the search for unusual fluctuations, which might signal pooling, rebating, or other prohibited collusive activities. Like Charles Francis Adams, Henry Carter Adams initially attempted to persuade the railroads to comply with regulations through the pressure of public opinion, informed of probable infractions through accounting transparency. In this way, accounting information would contribute to what Henry Adams’ termed “self executory” regulation (Miranti, 1989: 478). The fear of exposure through accounting reporting was believed to be an effective deterrent to corporate malfeasance. The railroad companies were required to report information about their financing and other operating activities monthly to Washington. ⁶ Informational disclosure would allow interested parties to exert control over prices and services. Actual experience, however, proved that this monitoring activity provided insufficient control.

Challenges to the successful operation of a self-regulatory model also came from the courts. The ICC’s authority during its first two decades was challenged legally on three fronts. First, actions to punish illegal rebating frequently failed because of such matters as lack of cooperation between government officials, jurisdictional disputes, excessive evidential demands by judges, unreliable witnesses, and limited investigative resources (Churchman, 1976: 278–284). Second, although the ICC was empowered to judge rate reasonableness, it was successfully opposed when it attempted to mandate fair rates, a power not specifically granted to the agency at its inception. In the ‘Party Rate’ (1892) case, the Baltimore and Ohio railroads legally deflected the ICC’s efforts to curtail discounting on passenger fares. In the “Social Circle” (1896) and the “Alabama Midland” (1897) cases, the Supreme Court, while recognizing the ICC’s authority for judging reasonableness, indicated that the ICC did not have the power to set rates. Third, two important cases also curtailed the ICC’s power to apply accounting information in regulation. In the “Smyth v. Ames” (1898) case, also known as the “maximum freight rate” case, the Supreme Court mandated that owners of private property committed to public service must be allowed to earn a fair return on the fair value of their assets but did not explain how fairness was to be measured. Instead, the Court identified a range of possible measures that might be relevant without specifying how such information should be applied (“Smyth v. Ames,” 1898). More worrisome from the perspective of accounting standardization was the decision in “Knapp v. Lake Shore Railroad” in 1905. While the 20th section of the ICC legislation authorized the collection of industry data, the Court decided that the ICC lacked the power to sanction railroads refusing to comply with its uniform reporting rules (“Knapp v. Lake Shore Railroad,” 1905).

The Hamiltonian model strengthened as the ICC rebounded strongly during the Progressive era, the early twentieth-century movement whereby reformers attempted to counter the ills associated with American industrialization via the growing extension of federal authority over the national economy. Skowronek (1982: viii) has described this as the beginning of the administrative state. Many of these Progressive initiatives, especially in relationship to federal bureaucracies, relied upon partnerships with public interests groups to launch their initiatives, but by the time of the Progressive presidencies, the ICC had been in place for almost 20 years. Industry groups such as the AARAO and NASRUC traced their genesis to the ICC and were accustomed to working with the commission. Administrative success may have previously eluded the agency, but now, with executive support, the agency could begin to exert real power. Moreover, as the ICC gradually increased its internal administrative capacities, reliance on outside professional groups was not as crucial for effective administration, thus enabling a pronounced shift toward a Hamiltonian administrative stance.

President Theodore Roosevelt extended the ICC’s power through passage of the Hepburn Act in 1906, legislation which reaffirmed the ICC’s power to regulate railroad accounting (Blum, 1954: 87–105). It also mandated the use of accrual accounting and the regular depreciation of equipment and rolling stock, but not of roadbeds and structures (Adams, 1908). ⁷ The Hepburn Act also empowered the ICC to determine maximum rates and increased the scope of ICC authority over ancillary businesses such as pipelines, sleeping and refrigerated car services and terminal switching companies (Hoogenboom and Hoogenboom, 1976: 49–59).

By 1907, Roosevelt wanted to strengthen the ICC’s ability to address the problem of watered stock, or overcapitalization, which created distorted values that under the Supreme Court’s fair value, doctrine could provide a basis for justifying unreasonable high rates for rail service. Especially worrisome was the penchant for the manipulative inflation of asset values through speculative consolidations and combinations of railroad companies. To resolve public uncertainties about the reliability of railroad accounting values used by both investors and rate setters, Roosevelt (1910) wanted to launch a physical inventory and valuation of industry assets (pp. 1495–1496). These plans did not come to fruition, however, until later during the subsequent administration of President William Howard Taft.

In the interim, to build public support for the extension of federal authority over railroad finance, the ICC sought to support Roosevelt’s desired policy by highlighting purported inequitable gains from speculative finance through its investigation of rail consolidations in 1908. The focus centered on the actions of rail magnate E.H. Harriman and his 1898 acquisition of the Chicago and Alton railroad. Harriman had expanded the firm’s surplus by capitalizing earlier operating costs, using the resultant increase in retained earnings to finance a 30 cents USD cash dividend. Harriman’s consortium also issued a new bond series offered to his cronies at 65 per cent of par value (ICC, 1908; Kennan, 1922: 228–274; Ripley, 1915: 262–266). The ability of Roosevelt and his ICC allies to capitalize politically on these findings, however, was blocked, in part because of a public perception that passage of the Hepburn Act contributed to the stock market panic in 1907 (Edwards, 2007: 66).

The question of rail valuation was finally addressed by the Federal Railroad Securities Commission, formed in 1911 under the presidential administration of William Howard Taft and chaired by Arthur Twining Hadley, president of Taft’s alma mater Yale University. To confront the problem of fair accounting valuation raised by “Smyth v. Ames” case, the Commission needed to choose between three possible approaches to valuation: historical, replacement, or estimates based on the capitalization of expected future earnings. The answer was the Valuation Act of 1913. The law did not accept values as proffered by railroad management but instead authorized the federal agency in Hamiltonian fashion to conduct an inventory of rail assets nationwide and to determine their original costs of acquisition and their costs of reproduction adjusted for depreciation. Rail land was to be evaluated using current prices of similarly situated parcels. The proposed valuation allowed the government to assess a railroad’s rate of return on investment and provided a basis for investors to assess questions of stock watering by comparing original and replacement costs of rail assets, corporate book values, and the market prices of railroad securities. Concurrently, it helped surmount the problem of inconsistency in the treatment of capital costs for equipment and rolling stock versus roadbeds and structures as allowed under the Hepburn Act. However, because of the magnitude of the task, it took over two decades to complete, a period during which rate matters often had to be resolved with preliminary findings (Cleveland and Powell, 1919: 322–352; Ripley, 1907, 1911, 1915: 227–280).

In spite of these changes, prominent reformers such as railroad expert Professor William Z. Ripley of Harvard University or future Supreme Court Jurist Louis Brandeis, who advocated application of scientific management principles to railroads (Cunningham, 1911; Oakes and Miranti, 1996), remained dissatisfied with the scope of federal regulation and looked to the furtherance of Hamiltonian solutions. Their concern was that the valuation process did nothing to stop railroads from increasing their balance sheets through consolidation, combinations, or the retention of earnings that inflated the asset bases. Reformers believed that the fair value mandate could only be maintained by the ICC’s acquisition of control over railroad finances (see Olson, 1979; Ripley, 1915). Moreover, they felt that in a mature industry with strong monopoly power and low financial risk, investor returns should be limited. They believed that part of the railroads’ earnings should be shared with the government, which, as representative of the public, had originally endowed them with their valuable franchise. This position effectively evolved into the rate of return regulation advocated by Ripley. Both Brandeis and Ripley were well-known public figures, ⁸ allowing their positions to be widely disseminated.

The full extension of ICC power over railroad finance occurred after World War I. During the war, the industry was nationalized and placed under the control of the US Railroad Administration. The postwar Transportation Act of 1920 authorized the transfer back of railroad ownership to private interests while concurrently granting the ICC the power to review and approve prospectively all rail financing. The extended power over finance plus the information from the Valuation Act facilitated the agency’s plans to eliminate redundant lines and create a well-integrated national system. The plan involved following the recommendation made by Ripley, who served as an advisor to the federal agency for consolidating the nation’s railroads into 24 geographic systems (Leonard, 1946: 64–86).

Following Ripley’s Hamiltonian notions justifying the public’s sharing railroad profits because of the grant of monopoly franchises, the ICC through the Transportation Act mandated a rate of return limitation to control the distribution of operating surpluses to private investor groups. The railroads were required to pay any earnings in excess of 6 per cent of the total value of assets to the US Treasury. Half of these proceeds were earmarked for loans for financially weak railroads to fund line improvements. The other half was a rainy day fund available to offset financial stress experienced by donors during business downturns. While the railroads resisted this, it remained active until 1929 (Sharfman, [1931]1937: 221–225, 253–255).

The ICC’s Hamiltonian approach continued during the Great Depression and the advent of the presidential administration of Franklin Delano Roosevelt. The Transportation Act of 1933 abandoned fair value strictures and profit rate limits, seeking instead to stabilize railroad profits in the face of sharply contracting economic activity. Hamiltonianism was further expressed in the passage and implementation of the Motor Transport Act of 1935 and the Transportation Act of 1940, which extended the ICC’s authority for regulating rates and competition over interstate trucking and barge and water carriers, respectively (Hoogenboom and Hoogenboom, 1976: 129–138). The federal agency sought to divide equitably the pieces of a much diminished transportation pie among three competing industries. The old metrics developed for the rail industry continued to inform regulatory decisions, but the ICC increasingly came to rely on marginal cost analysis in determining rates that allocated demand among the rival modalities.

Thus, despite side trips into self-regulation, the Hamiltonian model in relation to transportation came to full maturity during the New Deal. This structure remained largely in place until 1978, when it was rather abruptly abandoned during the presidential administration of James Earl Carter. This change reflected a confluence of factors. For decades, economists had pointed out how distortive the tight controls exercised by the ICC were to the efficient evolution of the entire transportation sector (see, for example, Clark, 1910). At the same time, the United States was gravitating toward freer trade as a means to increase national wealth. Market regulation practices at the ICC were inconsistent with the World Trade Organization’s ideal of free and unimpeded trade among nations. Rate regulation was no longer seen as acceptable in the growing global business environment because it embedded hidden subsidies for particular national interest groups that hindered international competitiveness and free trade. Supporting economic nationalism as espoused by Hamilton had become politically unacceptable.

Jeffersonian ideals and the SEC

In the context of this study, Jeffersonian ideals involve the devolution of significant power over decisions about how best to oversee the economy and societal relations, including through the application of accounting knowledge, to individuals or private groups making up a polity rather than formal state entities. This idea was deeply ingrained in the early agrarian-local society that characterized the United States well into the nineteenth century. Alexis De Tocqueville (1838), a perceptive visitor from France in the 1830s, was impressed by the high degree of individual autonomy and independence in business life and by the national penchant for citizens to form associations addressing a wide range of socioeconomic matters. Rather than immediately appealing to governmental authorities for help, interested parties formed associations to find solutions for shared problems. This reflected Adam Smith’s optimistic belief that individuals acting in their own self-interest would also build a better society, rather than a Hobbesian image of individuals’ competing interests destroying civilization.

While in nineteenth-century America most individuals’ connection to the power of government was through the party system, toward the end of the century reform movements chipped away at this relationship. The rise of formal interest groups offered individuals another way to ensure their voices were heard. Interest group formation was yet another strand in the long-standing proclivity of Americans to join voluntary organizations. By the late 1800s, associational politics had begun to replace party politics as Americans primary way to interact with their government (Balogh, 2015: 139).

The symbiotic relationship between federal bureaucracies and interest groups reached its apex in the notion of the “associative state” advanced in the 1920s by Commerce Secretary (under President Warren G. Harding) and future president, Herbert Hoover. Hoover attempted to use interest groups to self-regulate and create close cooperation between private business associations and government. This would create

a synthesis, a way whereby America could benefit from scientific rationalization and social engineering without sacrificing the energy and creativity inherent in individual effort. This would make the ‘American system‘ superior to any other. (Hawley, 1974: 117)

Importantly, unlike the ICC, which had been in operation for over 40 years, at this time most federal bureaucracies, such as the Departments of Labor and Commerce, both created in 1903, ⁹ were still fledgling. Immediate resources did not exist at the federal level to tackle most economic and social problems. By seeking to bring industries and professional groups into governance, the federal bureaucracies recognized these as having the particular knowledge and skills necessary to tackle challenges faced by American society. Skilled individuals with specific industry knowledge would be instrumental in devising solutions to problems that the experts understood better than the federal government (Balogh, 2015: 35).

The associational bent of attacking sociopolitical problems was prevalent when the federal government entered the field of financial market regulation. Prior to the establishment of the SEC, following in the Jeffersonian tradition, most financial regulation had been at the local (state) or industry level. There had long been public concern about the “publicity of accounts” as a means for providing oversight in business governance, and by the early twentieth century, many states required the filing of financial statements for locally chartered banks, insurance, gas, electrical, and railroad companies (Berle, 1927). As early as 1911, many states had enacted “blue sky” laws prohibiting securities’ promoters and dealers from bilking investors through the provision of inadequate or misleading information. The US Comptroller of the Currency required nationally chartered banks to submit financial statements and, as previously discussed, railroads were required to provide standardized financial and operational information to the ICC. Private groups like the New York Stock Exchange encouraged listed companies to file financial statements, although these documents were often difficult to analyze because of extensive account aggregation and the lack of significant informative disclosure in the form of footnotes (Feeney, 2012; Previts and Merino, 1998; Thompson, 2013; Zeff, 1988).

In 1915, the administration of Woodrow Wilson secured passage of the Clayton Act. This extended the government’s antitrust power through the formation of the Federal Trade Commission (FTC hereafter) but failed to institute a uniform system of industrial accounting sought by Wilson advisor Louis D. Brandeis as a step that would facilitate the discovery of antitrust violations (McCraw, 1984: 130–132). The FTC failed in its efforts to gain control over corporate financial reporting. The Wilson administration was unable to overcome business opposition to this extension of control because by this time the administration had used up much of its political capital in creating a federal income tax, a central bank, and even the FTC itself (McCraw, 1984: 131–139). Instead, in 1917, the public accounting profession, represented by the American Institute of Accountants (forerunner of the modern day American Institute of Certified Public Accountants), in conjunction with the firm of Price Waterhouse, provided the Federal Reserve Bank with a prototype balance sheet and auditor’s report for businesses (McCraw, 1984: 167–168). Simultaneously, many public accounting firms contributed information on cost accounting designs to the Commerce Department to assist small businesses (Carey, [1969] 1970: 62–63; Zeff, 2003).

Federal interest in the regulation of financial accounting for the stock market now experienced a relatively long hiatus, and what regulatory action did occur was at the state level. Investors turned to the courts for help. Increasingly, however, the canons of common law seemed inadequate in confronting the problems of modern finance. Initially, the only remedy open to aggrieved third parties misled by financial statements was to sue for fraud. This, however, did not protect investor interests because they lacked privity in the contracts for audit services between corporations and their auditors (auditors were recognized as having a primary duty to the clients they audited, not outside parties). A partial remedy came in the doctrine established in the “Ultramares v. Touche” (1931) case. Here, Judge Benjamin Cardozo of the New York Court of Appeals ruled that while audited firms were the auditor’s primary clients, unidentified third parties in contracts for audit services (i.e. investors) could sue for constructive fraud or gross negligence and that identified third-party beneficiaries had the right to sue for ordinary negligence (“Ultramares v. Touche” case). However, there was still no body of federal administrative law to address these matters (Carey, [1969] 1970: 163–166; Edwards, 1965: 141–145; Previts and Merino, 1998: 238; Sriram and Vollmers, 1997).

Change at the federal level occurred in 1933, four years after the Great Crash. This came about partly in response to militancy for greater action from leading academics, including Ripley’s (1927) “Main Street to Wall Street” and “The Modern Corporation and Private Property” by Adolf Berle and Gardiner C. Means (1932). The Securities Act of 1933, which dealt with the problem of new security issuances, began with a more Hamiltonian than Jeffersonian stance. It was one of a cluster of new emergency laws during the first hundred days of the administration of Franklin Delano Roosevelt. In addition to the Securities Act of 1933, the Roosevelt administration enacted the Agricultural Assistance Act that curtailed output to stabilize prices, the National Industrial Recovery Act that controlled prices and competition in the industrial and commercial sectors, and the Glass–Steagall Act that forced a separation of investment and commercial banking. These laws were Hamiltonian to the extent that they involved strong, direct intervention by the federal government to restrict output, control market competition, dissociate banking specialties, or impose strong penalties for propagating materially false information.

In Hamiltonian fashion, the Securities Act of 1933 strengthened the position of consumers nationally and local governments by allowing either to sue issuers of new securities and their professional agents for registration filings, which were found deficient because of the inclusion of material factual errors or the omission of material facts. Auditors, however, felt vulnerable because the law provided few defenses. Moreover, the new law centered oversight authority in the FTC, whose traditional mandate had been in monitoring for antitrust violations and whose organizers had favored a system of uniform accounting like that of the ICC (Fleming et al., 2004). This law led to a strong pushback by representatives of Big Business who were concerned about the implications of the FTC’s dual mandate (Parrish, 1970: 48–54, 204–205). For accountants, there was a concern about the potentially adverse effects on clients as well as confusion about who would be responsible for certifying financial statements. As a profession, however, accountants did little to oppose this legislation because the profession was divided through the conflicts of two rival representative associations, the American Institute of Accountants and the American Society of Certified Public Accountants. Moreover, this competition confused the public about the proper source of authority regarding accounting matters (Miranti, 1990: 146–177).

Although Harvard University law professor and future Supreme Court justice Felix Frankfurter, who played a key role in drafting the stock market legislation, initially felt financial markets regulation would have a Hamiltonian cast, experience on the bench and with reactions to the 1933 Securities Act helped change his mind. In a letter written in January 1934 to Yale Law School Professor and future Supreme Court Jurist William O. Douglas, Frankfurter indicated,

I was a hot Hamiltonian when I went to Washington in 1911, but the years in the government service and all of the rest of the years watching its operations intently have made me less jaunty about devices for running a whole continent from Washington. This isn’t theory but fear that the big fellows will thus be relieved from the effective controls that we can fashion against them without putting all our eggs in one basket. (Quoted in Parrish, 1970: 61–62)

Frankfurter’s importance in drafting the SEC legislation has been well documented (Parrish, 1970), and the change in his position regarding effective regulation is therefore of supreme importance. As noted by Doron (2015), regulatory reform requires executive or governmental support, and lack of support at the top for Hamiltonian solutions made reversion to a Jeffersonian approach seem more responsive to the needs of a complex system of government–business coordination. This became increasingly apparent with the growing political opposition and legal challenges to the initial New Deal recovery initiatives, such as the US Supreme Court’s declaration that both the Agricultural Adjustment Act and the National Industrial Recovery Act were unconstitutional.

In crafting the Securities Exchange Act of 1934, Frankfurter relied on the same team of young attorneys he recruited to work on the 1933 Securities Act, including Benjamin V. Cohen, Thomas G. Corcoran, and James M. Landis. The new law transferred the focus of federal authority for securities market regulation from the FTC to the newly formed SEC, which narrowly focused on the problem of assuring probity and competent practice from the professional groups serving the financial markets (Doron, 2016; Flesher and Flesher, 1986; Merino and Mayper, 2001). The 1934 Securities Exchange Act also developed a new perspective about the significance of securities market function and the responsibility of the professional groups. The securities business depended on the competent and honest application of knowledge by many professional groups, including the exchanges themselves, attorneys, appraisers, bankers, brokers, engineers, promoters, underwriters, and certified public accountants. Market efficiency involved the effective coordination of the skills and proficiency of these interdependent professions (McCraw, 1984: 169–181; Parrish, 1970: 62–72). While the SEC would help create a broad framework for market oversight, much of the responsibility for the implementation of the rules would rest with professional groups whose responsibilities eventually grew to include standard setting for accounting and the definition and implementation of ethical standards (Doron, 2011; McCraw, 1982; Zeff, 2003). Although the SEC could initiate actions to combat financial malfeasance, its staff remained relatively small and limited in its ability to act. However, the laws enabled individuals and their legal representatives to seek redress from agent or corporate malpractice directly through the federal courts. The new system reinforced existing market institutions by creating a new framework of oversight and responsibility (McCraw, 1982: 352–353). In this way, the New Deal reduced the costs of governmental oversight by establishing a cooperative relationship between government and professional and business groups. Markets remained free, but the responsibilities of its agents in protecting the public interest were sharply defined, with penalties for incompetence or dishonesty. Thus, the Jeffersonianism triumphed on Wall Street.

Other scholars have questioned the efficacy of reform. Bealing et al. (1996) have noted that the actors involved in establishing the SEC represented various and competing interest groups. The resulting agency used accounting technologies as a way to gain legitimacy, while concurrently allowing the public accounting profession to maintain self-regulation. Radcliffe et al. (2017) argues that the intent behind financial regulatory reform in the early twentieth century, including the SEC, was to appear to tackle problems in corporate governance while the real beneficiaries were not users of financial information but the accountants whose role in the financial marketplace expanded. In their opinion, the regulatory changes were initiated by a ‘misguided belief in the power of accounting’; rather than sparking corporate reform, the proliferation of accounting reports merely obscured corporate America’s continued disregard for the public interest. Merino and Mayper (2001), as well as Merino and Neimark (1982), contend that such change often was symbolic as reflected by their finding that the Securities Acts were a placebo rather than a palliative for financial crisis, essentially “part of an ongoing attempt to maintain an ideological, social, and economic status quo.” This conclusion, however, was qualified by Michael Doron (2015) who has argued that initial accounting reforms during the 1930s were incomplete and required the implementation of a government-sanctioned system of public auditing to stabilize the financial market and to reduce the perceptions of risk.

Our interpretation of the imperatives behind the financial reforms that eventually resulted in the formation of the SEC sees the government’s actions as attempts to both stabilize the capital markets and provide better protection to investors. Whether or not the reforms were successful, they were intended to reduce investor risk perceptions through greater corporate transparency and by establishing channels for legal redress of corporate and agent malfeasance. This represented a significant departure from previous circumstances. The degree to which the regulatory changes accomplished these intentions can be debated, but we do not believe that the SEC was immediately “captured” by the corporations or professionals it was intended to police. Instead, it reflected the involvement of a variety of interested parties working to oversee the markets, constrained by potential financial and legal penalties.

What seem clear are the Jeffersonian consequences of this solution, as manifested in the development of numerous diverse bases on which financial accounting reports would be predicated. For the ICC, the emphasis had been on uniform formats and methods to enhance control over markets and finance. This partly occurred because early regulators thought of the railroads as a cohesive national system that necessitated the standardization of all its operating elements, including accounting. Designers believed that uniformity provided the best assurance of comparability between the various independent railroad units whose competitive practices were closely and directly monitored by the ICC. Standardization of accounting in the broader financial markets, however, was more problematic because of the diversity of businesses that offered investment securities. Professor Thomas Sanders of Harvard Business School, who had studied the problem of cost accounting systems dating back to the American Institute of Accountant’s compromise with the FTC in 1917, identified over 80 such systems sponsored by particular industrial associations (Sanders, 1923, 1928, n.d.). Broad uniformity thus seemed an impractical basis on which to structure accounting standards (Sanders, 1934: 815-816; 1935: 163, 167). In addition, business leaders in hitherto unregulated industries feared that the uniformity in accounting expression favored by the FTC could be employed as a monitoring modality by bureaucrats in the search for antitrust activity (Parrish, 1970: 203–205; Sanders, 1923: 170–171).

Finally, in the early 1930s, there was an endorsement of the British Companies Act by the Investment Bankers Association as a model to emulate in structuring US stock market reform (Parrish, 1970: 8, 12, 17). British practice was influential because London at this period retained the title of the world’s leading financial market, and British practitioners played a leading role in the development of the US public accounting profession. Since 1900, the Companies Act required that British firms file annual financial statements with Registrar of Companies in the Board of Trade (Jones, 1981: 111–116). Here, independent professional groups like accountants and attorneys served as key adjuncts to boards of directors in establishing corporate financial oversight (Mepham, 1988b; Walker, 2004).

Although similar to the British practice with regard to the important role played by professional groups, the United States’ Jeffersonian model differed significantly. The SEC, for example, had the power to intervene in the financial markets when it deemed that professional groups were not adequately protecting the public interest, hinting at potential limits to decentralized control. The Securities Act of 1933 and the Securities Exchange Act of 1934 clarified the legal responsibilities of corporations and professional groups serving the financial markets. In addition, in good Jeffersonian fashion, the SEC eventually deferred to a self-regulating profession for the definition of standards for accounting, auditing, and ethics, provided the rules proved effective in assuring effective market oversight. Standards were gradually elaborated by the independent profession to cover virtually all dimensions of public practice (Edwards, 1965: 156–160; McCraw, 1982).

The SEC’s Jeffersonian model was dynamic, changing in response to significant new developments. It was a system that transferred significant responsibility for oversight from government to those groups in which the market depended for effective operation. This basic pattern was also evinced by the evolution of accounting standards setting. Through a long process of experiential learning, government and the public accounting profession shaped three successive structures for determining how generally accepted accounting principles (GAAP) were to be defined. Beginning during the late 1930s, the SEC retained its right to specify accounting rules while agreeing to accept the guidance advanced by the American Institute of Accountants’ Committee on Accounting Procedure (CAP) to resolve many problems related to poor corporate reporting quality. CAP was composed primarily of practitioners with the occasional participation of academic leaders, such as Roy B. Kester of Columbia University, A.C. Littleton of the University of Illinois, and William A. Paton of the University of Michigan. A small unit headed by Thomas Sanders of Harvard University provided research support. CAP fundamentally sought to narrow the options of what constituted “generally accepted accounting principles” through debate and consensus formation. They documented their recommendations in “Accounting Research Bulletins” (ARB hereafter), which, though not constituting formal rules, were recognized by the SEC as definitive to the extent that registrants had to explain any deviations in their filings from these standards (Carey, [1969] 1970: 12–16; Previts and Merino, 1998: 284–286; Zeff, 2003).

The second institutional iteration involved the formation of the Accounting Principles Board (APB) in 1959. The APB’s approach to accounting standards rested on flexible principles informed by theory rather than prescribed uniform rules. The determination of what was “generally accepted” resulted from a two-step process. Accounting questions were first examined by leading educators who would issue “Accounting Research Studies” to guide the APB’s practitioner membership. ¹⁰ The second step was the definition of the “Opinions” by the APB’s practitioner membership and accepted as authoritative guidance by the SEC.

The Jeffersonian model prevailed even after the APB was replaced in 1973 by the Financial Accounting Foundation (FAF) and its subsidiary Financial Accounting Standards Board (FASB). Standard setting drew on an expanded range of interested parties responsive to the needs of both financial statement users and issuers (Zeff, 2003: 197–198). The FAF received support from the American Accounting Association; the American Institute of Certified Public Accountants (AICPA); the Financial Executives Institute (now Financial Executives International); the Government Finance Officers Association; the Institute of Chartered Financial Analysts; the Institute of Management Accountants; the National Association of State Auditors, Comptrollers, and Treasurers; and the Securities Industries and Financial Markets Association. Furthermore, the FASB, which promulgated new standards, consisted of seven full-time members (only two of which were practicing Certified Public Accountants [CPAs]) serving five-year terms.

The SEC’s reliance on public accounting professionals to ensure financial probity of firms has not been uncontested, and electorate dissatisfaction with the oversight of financial markets has resulted in some loss of professional autonomy. For example, in 2002, in response to public dismay over scandals associated with fraudulent financial reporting, Sarbanes–Oxley (SOX hereafter) legislation modified in significant ways the structure of market oversight. SOX authorized the SEC in consultation with the Federal Reserve Board and the Department of the Treasury to nominate the five members of the Public Corporations Accounting Oversight Board (PCAOB), a private sector body with oversight responsibilities for accountants auditing public companies. At least two of the board members must be CPAs. The PCAOB was empowered to promulgate auditing, attestation, ethics, and practice quality standards; evaluate practitioner qualifications; and review practice quality of public accounting firms. Although the details of practitioner regulatory participation have again been redefined, the new structure falls short of the Hamiltonian model of direct governmental supervision. The modified Jeffersonian model now more closely brings together government and the independent professional groups that the financial markets rely on for efficient functioning.

Conclusion

Although Enlightenment thinkers could not foresee the particular form of challenges faced by future generations, they established useful approaches to solving social problems. Themes debated since the Enlightenment on the proper relationship between government, business, and the individual affected in important ways the gradual evolution of the use of accounting as a regulatory device.

Enlightenment thought encouraged the exploration of new ways to organize society. In the United States, this legacy took the form of two accounting regulatory models that both sought to organize economic activity and foster economic prosperity while seeking justification by articulating a rhetoric that harkened to ideals celebrated by the founding fathers, including government’s responsibility to promote equity, justice, and prosperity. The Interstate Commerce Act (1887) gave as its mandate ensuring “reasonable and just charges” (section 1) without giving preference to one customer over another (section 3) to best meet the needs of commerce and justice (section 17). The 1934 SEC law states, “there is an important national interest in maintaining fair and orderly securities trading” (15 U.S.C. § 78(b)), and so establishes the Commission to “prevent inequitable and unfair practices on such exchanges and markets.” The means employed to achieve these goals, however, diverged.

As in the case of much historical analysis, our findings indicate that the creation of regulatory institutions responded to unique configurations of circumstances and forces that differentiate particular moments in a society’s evolution. The ICC and the SEC both sought to employ accounting to address radically new economic conditions, though the underlying problems fundamentally differed. In general, American society has tended to first employ Jeffersonian solutions, devolving control to local authorities. This has not been absolute, however, and there have been repeated experiments with ceding power to a central authority. For this model to succeed seems to require strong governmental champions, such as Teddy Roosevelt and later Progressives championed the ICC. Without such support, the tendency is to revert to less centralized control.

Along with the existence of individual champions, professional organizations also play an important role. Besides being staffed by industry experts from its inception, the railroad’s national regulatory body helped organize the industry’s professionals. In contrast, exchange organizations and professional accounting bodies had formed well before consideration of the SEC regulation. The economic spirit of the times is also important; when the spirit of laissez-faire prevailed, the Jeffersonian vision predominated. In periods of economic nationalism, Hamiltonian interventions emerged.

The type of social problem confronted also helped guide the regulatory model eventually settled upon. With the ICC, the basic problem was the monopoly power of the railroads and devising ways that government could intervene to protect the public interest in terms of equitable rates and financial probity. Public opinion and transparency alone were insufficient to shape market competition in ways that would satisfy shippers who relied on rail service or those who worried about the sociopolitical implications of the rising concentrated power in the industry. Direct market intervention using accounting as a monitor for assuring compliance with regulatory requirements was the essential technique of oversight. The Hamiltonian model, however, created its own problems. Inherent in the design of the original system was the belief that it could accommodate the full range of problems confronting the industry. It could not: the demands of a changing environment revealed the model’s shortcomings and rigidities. It was not well geared to accommodate the competition of trucking and water-borne transportation, the diversification of national industrial endeavors, or the effects of major financial–economic dislocations. The regulatory stultification of interstate transportation would only come to an end when a national commitment to global free trade beginning in the 1970s forced the abandonment of a system that through its well-intentioned rules and findings had the effect of redistributing income between groups and regions.

The problem confronting the SEC was fundamentally different, involving consumer protection rather than control over market competition. In this latter case, accounting served not as a mechanism of control but rather as a cognitive resource whose reliability had to be assured because it was essential for financial market efficiency. Although a centralized, federal agency was born, the regulation created new institutions to provide incentives for compliance with laws intended to promote greater financial transparency. The Jeffersonian model diffused responsibility to widely dispersed professional groups on which the market depended for effective functioning, and it had many advantages. The development of a system that relied heavily on professional groups shifted the costs of regulation away from government toward the companies that wanted their securities traded in public markets. The Securities Act in 1933 also helped to stabilize finance capitalism by clarifying the roles and responsibilities of professional agents, including professional accountants, attorneys, and bankers. The decision to standardize accounting on broad principles also afforded greater measurement flexibility for the many dissimilar businesses that reported to the SEC. The new federal legislation built public confidence in investing by incorporating sanctions that empowered aggrieved investors to move legally against corporate filers or their professional agents for malfeasance resulting from incompetence or fraud. The new system of oversight helped to restore confidence in financial markets and to assuage the concerns of critics who had called for reform prior to the Great Crash of 1929. Ultimately, the Jeffersonian structure allied government and professions and helped to build broad social consensus about the direction and form of future change. Over the long term, the malleability of this linkage proved capable of adjusting to the changes that materially transformed the global economy, and though modified over time it has satisfied the financial information needs of a more globally integrated economic order.

Regulatory regimes, including the specification of accounting models for public oversight, have been part of the federal government’s attempt to ensure American unity, liberty, and economic prosperity. Their design has been inspired by both Hamiltonian and Jeffersonian perspectives on the relationship between government and the governed. Reference to both approaches has been a recurring theme in US history, depending in part on the problems faced, the executive champions who emerged, the vibrancy of professional organizations, and the resources available.