In management accounting literature an institutionalist stream is emerging that generates intense discussions and research (Scapens 1994; Burns and Scapens 2000; Duindam and Verstegen 2000). Although the discussion in the discipline of management accounting often refers to new institutional economics literature as well as original institutional economics literature, there are fewer references in the opposite direction. In this paper we try to strengthen the connection between management accounting and institutional economics. Analyzing the functioning of management accounting rules and practices creates an opportunity to substantiate the view of the economy seen as an instituted process. Management accounting practices are one part of the institutional infrastructure that control, coordinate and facilitate human decision-making.
We start from the very heart of management accounting, by giving contents to the concepts of "Management" and "Accounting." William Redmond's (2004) institutional rationality provides one of the cornerstones of the analysis. We consider management accounting rules as a means through which institutional rationality is achieved. Given these foundations, the functioning of management accounting mechanisms and principles within an organization is derived. If management accounting is based on institutional rationality, management accounting mechanisms can be seen as institutional rules i.e., a structure of routines and habits that guide behavior and create a predictable order. Through their influence on the decision room of decision makers in organizations, management accounting principles can play a coordinating role. Furthermore, management accounting principles evolve in interaction with other coordinating mechanisms; their development is context bound and path dependent.
As management accounting rules come to be seen as part of the institutional infrastructure, questions emerge about the relationship between management accounting rules and other institutional rules. A further elaboration of this relationship entails specifying "upward" and "downward causation" between institutional rules on various levels of generality (Hodgson 2003). In particular, upward causation would highlight processes of institutionalization of management accounting rules, which affect higher order institutional rules like laws or behavioral rules.
In this article we first show how management accounting systems and mechanisms support decision making within an organization. For this purpose decision making is regarded as being, by nature, institutionally rational. It appears that accounting principles, through their supporting function for the decision maker, also perform a role in coordinating various decision makers in an organization. Second, the evolutionary character and context bound nature of management accounting rules will be highlighted. We close by introducing several examples of the upward causation Hodgson (2003) talks about.
"Management" and "Accounting"
Management accounting is concerned with the mechanics of management accounting methods and techniques, the aims for which these principles can be used, and any adaptation of these principles. In this paper we restrict ourselves to the way management accounting principles function and to the adaptation of these principles.
We use a common definition of management accounting principles in which the principles are seen as the means through which information is acquired, processed and provided for the management of an organization. In general, management is concerned with decision-making and with planning and control. We focus on those situations where management can be interpreted as decision making (Atkinson, Kaplan and Young 2003). Therefore, we describe management accounting principles as the means of providing information for decision making within organizations (Hogarth 1993; Atkinson et al. 1997). Management accounting is not only concerned with financial information. Non-financial information (e.g., quantifying the environmental burden of activities, assessing risk, or measuring the performance of people or organizational parts) is considered relevant for decision making as well. In this article we refer to both financial and non-financial quantities at various places. The above definition shows that our analysis holds for profit as well as non-profit organizations.
Management accounting regards decision makers as being internal to the organization. Outside parties like tax authorities or stockowners are provided information too. However, this is the realm of "financial accounting." Financial accounting principles are highly regulated through law as well as through conventions within the profession. Roman Lanis and Bruce McFarling (2004) visit this "neglected area of institutional economics."
Our focus on the management of an organization implies that we cannot choose an aspect-driven approach using the ceteris paribus clause (i.e., holding all other aspects constant). Management has to deal with all aspects of a decision situation, both expected and unexpected. In principle, information provided to decision makers should address all aspects of a decision situation and not be limiting in any sense. After all, management will be interested in the specific decision situation rather than in decision making in general.
To investigate the role and quality of management accounting principles in decision making, we must have a particular view of human nature and of the human decision-making process. This section examines the way decisions come about, so we can set the stage for determining how accounting principles influence and facilitate decision making, the subject of the next section.
How Decisions Come About
Decision makers in organizations can be looked on in various ways. We may think of them as non-rational, quasi-rational (Russell 1997), bounded rational, unboundedly rational, or procedural rational etc. For the sake of consistency we should somehow stylize the decision maker. In this paper we choose institutional rational decision-making as our point of departure (Redmond 2004). Redmond argues that people have "a propensity for rule-following behaviors" (177) and states: "The institutionally rational mind has two modes of thought ... These correspond roughly with rule following and purpose seeking" (179). He calls this dual-mode rationality and he wants to examine the relation of "rule-following behaviors to purpose-seeking behaviors" (178, italics added). Redmond sees bounded rationality, as Herbert Simon introduced it (Simon 1982; Hogarth and Reder 1986; Fusfeld 1996), as "single-mode" rationality (Redmond 2004, 177). In particular he points to the limited capacity of the human mind in terms of attention, information processing and problem solving (175). This implies that the decision-making process in terms of purpose-seeking, calculating behavior is bounded in a number of ways. We try to relate the concept of bounded rationality to institutional rationality by viewing bounded rational behavior as one of the two modes Redmond introduces. In particular we will view bounded rational behavior as purpose seeking behavior; that is, solving a decision problem that consists of choosing from a set of choice alternatives according to preferences (the second mode). Prior to it, bounds are set to the decision problem through rule following behavior (the first mode).
Bounds to the Decision Problem
We will distinguish between two kinds of bounds. First, the set of choice alternatives is bounded. Not all possible alternatives are part of the choice set. Decision makers have limited information-processing capacities, make mistakes, take shortcuts and do not have all the time and money in the world to investigate all possibilities (Elster 1989). Additionally, decision makers know that their past decisions limit their current decision room. Laws influence the decision room available to decision makers; for example, the liability laws that pharmaceutical industries face. Market conditions also determine the decision room. Second, preferences too are bounded as they are determined by cultural norms and values, habits and routines, and group values. Geoffrey Hodgson (2003) mentioned learning and social interaction as determinants for changes in preferences. The interaction between the bounds that limit the set of choice alternatives of a decision maker and the bounds that influence the preferences is highly complex. For instance, smoking or nonsmoking habits influencing the preferences of employees may eventually be incorporated into organizational rules of conduct or even in legislation. Conversely, traffic rules may eventually become the behavioral norms of drivers (Posner 1997; Lindbeck 1997).
We view the factors that shape the preferences and the set of choice alternatives as the rules used to formulate the decision problem in the first mode. In the second mode, the decision problem is solved in a boundedly rational manner. As rules have a role in constructing the decision room for the decision maker, these rules are a means to achieve institutional rationality. They are a part of the institutional infrastructure that bounds purposive choice. Walter C. Neale said, "The institutions constitute the arenas in which people try to accomplish their aims. Institutions imply 'you may' as well as 'thou shalt not' thus creating as well as limiting choices" (1987, 1179). Management accounting principles too can be seen as rules that play a part in determining the decision room for decision makers.
How Management Accounting Principles Influence and Facilitate Decision Making
Management accounting principles may have an important role in shaping decision problems for decision makers in an organization. Other accounting principles might define other concepts in terms of which a decision problem can be considered as they can provide...