International Journal of Accounting Research

Riding the Iron Horse into the Future of Regulation: The Contribution of Charles Francis Adams Jr.

Timothy J Fogarty^* Department of Accountancy, Weatherhead School of Management, Case Western Reserve University, USA
^*Correspondence: Timothy J Fogarty, Department of Accountancy, Weatherhead School of Management, Case Western Reserve University, USA, Tel: 216 368 3938, Email:

Received: 23-Dec-2018 Published: 28-Jan-2019, DOI: 10.35248/2472-114X.19.7.193

Introduction

Studies in accounting history are predicated on the assumption that contemporary issues benefit from a more complete understanding made possible only by an analysis of origins. In other words better knowledge about the past provides a needed prologue to the appreciation of the present.

This paper takes up this gauntlet by highlighting the work of Charles Adams and the Massachusetts Railroad Commission in the decades following the Civil War in the United States. The assertion of this work is that the seeds of modern accounting and business regulation were planted by the man at this time. To some extent, these origins would revise the conventional placement of the genesis in the turn of the 20th century’s formation of the Interstate Commerce Commission (ICC) and the efforts of the Theodore Roosevelt administration. Although no contribution to our current way of thinking is so original or unprecedented to not owe equivalent debts to those that came before, the work of Adams merits additional attention in the regulation literature.

This paper is organized to first establish the historical facts, a retelling of which would be news to many. The two longest sections of the paper will detail the multifaceted contributions to the process of regulation and to the content of regulation. Throughout, parallels to the modern uses and debates will be identified. This paper concludes with a summary assessment of the place of Adams as a forerunner of modern regulatory thought.

The Historical Context

Although much has been written about the role of the railroad in the industrialization of the United States [1] a brief acknowledgement of the uniqueness of that moment is necessary. The dawning of a system whereby goods produced in one area could be sold in another held such obvious promise that the emergent industry’s capitalization was sudden and unprecedented [2]. America’s first real big business offered unique economic problems most notably, virtually unlimited economics of scale scrambled traditional ideas about competition. In addition, the fever to raise capital dispatched the traditional ideas that investors could ground trust in their personal knowledge of responsible individuals. In an era, resistant to both monopoly and public ownership, the practice of capitalism needed to evolve. Railroads were the harbinger and the facilitator of the legendarily sharp practices that would soon facilitate the rise of the robber barons. Ironically, the shenanigans that led to great fortunes tended to be obscured by the great commercial progress that new technology made possible.

Adams, a member of the illustrious New England family that included two presidents eschewed a career in the law for the opportunity to pave at then a relatively uncharted course as a regulator. Awed by the prospect of the railroad and mindful of its public interest implications, Adams instigated the formation of the Massachusetts Railway Commission in 1869. Well before the federal government would play any significant part, this body headed by Adams would be a role model for other states confronting the problem of the railroad. In reflection of the fractured power of the individual states, Adams organized the Saratoga Convention of 1879 that convened many state relations and advocated common solutions. This event would serve as a template for subsequent efforts by the ICC, which in turn would regularize the chaotic business of railroading.

Throughout his career, Charles Adams was at the fulcrum of weighty issues. He was called upon to consider the fairness of prices when markets did not operate as expected. He struggled with the dissemination of proprietary information in the name of a higher good. He recognized that the instinct of private enterprise for unfettered growth may prove destructive. Through his writings on various subjects, we find that Adams was a man ahead of his time. Many of the issues on his plate continue to bedevil us today.

The Process of Regulation

The pursuit of the public interest

At his core, Charles Adams wished to be a reformer. He believed that his calling was as an ombudsman who would mediate this economic conflict that the railroads created. Hailing from such a patrician family, such an aspiration was either a curiosity to others and psychologically difficult to admit. Adams sought to work within the system, believing that opposed interests could be harmonized through reasoned dialogue. Specifically, the science of economics, to which Adams subscribed, provided a field from which the objective facts, once seen, could forge agreement. Adams saw his role as the person who argued for a transcendent public obligation charged to private enterprise. This implied stewardship that this subtly suggests was as controversial in this time as it is now. For Adams, the railroad wielded great power that could be harmful to other interests unless tempered with the ideology of a public welfare.

Adams influenced the powers by which the public interest could be pursued. First, reform had to be based on deep knowledge of the phenomenon. Thus nothing could be expected from legislative bodies. Reform could only occur after a deep commitment to measurement had been made. Reformers like Adams knew the slow and relatively modest public interest concessions were all that could be hoped for in the situation.

In Adam’s view, any reform that was possible had to exploit market forces rather than attempt to contradict them. Toward that objective, Adams had an intuitive respect for the transformative power of new technology. The railroad presented an extreme case because of the tendency toward geographical, “natural” monopolies that limited the balance that competition could bring. Adams also appreciated the multiplier effect that efficient railroad service could mean for the country.

To many, public interest based reform necessarily suggests naked conflict. Adams however remained steadfast in the belief that discord of this sort could be avoided. For example, Adams was not a supporter of labor unions but was willing to work with these groups. Adams believed that the best resolutions were grounded in revealed self-interest, and not dogmatically imposed political edits. Conflict was inevitable but it did not, and should not, require power to be exerted.

The legacy of Adams can be observed in the accounting standard setting process. A large plurality of support exists on a normative level for public interest considerations in the process [32]. Lev argues that equity can serve as operational criteria for public interest concerns [26]. In fact, the consensus position acknowledges a deep link between accounting and the social welfare [8]. At the same time, hope is unlimited that reliable and relevant standards faithful to the economics of transactions can be produced, with financial consequences an acceptable result. Adams would be pleased with the broad acceptance of the infusion of professional values into standard setting, especially when such values suggest fidelity to the measurement ethic. Adams would have also looked with favor with how standard setting has made its peace with its political environment [12].

On the other hand, other current developments would have surprised or dismayed Adams. The public interest has itself become a rhetorical strategy. Sometimes this tactic is exerted by the standard setting body to define its work and marginalize alternatives [33]. Great legislation that has changed the course of accounting in the name of the public interest often has had hidden agendas [34,35]. Adams did not anticipate that historical cost accounting had limitations that could not be overcome [29]. Furthermore, the commercialization of accounting has created more dimensionality and complexity for standard setting [36], than Adams could have foreseen. Stewardship as a general motif has not achieved much traction, tending to dismiss any transcendent public service goal, following advice by Paton [37].

The regulation of competition

The development of the railroad changed the substantive meaning of economic competition in the US. For the first time, narrow geographic lamentations for choices faced by agents could be transcending by the movement of goods. Most market participants soon recognized the usual superiority of railroad transportation, an advantage that only grew as the network of connections was built out.

The transcendence of the local also brought unprecedented problems. Some of these, such as safe operation presented a high volume of tribulation without major conceptual difficulties. Others were enveloped in puzzles that had not been previously confronted. Most centrally, competition heretofore the central mechanism of the invisible hand of capitalism could not operate well. The infrastructure required usually meant that only one railroad could service any two points. Those that arrived first could exclude others and exploit their advantages with customers. The situation called into question the laissez-faire presumption that dominated the government section of that day. The capital accumulation needs of this new industry also formed a new class of potential victims. What rights investors had vis-à-vis management existed as a mostly legally untested field.

Adams discovered that the balance between the interested parties would be sufficiently contested that caution would be required. The operation of an ongoing commission created a forum for the airing of grievances, the testing of solutions, and perhaps most importantly fact finding. Although great compromises that refined the nature of property rights in the age of the day/ technological breakthroughs were few, Adams can be credited with not capitulating before the daunting task. Adams normalized the acceptance of reasonable compliance costs and made conceptual progress against the idea that people with property should be given unfettered freedom to use that property.

Adams’ efforts may have formed a necessary precedent for the famous “trust-busting” successes of the Theodore Roosevelt administration a few decades later. Continued problems with railroads’ exertion of unilateral privileges were also at the center of these actions. Since then antitrust law has evolved to grant the federal government power to identify anti-competitive actions (Sherman Act) and to pre-empt merger proposals (Clayton Act). Although little of this has been linear or apolitical, competition is now approached in a more nuanced way with some forms seen as substitutes for others. The important point remains that the need to regulate competition no longer is questioned.

The anti-fraud objective

Very few would associate Charles Adams with the fight against fraudulent practices and deceptive behavior. Adams was not part of any enforcement machinery, nor was he a muckraker who specialized in investigative journalism. Adams focused on normal operations which tended to presume the honorable intentions of participants.

Fraud has always been with us, and therefore should be considered an implicit component of the regulatory agenda. The potential for the reality of fraud justifies governmental intervention into private sector markets. The interaction between buyer and seller is governed by caveat emptor as the parties contract to allocate unknown risks. However, when results are unacceptable, in part due to disproportionate bargaining power and widely asymmetrical information, market results call out to be altered. Although regulation does not have to be a reactive response to actual fraud the prospects for such heightens the regulatory moment.

Adams was an early and strong proponent of the proverbial disinfectant quality of operating in the sunshine. This ethos casts a vote against fraud in that deception either needs or is facilitated by covert behavior. Fraudulent activity by companies also tended to require the falsification of accounting or operational reports. Companies able to claim proprietary reasons for not disclosing these records are better able to cover their tracks. As a strong and unwavering voice for an always expanding scope of information as part of the public record, Adams effectively fought fraud in a proactive sense.

The public quality of business and accounting regulation has long been accepted as the preferred modus operendi. Deliberations and even conversations tend to be “on the record” to the extent that parties not present can request transcripts and other preservations of these events. “Sunshine” laws became de rigor in the 1970s perhaps in reaction to the Watergate scandal. The Freedom of Information Act has been very useful to many that could otherwise be adversely affected by governmental activity. Accounting regulations enacted by the FASB tend to have complete packages of deliberation. Regulation FD made it necessary for corporate officials to avoid private disclosures to analysts. The advance of the “regulated by agency” regime means that less and less of which that occurs in corporations is truly secret. Nonetheless, corporations vigorously oppose forced disclosure of plans and forward looking information in their MD&A commentary. Adams would have celebrated this general victory of what at this time no doubt seemed exceptional and different.

Towards standardized reporting

Perhaps more than any other single accomplishment, Charles Adams is credited with major progress in the long march toward comparability in business reporting. His advocacy of this objective again outstripped actual attainment, but this would leave much to subsequent eras.

Requesting information and getting it in a useable form are two different achievements. Following self-devised arbitrary protocols, railroads assembled, compiled, and reported information as they pleased. A wide latitude of acceptability existed in an era when outsiders felt privileged to be receiving any information at all. Little was known about the production of this information and its internal reliability. Variation in form could be idiosyncratic, but it also could be strategic. This prospect naturally triggered skepticism among its readers. However, a broad appreciation did not exist at this time for the importance of format to substance. For example, a mountain of highly detailed operational results produced by the railroads could be greatly undermined by the lack of a common year end.

Much about railroads argued against any progress toward standardized information packages. Railroads, operating in different geographic areas, encountered different obstacles that drove operational costs. Other contingencies were induced by the nature of the clientele that railroads serviced. Every railroad conceived of themselves as sui generis, rather than as a unit of an industry. Whatever prospect existed for regulation began with the knowledge that could be obtained from standard reports. On an aspirational basis, these hopes ranged as far as for a system of taxation that was simple, proportionate, ascertainable, and collectible.

Many current debates continue to hinge upon the trajectory that Adams encouraged with the railroads. A series of events all point in the same direction of continuing to expand the total amount of information available to external parties, from the Jenkins Report of the 1990s (AICPA) to the “Big Data” push of today. Working with the existing scope of financial reporting, the gradual movement toward XBRL without convincing evidence of benefits illustrates how standardization has become a relatively uncontroversial objective. Meanwhile, behavioral studies have attempted to understand the influence of report structure on internal and external parties [38]. The worldwide harmonization of accounting standards tends to be accepted as a theoretically desirable objective, despite considerable implementation disagreements [39].

The apparent victory of standardization has triggered reactions and resistances. More flexibility is often hailed as desirable, be it based on the size of the reporting unit (Big GAAP vs. Small GAAP) [40] or by those that prefer a judgment-intensive conceptual accounting to one of bright-line rules. Some fear that the pressures toward standardization will stifle progress toward better approaches [41] or delimiting judgment that prevents the victory of form over substance [28]. Paton reminds us that varying circumstances call for varying accounting [37]. On a more macro-scale, others have called for new ways of thinking about accountability itself [27] and potentially re-imagining the standard-setting process as an unnecessary monopoly [42].

Rate regulation

Consenting to any inroads against its exclusive right of private parties to run their affairs presented difficulties for the railroads. However, their ultimate prerogative was the establishment of the rates charged to customers wanting to ship their products. Like several other concerns, rate regulation was not attempted by Adams in the Massachusetts Commission. Nonetheless the prospect of such was a distinct spectre.

Given certain costs, the rates set for customers determined profitability. Profits were central to investor confidence and to the ability of managers to perpetuate their positions. In normal industries price is held within reason by the elasticity of demand. However, once the superiority of shipping by rail was recognized, excessive rents could be extracted by monopoly pricing by railroads. Thus the idea of establishing an equitable price would serve as a Holy Grail of regulatory attempt.

Adams realized that rate regulation could never occur without good information about costs. The major advances in cost accounting lie in the distant future, so this objective would consume all of Adams’ talents. The cost recovery of initial capital outlays that we now recognize as depreciation would prove to be bedevilment. Knowing rate regulation would prove highly controversial; Adams denounced bold steps in the direction such as flat rates. Nor did Adams wish to be dragged into conversations that would attempt to calibrate cargo comparisons. Adams conceded how sensitive pricing was and was willing to leave its subjectivities to railroad management. Affected individuals had plenty of other concerns about the railroads that Adams was content to prioritize. Adams did appreciate that rate regulation would be necessary to the uniform valuation that could clear the way for an apportioned tax. True progress on rates needed the power of federal legislation that would appear for the ICC.

Broad recognition that the public interest demanded some control over pricing took many decades to develop. The designation of activities that provided very essential services as utilities preceded the establishment of commissions that would define costs that could be recovered through highly regulated prices. Although these companies remained in the public sector, this comprehensive regulation would relegate their appeal to investors that wanted a low risk steady return. Conversations along these same lines occur today with regards to the regulation of Internet access. Such requires much more concentrated power and political consensus than Adams could have ever dreamed possible.

Focus on the investor

The activity of Charles Adams and that of the Massachusetts Commission represented one of the first systematic efforts to protect the interest of the investing community. For the large part, these investors were bondholders who had lent the funds that initially allowed the railroad to be built and then satisfactorily operated. The size of this undertaking, combined with the widespread belief that railroading possessed “can’t miss” profitability horizons, magnified the distance between the investor class and the railroads operations. Such a situation placed an extra premium on reliable and sufficient information dissemination, usually in the form of cost accounting data. Unfortunately deception in these records was common and difficult to detect.

The idea of stewardship needed to be reinforced in an era where no tradition of voluntary annual reports existed. If management felt accountable to those that had risked their fortunes on the success of the railroads, they lacked any means to assure these individuals that the risks they faced were within reasonable bounds. Investors only knew that all was well when they experienced the returns to which they were entitled. Investors of the day were not seen as possessing information rights in part because their stake was perceived to be highly unliquid in secondary markets. Even if investors were given operating information, they usually lack a context to judge its implications.

By compelling information and explanation, the Commission sought nothing less than to make railroad management better. Given the precarious position of investors, nothing short of higher levels of accountability would make a difference. The Commission was not explicit in this effort, but no one could have missed the point that making decisions that were evidence-based would be in everyone’s interests. In that the information given to the Commission was also reported to the public, investors now possessed some means of comparing the fortunes of the line that they had trusted with their money with others. Although this context was both limited and somewhat speculative given the information at hand, it compared favorably with nothing at all.

Protecting investors never proceeded so far as to be tantamount with “swindle” investigations. The assumption in place was that management was honorable, and that all efforts would be made to repay investors and creditors. The forward-looking tendency suggests that better accounting would suffice to avoid investor complaints.

The centrality of the information needs of investors has gained great acceptance since Adams’ days. That financial regulation’s primary purpose is to add to the confidence of investors [43] would approximate an unchallenged proposition. So much effort aligns in this direction that the financial statement audit might have lost its unique value. As the capital markets have evolved, and differentiated impacts exist for different types of investors, we have reason to wonder if standard setting has erred in the effort to protect investors, to the neglect of more fundamental stewardship [24]. On another front, user needs is so firmly entrenched despite considerable mechanical vagueness [44] and rhetorical posturing [45].

The victory of user needs underlines the foray of accounting standard setting with fair value territory. A deeper question about the conceptual basis upon which such user needs rests [46]. Here one might be well advised to distinguish actual decisions that need good measures from decision theories [47]. Secondary effects on non-users should also not be ignored.

The role of accounting

In the mid-nineteenth century, not much accounting expertise existed in the US. Critical lines had not yet been drawn that would separate accounting information from operational/business data. Desire to answer the questions that accounting now addresses existed. However, the means to achieve answers that found broad agreement would prove difficult.

Adams began by realizing that the railroads had invested in accounting expertise, such as it was. The job proved not to be one in which accounting had to be imposed on the railroads. Adams introduced experts from outside the railroads in the process of attaining compromise.

Given the state of accounting, only minor victories were possible for Adams. He did deliver in consent to use the accrual method to value liabilities, and agreements regarding the calculation of rates of return. In a general way, Adams sought a principlesinfused accounting that usually eluded his efforts. It was an era of great variation in practice and only small inroads were possible. Accounting of this era tended to facilitate the results that companies wanted.

The passage of time has seen great investments in proper accounting. Although a coherent conceptual framework proved elusive, the variation in practice is not nearly as broad as it once was. The audit process induces considerable discipline. This progress has not prevented parties from rather systematic earnings management. Parties still make arguments for accounting methods that convey strategic advantage [25,41]. As parties become more conscious of accounting consequences, transactions have become more complex, thereby still challenging those that pursue ideal accounting. The debate between rules-based and a principlesbased rages on with professionalism arguments [36], evidence of opportunistic behavior at the margin, and a rejection of the question [48]. Adams possessed sufficiently robust thinking so as to side with all three lines.

Discussion

What Adams never imagined

Every person is a product of their times and Charles Adams is no exception. What people do reflects the institutions and worldviews of that period. However, the measure of the man can also be seen in counter distinction to perspectives revealed by subsequent times.

In a way, Adams’ belief in and pursuit of accounting truth seems almost quaint today. In retrospect, we now understand that accounting is too important to be left in the hands of accountants. In other words, while Adams appreciated the political aspects of what he worked upon, he did not realize that they could subvert the pursuit of good accounting. As also discovered retroactively by the APB, accounting problems are not mostly technical [12]. Adams would have been surprised at the effort by private interest groups and their lobbyists seeking advantage, in part by “spinning” a very pliable truth [11].

Adams sought a means to capture the economic reality that existed within the operation of the railroads. We now have been shown that accounting constructs its own reality in the contexts in which it operates [49]. In that people so fundamentally believe in accounting classifications and constructs in the modern world that they change their behavior in accordance with them, the world that Adams sought to create may have been too successfully wrought. In other words, accounting cannot be a neutral measure but instead is one likely to set unintended consequences in motion.

In that Adams and the Commission sought to be a body that caused the production of good information that would be available to the public, one usually thinks of him as a progenitor of the regulatory community.

However, one now sees most of this work handled in the private sector world of auditing. This line of development becomes compromised when one observes that public accounting firms have not been content to play the role of neutral arbiter of good accounting between corporate preparers and accounting users. In many ways the foray into lucrative consulting practices have aligned them with the former to protect future revenue streams. As such, they add dimensionality to the production of good accounting [50].

Conclusion

Adams, mostly through his early work with the Massachusetts Commission, was positioned at a unique important moment in time. The railroads as America’s first Big Business had arrived in America and would change the country in permanent and not entirely desirable ways. Adams helped to formulate the outlines of a regulatory response that would contain the seeds of much that we believe to be appropriate today about the negotiation between public and private spheres.

One reason that Charles Francis Adams Jr. has not received due recognition as a forefather of regulation is that his tangible achievements are not large. His name is not associated with a great decision or a turning point resolution. However, he did initiate a process that has been much replicated for more than a century and a half. Adams also should be credited by having the ideas about regulation that are likely to normalize a highly conflictual circumstance.

Much has happened since the time of Adams. Railroading in the US is still a commercially critical operation since where goods originate and where they can be sold still need to be aligned. In densely populated corridors, people commute and travel using trains. Derailments and other accidents are still first page news. However, media attention has migrated more routines to new technologies and new forms of business. The railroad remains geographically grounded in an era more sensitized to that which connects globally. Nonetheless, we need to respect our past and to discover that which we have always known. And when discussing regulation that brings us back to ideas generated by Adams and his somewhat novel idea of publicity-the commission represented public opinion: to listen, investigate and report; with “the board of commissioners set up as a sort of lens by means of which the otherwise scattered rays of public opinion could be concentrated to a focus and brought to bear upon a given point.

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