Accounting in Partnerships

Abstract

In 1914, an accounting professor named Arthur Andersen founded a public accounting practice that became the world’s largest professional-services firm. For years preceding the Enron debacle and Andersen’s collapse, the firm had struggled to create incentives within the organization for partners to provide highquality service, develop and sell new services, and meet the compensation expectations of various factions of partners. A years-long dispute over the division of profits between the firm’s consulting and accounting arms led to the 1998 separation of the consulting practice from the audit and tax practices. The rise, break-up, and fall of Andersen underlines the importance of questions concerning incentive structures within public accounting firms in particular, and partnerships of professionals in general. This paper offers a perspective on partner compensation schemes and the accounting information systems that support them. In partnerships, ownership and control lie with the partners. Furthermore, each member of a partnership is endowed with human capital that may be employed either within the firm or without. Every partner is simultaneously a principal (who shares in the net output of the partnership) and an agent (who produces output). Ownership and control are diffused among many persons, and partners are subject to moral hazard. Each must be motivated by his peers. It is intuitive that the structure of professional partnerships is a function of the production and monitoring technologies available to the partners. As Oliver Williamson (1975 p. 43) points out: Group affiliation ... can provide income guarantees to buffer the effects of unanticipated contingencies on terms superior to that which market insurance can provide ... . A group will have an advantage over the market to the extent it is better able to ... check malingering and other ex post manifestations of moral hazard. [This advantage requires] ... that performance be accurately assessed.