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Why Did Cambridge Hospital Undertake the Abc Study

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The Role of Accounting in the Financial Crisis: Lessons for the Future

S.P. Kothari kothari@mit.edu 617-253-0994

and Rebecca Lester rlester@mit.edu MIT Sloan School of Management E60-382, 30 Memorial Drive Cambridge, MA 02421

December 14, 2011

ABSTRACT: The advent of the Great Recession in 2008 was the culmination of a perfect storm of lax regulation, a growing housing bubble, rising popularity of derivatives instruments, and questionable banking practices. In addition to these causes, management incentives, as well as certain US accounting standards, contributed to the financial crisis. We outline the significant effects of these incentive structures, and the role of fair value accounting standards during the crisis, and discuss implications and relevance of these rules to practitioners, standard-setters, and academics.
This article is based on a presentation by Deputy Dean and Professor SP Kothari of the Sloan School of Management, Massachusetts Institute of Technology, at Baruch College on October 25, 2010.

1
Electronic copy available at: http://ssrn.com/abstract=1972354

The Role of Accounting in the Financial Crisis: Lessons for the Future
I. Introduction

The Great Recession that started in 2008 has had significant effects on the US and global economy; estimates of the amount of US wealth lost are approximately $14 trillion (Luhby 2009). Various causes of the financial crisis have been cited, including lax regulation over mortgage lending, a growing housing bubble, the rise of derivatives instruments such as collaterized debt obligations, and questionable banking practices. In addition to these and many other reasons, we explain two factors that partially contributed to the crisis: certain management incentives and fair value accounting standards. This article discusses the causes of the financial crisis, with particular focus on…...

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