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Premises and Promises of Theory Formation in Economics

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Title: Premises and Promises of Theory Formation in Economics


1
Premises and Promisesof Theory Formation in
Economics
  • ao.Univ.Prof. Dr. Franz Hörmann
  • University of Economics and Business
    Administration, Vienna
  • http//www.franzhoermann.com
  • http//www.antibilanz.info

2
Introduction
  • Franz Hörmann
  • franz.hoermann_at_wu-wien.ac.at
  • Department for Accounting and Tax Management
  • University of Economics and
  • Business Administration, Vienna
  • Fellow at University Linz
  • Main Field of Research
  • Accounting Information Systems Knowledge
    Management

3
Contents
  • Why (Macro- Micro-)Economics?
  • Use and Abuse of Science (Scientific
    Whistle-Blowing)
  • From the Hidden Premises to the Economical
    Nonseum
  • What Can (Must) Scientists Do?
  • Some Visions, Not Too Far

4
Why (Macro- Micro-)Economics?
  • Why (Macro- Micro-) Economics?

5
Why (Macro- Micro-)Economics?
6
Why (Macro- Micro-)Economics?
  • The utmost Goal of Economics
  • The Optimal Use of Scarce Resources
  • Optimal Use ? Mathematical Methods
    (Optimization)
  • Scarce Resources ? Tangible Assets, Raw
    Materials etc.

7
Why (Macro- Micro-)Economics?
  • Optimal Use
  • The Optimal Use is already known beforehand, it
    can only be ONE use (the optimal), all future
    production methods, future demands, future
    possible uses etc. must already be known
    (otherwise what would a temporary optimality
    criterion be good for?).

8
Why (Macro- Micro-)Economics?
  • Optimal Use
  • Using mathematical models (Equations) ? up pops
    the market equilibrium (what else can we find,
    if we describe everything using equations?!)
  • Measurement of optimality Numbers (monetary
    values, money measure whats the value of
    money itself??) ? Numeromania (temperature, stock
    rates, news reports, sports news?)

9
Why (Macro- Micro-)Economics?
  • Scarce Resources
  • They are scarce by definition (finite
    quantities at hand but potential infinite demands
    for in the future) Natural Resources, Production
    Plants, Money,
  • ? Scarcity Measure of Value (Manipulation!)

10
Why (Macro- Micro-)Economics?
  • Scarce Resources
  • But Limited Resources (Supply) possibly
    unlimited Demand gives us a Scientific Rationale
    for War (Warfare by the Laws of Nature)
  • Economics ? Bunch of Zero-Sum Games (only by the
    magical power of words, some thoughtless
    definitions)
  • The Limits of Growth apply!

11
Why (Macro- Micro-)Economics?
  • Alternative View
  • The Goal of Economics
  • To Promote Human Evolution (mental, social, ) by
    supporting individual development
  • EVOLUTIONARY ECONOMICS
  • Growth in knowledge, skills, understanding,
    empathy, in mental and spiritual areas
    unlimited growth is possible ? no scarcity of
    resources, no reasons for war!

12
Why (Macro- Micro-)Economics?
  • Alternative View
  • How do we Measure Success (do we need some
    numbers)?
  • For meaningful measurement the final goal must
    already be known in advance (length, weight,
    temperature we know, why we measure them,
    because some causality is implied).
  • But whats the final goal of Human Evolution?
  • ? only if we can answer this question,
    mathematical measurement makes sense!

13
Why (Macro- Micro-)Economics?
  • Alternative View
  • We (Humans) are the Products of our own Evolution
    (we can only mistrust and restrain or trust and
    further, but never measure it).
  • Evolution has given us all the necessary decision
    tools we need to succeed on our way (pleasant
    and unpleasant) Feelings
  • Behavioral Finance, Behavioral Economics, why
    so late?

14
Use and Abuse of Science
  • Use and Abuse of Science

15
Use and Abuse of Science
  • The Use of Science
  • Innovation, Solution of Problems for Society,
    Discovery of new Knowledge,
  • Definition of Science
  • what scientists do ( the biography of a
    scientist)

16
Use and Abuse of Science
  • The Abuse of Science
  • Personal Wealth, Fame, Support of Lobbies and
    Political Parties to gain or sustain Power
  • To keep the Business Models of powerful
    Professions going (Stock Exchanges, Investment
    Banks, CPAs, ).
  • (ever wondered, why tax laws are so overly
    complicated and why the new members of the EU
    the former communist countries are the first
    ones to implement a Flat Tax system?)

17
Use and Abuse of Science
  • The Abuse of Science
  • Publish or Perish Quantity instead of Quality
    in all-important Journals (quantitative
    measurement of science!)
  • Science Earn your living as a scientist write
    (many) articles in prominent journals ? get
    famous ? get rich (by publishing sensational
    discoveries using some statistical tricks, e.g.,
    again faked numbers!)
  • Management BY the Numbers ? Management OF the
    Numbers

18
Use and Abuse of Science
  • The Abuse of Science
  • Management Consultants sell Methods (Formulas)
    for Controlling Corporations (Financial
    Management ? Formulas containing monetary
    numbers, Shareholder Value, e.g. symbolic
    services)
  • The rising importance of Shareholder Value
    (Value Orientation) leads to dominance of
    pseudo-scientific formulas in our economies

19
From the Hidden Premises to the Economical Nonseum
  • From the Hidden Premises
  • to the Economical Nonseum

20
From the Hidden Premises to the Economical Nonseum
  • Hidden Premises
  • Implicit assumptions (mental models, e.g.) that
    shape structure and/or meaning of the models
  • Nonseum
  • Kind of museum of nonsensical artefacts
  • If fundamental premises of models remain
    implicit, those models are endangered of
    degeneration to nonsensical artefacts

21
From the Hidden Premises to the Economical Nonseum
  • Some Hidden Premises
  • Homo Oeconomicus the decision maker is
    simplified to become an algorithm
  • If this would be possible, our mathematical
    methods would apply (kind of wishful thinking)
  • Financial Statements
  • a) Financial Statements dont report (any kind
    of) reality but they are the result of
    application of reporting standards (US-GAAP,
    IFRS, national laws etc.)
  • What kind of economical reality can we describe,
    if we follow normative rules (regarding structure
    as well as valuation of financial statement
    items) True and Fair View?

22
From the Hidden Premises to the Economical
Nonseum Financial Statements
  • b) Financial Statements (FS) are always outdated
    (closing the books, preparation, auditing,
    publishing)
  • c) FS show the liquidation value of the
    corporation (and not the value of the going
    concern!) corporations are not normally run
    to be liquidated! (Peter Drucker) The
    valuation of single items and the premise of
    going concern are a contradiction! But whats
    the value of the going concern? Is business
    valuation (shareholder value) an answer?

23
From the Hidden Premises to the Economical
Nonseum Financial Statements
  • d) Valuation of single balance sheet items isnt
    any measurement method
  • measurement always the same rule is applied
    (length, temperature etc.)
  • balance sheet items many different valuation
    rules (comparable??)
  • e) Fair Values (market values) for long lived
    assets are meaningless! Market values have only
    some (very limited) meaning for retail goods or
    finished products never for buildings, plants,
    etc.

24
From the Hidden Premises to the Economical
Nonseum Financial Statements
  • f) Who wants to compare companies using
    financial statements?
  • American Institute of Certified Public
    Accountants (AICPA) nobody!
  • Research shows investors, creditors and company
    executives in fact dont use financial statements
    as their primary decision-making tool.
    (http//www.aicpa.org/pubs/jofa/jun2005/anderson.h
    tm)
  • Outsiders (external investors) without
    knowledge of the company and its business model
    speculators
  • They are the only ones who could benefit from a
    comparable international reporting standard.

25
From the Hidden Premises to the Economical
Nonseum Financial Statements
  • The AICPA already knows, that the FS-model isnt
    useful for their clients any more
  • 1991 Jenkins Report (A Customer Focus -
    http//accounting.rutgers.edu/raw/aicpa/business/m
    ain.htm)
  • 1997 CPAVision Project (2011 and beyond
    financial statement preparation and auditing as
    business model already missing consulting as
    new primary business focus for CPAs -
    http//www.cpavision.org/)
  • 2005 Enhanced Business Reporting Consortium (
    will improve information quality, integrity and
    transparency subject to reasonable limits for
    commercially sensitive information. -
    http//www.aicpa.org/pubs/jofa/jun2005/anderson.ht
    m http//www.ebr360.org/) The founding members
    AICPA, Grant Thornton LLP, Microsoft,
    PricewaterhouseCoopers LLP

26
From the Hidden Premises to the Economical
Nonseum Financial Statements
  • When part of the CPA profession deserted to
    managment consulting and 30 less students took
    accounting as a major at US-Universities up
    popped the so-called financial reporting
    scandals (ENRON, WorldCom, )
  • "Lynn Turner, who was the chief accountant at the
    SEC in the late 1990s, has described very plainly
    what goes on behind the scenes. Turner abhors the
    games that accountants play, but he nevertheless
    knows the world where they go on for years he
    was a partner at one of the major auditing firms,
    and he has also served as chief financial officer
    of an international manufacturer of computer
    products. In spring 2002 Turner was interviewed
    on a nationally televised program about the
    accounting scandals being uncovered. ... The
    interviewer asked him (in italics below with his
    response following)

27
From the Hidden Premises to the Economical
Nonseum Financial Statements
  • What kind of things were being done when you were
    working on Wall Street for an accounting
    firm?"All of the Big Five accounting firms have
    a group of accountants kind of like a financial
    services group, and that group of accountants
    works with Wall Street. In my prior life, we
    acutally had a retainer arrangement with each of
    the major Wall Street investment banking firms
    under which we would help them financially
    engineer or structure hypothetical transactions
    for finding financing, keeping it off balance
    sheet, making companies look better than, quite
    frankly, they really were."

28
From the Hidden Premises to the Economical
Nonseum Financial Statements
  • You mean doing the kinds of things that Enron and
    Andersen did?"Yes. Exactly."So there's a whole
    system that does this?"A system that turns
    around and does it. Without a doubt."And all of
    the big accounting firms have that?"Yes. Every
    one of the big accounting firms has such a
    group...."So, in Enron, we haven't just
    stumbled into something that may have happened.
    We've run into something that is a fairly common
    practice?"This is day-to-day business operations
    in accounting firms and on Wall Street. There is
    nothing extraordinary, nothing unusual in that
    respect with respect to Enron."
  • D. Quinn Mills ("Wheel, Deal, and Steal -
    Deceptive Accounting, Deceitful CEOs, and
    Ineffective Reforms", 2003, pp. 84)

29
From the Hidden Premises to the Economical
Nonseum Financial Statements
  • g) Private Standard Setting doesnt work As
    harsh as it might seem, we think that essentially
    the only message today's auditors send to users
    is that they should consider the financial
    statements to be essentially useless because they
    comply with politically derived accounting
    principles."
  • Miller/Bahnson ("Quality Financial Reporting",
    2002, p. 50)

30
From the Hidden Premises to the Economical
Nonseum Financial Statements
  • h) Private Standard Setting Market Inefficiency
    (overregulating the Market of Company
    Information)
  • Alternative View
  • Investors and Corporations should be enabled to
    negotiate freely the kinds and methods of
    information flows between them (including
    communication technology) Contract Based
    Capital Market Communication.
  • Financial Accounting Standards Board (FASB) and
    International Accounting Standards Board (IASB)
    hinder the evolution of communication methods
    (like in the Soviet aera of total economical
    planning!)

31
From the Hidden Premises to the Economical
Nonseum Investment Theory
  • Net Present Value
  • Discounting future cash flows to make them
    comparable with the cash flows in t0 (the
    moment of decision).
  • But future cash flows (in t1, t2, tn) are no
    cash flows at all! They are planned, promised,
    negotiated, contracted, but no REAL cash flows
    (categorization error!).
  • And the formulas of financial mathematics are
    plain mathematics nothing economical can ever
    be found in them (equations of a higher degree)!
  • Using the same formula (NPV, SHV e.g.) for
    different corporations ? the result tells us only
    something about the mathematical relations and
    NOTHING about economic causes (customers,
    competitors, employees, dont exist!).

32
From the Hidden Premises to the Economical
Nonseum Investment Theory
33
From the Hidden Premises to the Economical
Nonseum Investment Theory
34
From the Hidden Premises to the Economical
Nonseum Investment Theory
35
From the Hidden Premises to the Economical
Nonseum Investment Theory
36
From the Hidden Premises to the Economical
Nonseum Investment Theory
  • Internal Rate of Return
  • Its a simple mathematical formula with no
    possibility of any meaningful economical
    interpretation!
  • Net Present Value
  • To calculate NPV the knowledge of all future cash
    flows AND the expected life of the investment
    object MUST BE KNOWN IN ADVANCE. Otherwise only
    rough estimations but no exakt calculations are
    possible!

37
From the Hidden Premises to the Economical
Nonseum Investment Theory
  • Why calculate (demand, negotiate) compound
    interest at all?
  • Compound interest a mathematical
    (pseudo-scientific) method to make even more
    money out of some money. Its a matter of culture
    (religion) and NOT OF SCIENCE (islamic countries
    no compound interests are used, Martin Luther
    puts usurers on a level with robbers and
    murderers usury to demand any kind of
    interest, not only exorbitantly high rates!).

38
From the Hidden Premises to the Economical
Nonseum Investment Theory
  • Why is interest earned?
  • The creditor foregoes the use of his money
    (consumption or an alternative investment
    opportunity costs)
  • But the alternative investment is never really
    carried out!
  • The so called opportunity cost is in fact
    arbitrary (justified by pseudo-scientific
    formulas with no economic meaning)!

39
From the Hidden Premises to the Economical
Nonseum Mainstream Finance
  • Mainstream Finance
  • Dogma The capital markets are efficient (all
    market participants have the same expectations
    and no one can use any information for his own
    advantage, because the market knows everything
    already in advance).
  • ? If it would be so financial reporting would be
    a very costly, but totally useless endeavor (as
    well as investment newsletters, technical chart
    analysis etc.)!

40
From the Hidden Premises to the Economical
Nonseum Mainstream Finance
  • Mainstream Finance
  • Efficient capital markets and financial reporting
    standards are a logical contradiction
  • Departments for Finance and Accounting at
    Universities a practical joke?
  • Diversification Buy non-correlated assets to
    reduce risk.
  • But it cannot work, if everyone has a
    diversified portfolio and in times of falling
    market rates all investors sell all their assets
    ? then asset correlation 1.

41
From the Hidden Premises to the Economical
Nonseum Mainstream Finance
  • Mainstream Finance
  • The myth (q.e.d.) of diversification
  • In times of rising market rates ? diversified
    portfolio generates less profit.
  • In times of falling market rates ? all investors
    sell all their assets, correlation 1, risk
    cannot be reduced!
  • Diversification can be defeated without a single
    line of mathematical formulas (plain logical
    thinking!).
  • But even nobel laureates had to learn it the
    hard way by losing billions of dollars
    (http//www.amazon.com/gp/product/0375758259/)

42
From the Hidden Premises to the Economical
Nonseum Business Valuation
  • Business Valuation (using Discounted Cash Flow
    Models, DCF)
  • The future cash flows of the next 5-7 years are
    discounted and for the rest of the lifetime of
    the corporation an perpetual annuity (continuing
    value) is calculated (CF/p). For this the CF of
    the last year (5th or 7th) are used the most
    uncertain CF have the most influence on the
    calculation result!
  • In many cases, the sum of the residual value
    makes for 75 of the total business value (or
    even more than 100 in the case of start ups with
    negative CFs in the first years).

43
From the Hidden Premises to the Economical
Nonseum Business Valuation
44
From the Hidden Premises to the Economical
Nonseum Business Valuation
45
From the Hidden Premises to the Economical
Nonseum Conclusio
  • Financial Planning is a Myth
  • The future cash flows are never known in advance
  • The decision criteria are unlogical and are
    derived from oversimplified, plain mathematical
    formulas with no economical meaning (no goods,
    services, customers, creditors, employees, are
    represented in those models)
  • Financial numbers are only the result of economic
    activities and can never provide any causal
    explanations of events in the real economy

46
From the Hidden Premises to the Economical
Nonseum Conclusio
  • Economic Education aims at Behavior
  • The real goal of economic education today is a
    kind of behavioral conditioning of students to
    fit the existing power structures in private and
    public industries
  • Those structures are frozen and cannot be changed
    simply by publishing scientific theories (they
    are part of our western culture and a way how we
    differentiate from people of other parts of the
    world, therefore they resist change and evolution
    ? a kind of religion?)

47
From the Hidden Premises to the Economical
Nonseum Conclusio
  • Economic Education in the current form endangeres
    human evolution
  • It makes students thoughtlessly obey rules
  • It destroys creativity
  • It kills the believe that evolution and change
    (to the better) are possible
  • Those frustrations in the subconscious minds of
    the masses will certainly rise violence (France)
  • Economical arguments (cost cutting, short term
    planning of quarterly revenues) hinder scientific
    progress a recursive problem structure!

48
What Can (Must) Scientists Do?
What Can (Must) Scientists Do?
49
What Can (Must) Scientists Do?
  • Question all models that are widely used
  • The older and more prominent models are the
    more illogical and the better hidden are their
    premises!
  • Those very old models have mostly become part of
    our thought structures and part of our (business)
    culture.
  • Develop alternatives (even if they seem quite
    alien dont use interest, e.g.).

50
What Can (Must) Scientists Do?
  • Change the way of teaching
  • Personal development of students is (far!) more
    important than scientific skills and methods. We
    need every piece of creativity that we can find!
  • Show students, that THEY are responsible for
    improving our societies and NOT the lecturers,
    deans, university administration, politicians,
    scientists,
  • Give room (physical and in the curriculum) for
    experimentation and learning by doing.

51
What Can (Must) Scientists Do?
  • Change the way we think of errors
  • Errors are necessary for learning and our
    evolution.
  • And only after the facts we know, what really
    was an error (and even this conviction might
    change once again!).
  • Errors should be documented, published,
    celebrated, rewarded they are necessary and
    valuable!
  • Its a matter of culture dont avoid errors,
    but never commit an error twice.

52
What Can (Must) Scientists Do?
  • Change the academic Institutions
  • Universities have not been invented to earn
    profits!
  • They should be places to experiment, and dream
    (without calculating the opportunity costs of
    those dreams!)
  • We must relieve the burden of all day life
    (earning a living) from students as well as
    scientists only then there will be enough
    leisure for dreaming and creativity!

53
What Can (Must) Scientists Do?
  • The VINDOBONA University Project
  • (in accreditation)
  • Reinventing Economics and Social Sciences around
    Philosophy and Psychology (model of humans in the
    center of communication networks)
  • Business and political leaders with mainstream
    education in management science and economics
    cannot cope with paradigm shifts (crash of the
    economy, break thru innovations, radical change
    of social values etc.), because they know only
    one (western) model of an economic system
  • We need the capability to communicate with
    members of different economies and cultures on an
    even level (without falling prey to our
    prejudices, that are part of our education!)

54
Some Visions, Not Too Far - Economics
Some Visions, Not Too Far
55
Some Visions, Not Too Far - Economics
  • What is money?
  • Using current technology whatever we want it to
    be!
  • Not only a certain data type (float, currency),
    i.e. one number, but arbitrarily complex data
    structures (the end of anonymous money).
  • ? Money with its own memory (linked to
    electronic contracts, everyone can see why this
    amount of money has been exchanged by whom and
    for what kind of product or service).

56
Some Visions, Not Too Far - Economics
  • What is money?
  • Money with an (electronic) endorsement (whenever
    a customer complains about the quality of a
    product the money he once used to pay loses its
    purchasing power and cant be used any more the
    former seller of the critized product must
    provide other electronic coins and cant use
    the protested money until the complaint of his
    customer is settled).
  • Virtual money is the great chance to make those
    things valuable in society, that we all think are
    valuable!

57
Some Visions, Not Too Far - Economics
  • How do we earn (and spend) money?
  • Virtual communities will provide their own money
    (money-servers, economy-servers, LET-Systems
    http//www.gmlets.u-net.com/, http//www.openmoney
    .org/, http//www.complementarycurrency.org/,
    e.g.)
  • Virtual realities will spread and transform into
    parallel economies, where soon children will
    earn more money than their parents
    (http//www.entropiauniverse.com/,
    http//www.secondlife.com/, e.g.)

58
Some Visions, Not Too Far - Economics
  • How do we earn (and spend) money?
  • If the (M.I.T.-developed) Fabricator comes into
    every house (within the next 20 years), our
    economy might completely transform into
    online-games.
  • Question is an economic system as gamblers
    paradise (the way mainstream finance describes
    it) as an online-game less harmfull than our
    real economic system of today?

59
Literature
  • Alex Berenson The Number - How the Drive for
    Quarterly Earnings Corrupted Wall Street and
    Corporate AmericaISBN 0375508805
  • Roger Lowenstein When Genius Failed, 2001, ISBN
    0375758259
  • Miller/Bahnson Quality Financial ReportingISBN
    0071387420  
  • Mills Buy, Lie, and Sell High - How Investors
    Lost Out on Enron and the Internet Bubble ISBN
    0130091138  
  • Mills Wheel, Deal, and Steal - Deceptive
    Accounting, Deceitful CEOs, and Ineffective
    Reforms ISBN 0131408046  
  • Mulford, Charles W./Comiskey, Eugene E. The
    Financial Numbers GameDetecting Creative
    Accounting Practices, 2002, ISBN 0471370088  

60
Literature
  • Howard M. Schilit, Financial Shenanigans - How to
    Detect Accounting Gimmicks Fraud in Financial
    Reports, 1993, ISBN 0070561311
  • Robert J. Shiller Irrational Exuberance (2nd
    Edition), Feb. 2005, ISBN 0691123357
  • Nassim Nicholas Taleb Fooled by Randomness,
    2005, ISBN 0812975219
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