JOURNAL OF FINANCIAL REPORTING American Accounting Association

Vol. 1, No. 2 DOI: 10.2308/jfir-51617

Fall 2016
pp. 47–58

Thoughts on the Divide between

Theoretical and Empirical Research in Accounting
Qi Chen
Duke University

Joseph Gerakos
Dartmouth College

Vincent Glode
Daniel J. Taylor
University of Pennsylvania
ABSTRACT: What is the relation between theoretical and empirical research in accounting? What should be the
relation? As a mix of individuals with experience in both theory and empirical research, we offered our perspectives
on these issues during a lively panel discussion at the 2015 Junior Accounting Theory Conference. This paper
highlights key themes from our discussion.

INTRODUCTION

W
hat is the relation between theoretical and empirical research in accounting? What should be the relation?
Accounting researchers have struggled with these questions since the ‘‘economics revolution’’ in the accounting
literature in the early 1970s. During that period, path-breaking empirical research on the information content of
accounting disclosures coincided with path-breaking theoretical research on capital markets and the efficiency of alternative
information systems.1
Almost five decades later, a vast and growing divide separates theoretical and empirical research in accounting. This
divide, and the need to bridge it, was the topic of our panel discussion at the 2015 Junior Accounting Theory Conference. In
this paper, we highlight key themes from this discussion with the hope that they will be useful for future generations of theory-
oriented empiricists and empirical-oriented theorists—future generations of accounting researchers interested in bridging the
divide.
Before turning to the panel discussion, it is useful to reflect on the state of affairs in accounting research as it concerns the
relation between theory and empirical work. While concerns about the divide between theory and empirical work are not new
(e.g., Ball and Foster 1982), we are concerned that the divide has grown to the point that—within the next ten years—theory
will no longer be viewed as an important methodology within accounting research.2
To provide some hard evidence on the matter, we collect data on the number of theory papers published each year between
2001 and 2014 in the top four journals in accounting: The Accounting Review (TAR), Journal of Accounting & Economics

This paper is adapted from a panel session at the 2015 Junior Accounting Theory Conference where Professors Chen, Gerakos, and Glode were invited to
serve as panelists and Professor Taylor was invited to serve as the moderator. Professor Taylor’s remarks draw heavily on the material in Bertomeu, Beyer,
and Taylor (2016). We thank the Conference organizers for inviting us to serve on the panel, the conference participants for comments and encouragement
to formalize our remarks, and the editors for providing the opportunity to combine our remarks into this paper.
Editor’s note: Accepted by Richard A. Lambert.
Submitted: July 2016
Accepted: September 2016
Published Online: October 2016

1
See Ball and Foster (1982), Jensen (1982), and Verrecchia (1982b) for excellent commentary on this early literature, especially as it relates to the relation
between theory and empirical work.
2
When reading an earlier draft of the manuscript, a well-respected theory colleague commented that this view was too optimistic––that theory in
accounting was already dead.
47
48 Chen, Gerakos, Glode, and Taylor

(JAE), Journal of Accounting Research (JAR), and Review of Accounting Studies (RAST). Panel A of Appendix A shows a
striking downward trend in the number of theory papers (as a fraction of total papers) published in leading accounting journals.
While there is no apparent time trend in theory papers published in TAR, there are pronounced downward trends in the number
of theory published in the JAR, JAE, and RAST. Over the 2001–2005 (2010–2014) period, theory papers comprised 26 percent
(10 percent) of papers published in RAST, 18 percent (11 percent) of papers published in JAR, 12 percent (10 percent) of papers
published in TAR, and 9 percent (4 percent) of papers published in JAE. Collectively, these changes constitute a 44 percent
reduction in the fraction of theory papers published in top journals.
To examine whether this pronounced downward trend is unique to accounting, or indicative of a more general trend away
from theory in the related social sciences, Panel B of Appendix A presents similar data for the top three journals in finance: The
Journal of Finance (JF), Journal of Financial Economics (JFE), and Review of Financial Studies (RFS). With the exception of
RFS, there is not a pronounced downward trend in theory papers in finance. While JF and JFE remain flat around 30 percent
and 24 percent, respectively, RFS moves from 48 percent in the 2001–2005 period to 37 percent in the 2010–2014 period.
Notably, RAST and RFS were created with the explicit intention of catering to theory work and elevating the role of theory
within their respective fields. For example, in the first five years of RAST (i.e., 1996–2000), theory papers comprised 42 percent
of published papers. Given this intention, it is striking that 15 years later theory papers consistently comprise only 10 percent of
papers in RAST.
The vast divide between theory and empirical work also manifests in the training of future generations of accounting
researchers. While every top research university offers theory seminars in finance and economics, it is not the case for
accounting. The number of accounting researchers with sufficient quantitative training to produce first-rate theory work is too
few to go around. Hence, theorists are concentrated in only a few schools. As a direct consequence, the vast majority of
accounting doctoral students is not exposed to a theory course in their field of study. In the absence of exposure and training, it
is difficult to imagine theory guiding or enriching the work of future generations of empirical accounting researchers.
Perhaps as a result of these fundamental differences in training, few theorists have a grasp on empirical work, and few
empiricists have a grasp of theory work. While individual researchers may have incentives to specialize in either empirics or
theory, it is unclear that such incentives serve the profession. A key feature of the scientific process is the complementarity
between theory and data. However, our sense is that complementarities between theory and empirical work are valued less in
accounting than in related fields, and that the value of these complementarities has declined over time.
Assuming for the moment that theory-empirical complementarities are valuable in related fields, why are such
complementarities less valuable within accounting? Is it training? Are features of accounting research topics less amenable to
formal modeling than in related fields? Are theory models in accounting less amenable to empirical testing than in related
fields? These are not easy questions to answer, but attempting to answer these questions helps illuminate our own biases, the
institutional forces that shape our profession, and the unique features of accounting topics.
The remainder of the document offers a commentary on several thought-provoking questions, with responses broken out
by panelist. Each of the second through eighth sections corresponds to a different question. The ninth section concludes and
summarizes.

WHAT ARE THE PRIMARY BARRIERS TO DOING THEORY WORK IN ACCOUNTING?

Daniel J. Taylor (Moderator)

Is this just an issue of training? Of mathematical prowess? My sense is that to make a theoretical contribution, nowadays
you really have to impress people with your mathematical horsepower. Simple models that make a simple point are no longer
welcome—even if directly relevant to an institutional setting or set of empirical findings. Instead, you need an impressive
display of analytical pyrotechnics that is often inaccessible to a broad empirical audience; math for the sake of math will get
you farther than a simple point targeted at an empirical audience. It seems, empirical relevance is neither necessary nor
sufficient. I know many theorists who unabashedly profess not to care that their work is not accessible by empiricists.

Vincent Glode (Panelist)

I disagree with Dan. I think this is how we, junior people, view the profession, that is, theoretical contributions must be
highly technical nowadays. However, I know a few current and former editors at top finance journals very well, and not a single
one of them seems to believe that simplicity is not better than complexity. I have also been involved in the review process for
my papers and many others that I refereed and there clearly is a concern for simplicity from journal editors. Editors have a long-
term view and care about impact, so they probably want to minimize the barriers to understanding your contribution. But bear
in mind that we, junior people, do play a role in creating this problem when we act as referees and discussants. The discussants
who tend to ask me to complicate my models are rarely the senior ones; they are more often the junior ones. And if as referees

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we do the same thing or we complain that simple models are perhaps ‘‘not robust,’’ without really knowing, or we confuse
simplicity with obviousness, then we are contributing to making simple models harder to publish, despite perhaps what the
editors think is best for the profession.

Qi Chen (Panelist)
I agree with Vincent that good economic insights do not necessarily need to be proven or stated using complex models
(Modigliani-Miller Theorem is a good example). Dan raised an important point about training. Information economics is a
difficult field and is still being developed. A solid training in economics and quantitative methods is a prerequisite for doing
good theory work. However, the average applicant to Ph.D. programs in accounting is ill prepared for quantitative training in
economics, mathematics, and statistics—especially when compared to the average applicant to Ph.D. programs in economics,
finance, and other quantitatively oriented social sciences. This situation is not helped by the fact that most Ph.D. programs in
accounting require only Introductory Microeconomics and Introductory Econometrics courses in their Ph.D. curriculum and do
not have any faculty who do theoretical research. So yes, training is a big hurdle.
Unfortunately I do not see any urgency by our profession to change the situation. This is dangerous and damaging to the
long-run success of helping accounting academia to be a respectful research field, as theoretical research is the ultimate source
of rigorous new insights and methodologies. Lack of theory training not only reduces the number of theory researchers, it also
reduces the number of well-trained empiricists capable of absorbing, disseminating, and testing economic models. Insufficient
theory training results in deficient empirical research—empirical research that cannot challenge existing paradigms and inspire
new theoretical research. Instead, published empirical research tends to gravitate toward the theories (or verbal conjectures)
most recognized by referees and editors (e.g., Jensen and Meckling 1976) at the expense of new alternative theories that have
the potential to challenge conventional wisdom and generate significant new empirical predictions.
One example is the issue of whether accounting conservatism is desirable for debt contracting. The conventional view is
that accounting conservatism is desirable for debt contracting, although the argument is made in a rather ad hoc manner.
Perhaps because the argument is intuitive, and is made by well-known and well-respected scholars in the field (e.g., Watts
2003), the profession has gathered volumes of empirical correlations that appear to ‘‘confirm’’ the validity of the argument.
Meanwhile, Gigler, Kanodia, Sapra, and Venugopalan (2009) provide a rigorous theoretical analysis of the argument and show
that the argument is based on tenuous assumptions. Nonetheless, it seems that many have already taken the desirability of
conservatism in debt contracting as a truism and any evidence to the contrary must be false.
Should accessibility to empiricists, empirical relevance, or empirical testability be a sufficient or necessary condition for theory
papers? The answer depends. Accessibility is perhaps the most tenuous of all. Even empirical research is not accessible without
sufficient training. My view is that good theories should always have empirical relevance and/or policy implications, although the
distance between a particular paper and its ultimate empirical relevance and testability depend on the nature of the question being
addressed. For example, the Arrow-Debreu general equilibrium theories are perhaps inaccessible to the average researcher and have
no directly testable predictions, but they set up the foundation for future theories that can speak directly to empirical work. Cynics
may also dismiss the Modigliani-Miller Theorem on the grounds that the assumptions are unrealistic. But it is nevertheless
empirically relevant because it formalizes the necessary assumptions that one has to make in order to generate empirical predictions.

WHAT ROLE DO EMPIRICAL FINDINGS PLAY IN INFORMING THEORY WORK?

Vincent Glode (Panelist)

I think the role played by empirical work in informing theory greatly depends on the ultimate contribution of the paper. As an
applied finance theorist, many of my papers are written in response to a puzzling empirical fact. This is how I was taught at
Carnegie Mellon University—you find an empirical fact that appears puzzling and that needs to be explained and you build a
model to explain it. So without empirical facts, there is no paper like that. Other papers are written around a theoretical insight that
I find interesting, even without thinking about the implications of that insight for the real world. But even these papers end up
making a link with empirical facts because I still want to convince many readers of the economic importance of my insights.
Sometimes, I calibrate the model to show that the mechanism is important quantitatively and can match some empirical quantities.
I should note that when I submit my papers to finance and economics journals, the assigned editors tend to be theorists,
sometimes they are what we could call ‘‘pure’’ theorists, yet they still ask for a good empirical motivation for my models. I
suspect that it comes from the fact that a paper can make a much broader impact if it speaks both to theorists and
empiricists rather than to only one of these groups. You can speak to empiricists by linking your insights to facts that are
already documented, but you can also speak to empiricists by linking your insights to tests that could be implemented in
the future.

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50 Chen, Gerakos, Glode, and Taylor

Qi Chen (Panelist)
Empirical research should play a significant role in informing theory work and in challenging existing theories. Many good
theory papers in accounting are motivated by empirical findings. For example, empirical regularities about how stock prices
(returns) relate to accounting numbers are the main motivation for a significant amount of theoretical research. These papers
address the role of accounting information in different contexts, for example, its role in communicating information about firm
production (e.g., Kanodia and Mukherji 1996; Kanodia and Lee 1998; Kanodia, Singh, and Spero 2005), its role in addressing
incentive misalignment, i.e., stewardship role (e.g., Gigler and Hemmer 1998, 2001), its role in helping traders forecast future
cash flows/dividends (e.g., Verrecchia 1982a), and its role in properly representing value dollar-by-dollar (e.g., Ohlson 1995).
In each of these contexts, in order to focus on the key issues and gain sharper insights, researchers often need to turn off
key features of other contexts. For example, Ohlson (1995) is concerned about accounting numbers’ ability to represent value.
Therefore, the paper starts with a model where firms’ dividends are exogenously determined, and focuses on how key
accounting institutional features (book value, earnings, clean surplus relation) can produce a theoretically correct number (in
dollar terms) for the value of the dividend stream. In doing so, it suppresses investors’ need for information (e.g., to learn about
future dividends) and therefore has limited value in assessing the usefulness of accounting in settings where investors have
incomplete information (e.g., Holthausen and Watts 2001). Models dealing with the role of accounting information in
secondary trading markets (e.g., Verrecchia 1982a) address investors’ need for information to learn about future dividends, at
the expense of suppressing institutional features of accounting (e.g., the balance sheet is not explicitly modeled in these types of
trading models). Both models take a firm’s future cash flows as given, that is, they focus on the exchange/consumption side of
the economy, suppressing the production side.
Models on accounting’s stewardship role have the production side in the background. In contrast to the pure-exchange type
of models where information disclosure does not affect the underlying fundamentals (e.g., future cash flows) that the disclosure
is about, these models highlight that how the information system is designed can also alter the fundamentals. In addition to
highlighting the importance of accounting measurement, it also shows that it is difficult, and perhaps not meaningful, to attempt
to separate a ‘‘business fundamental quality’’ from ‘‘accounting measurement quality,’’ as they are intrinsically related.
Kanodia and Mukherji (1996), Kanodia and Lee (1998), and Kanodia et al. (2005) directly address the production side, and
contain some of the most significant and promising insights in recent accounting theory. Unlike most of the agency-based models,
this line of work directly models the separate reporting of firm decisions versus the outputs of these decisions, and therefore brings
theory closer to capturing institutional reality: accounting reports both the balance sheet and income statements, and the
measurement issues are related to both the reporting of decisions (e.g., assets) and of outputs (e.g., earnings). As such, these works
have the potential to shed light on the desirability of key accounting institutional properties including, for example, the role of
accruals, and the role of the measurement of firms’ assets and earnings (see Kanodia and Sapra [2016] for a review of this
literature). Yet, little, if any, empirical research has assessed the empirical validity and implications of this line of work. This is
unfortunate, as the role of accounting for communicating production-related information is no less important than its stewardship
role, or its role in secondary trading markets. It is true that models in this literature are more mathematically complicated, but
certainly not for the sake of mathiness. The situations they study are inherently more complex and the ideas more sophisticated.
Nonetheless, the fact that the majority of empiricists do not seem to be aware of or understand these papers means the payoff to a
theorist from investing time to learn and absorb their insights is not immediate.

WHY DO YOU THINK THERE IS VERY LITTLE COLLABORATION BETWEEN THEORISTS AND
EMPIRICISTS?

Qi Chen (Panelist)
Mutual misunderstanding contributes to the lack of cooperation. Each focuses on what the other cannot do. The ironic part
is that their criticism for each other is really the same criticism: theorists think it is impossible to conclude with certainty from a
regression of Y on X that X affects Y (when they believe so many other things in reality could also affect Y); empiricists think
theories cannot really say anything useful when the models are so stylized and abstract. Lack of training is the key factor:
theorists should gain better appreciation for how empirical studies actually work; and empiricists should improve their
understanding of how to evaluate a model and to draw proper empirical implications from theory.

Joseph Gerakos (Panelist)

From a junior empiricist’s perspective, the primary barrier to collaboration is the fear of getting rejected by a journal.
Unfortunately, this is a healthy fear. It is relatively straightforward to write a paint-by-numbers empirical paper and push it
through a top-tier accounting journal. When I say paint-by-numbers, I mean, for example, that there are a bunch of studies that

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correlate X with A, B, C, and D, so I am going to correlate X with E. The primary objective of such papers is to document
interesting new descriptive facts rather than to develop and test formal theory. When providing such descriptive evidence,
validity threats are few and, ex post, such threats can often be converted into interesting ‘‘findings’’ to be explored in future
research.
In contrast, consider a joint theory-empirical project. For projects that combine theorists and empiricists, both parties need
to learn how to communicate and collaborate together. This is nontrivial; empiricists likely lack in-depth theory training and
theorists likely lack in-depth empirical training. Both types of authors will have to learn an entirely different vocabulary and set
of tools. Hence, the joint theory-empirical approach inherently takes longer. Moreover, by its very nature, the depth of
analysis—measured along a single dimension—does not match that of either a pure theory paper or a pure empirical paper.
Such a study’s contribution relies on complementarities between theoretical and empirical approaches. Moreover, it is harder to
ex post rationalize results in a joint theory-empirical paper.
Unfortunately, and perhaps due to a deficiency in training, joint theory-empirical papers do not appear to be valued by
many in the profession, thereby leading to a higher likelihood of rejection by a journal. In terms of incentives, tenure clocks are
short. Rationally anticipating the resistance to joint theory-empirical projects, many faculty opt for the path of least resistance—
write pure empirical papers.3 At the same time, however, the status quo provides opportunities for researchers who are willing
to take risks.

Vincent Glode (Panelist)

As Qi and Joseph mentioned, there is a lot of specialization. With short tenure clocks, it is hard diversify your training,
your expertise, and your research. And I think the optimal degree of specialization may differ from an individual’s perspective
and from a social perspective. I also think the concerns that empiricists have when they worry about perfect identification are
almost opposite to the concerns that theorists have when they build a model. Empiricists need to know all the institutional
details in order to build a convincing test that shows causality—assuming causality is the goal. Theorists abstract away all the
possible interferences and build models that focus on one possible mechanism. So in one case, you want to rule out alternative
channels, in the other case, you simply omit them.
I think it is important to understand that the two types of research are trying to play very different roles. Theorists are not
trying to identify all causal channels. Usually, they propose and explain just one channel. Then empiricists can look for
evidence for or against the conjectured channel.

Daniel J. Taylor (Moderator)

As an empiricist, I think it is important to keep in mind that some of the better theory papers use simple mathematical
models as a tool for illustrating very general economic intuition. The purpose of such papers is not to model the real world, or to
show X causes Y, but to explain why X might cause Y in a particular setting. Empiricists can then look at the results and ask (1)
To what extent do the theoretical assumptions comport with the real world? (2) To what extent do violations of the assumptions
alter the intuition that I learned from the theory (i.e., to what extent is the intuition generalizable)? And ultimately, (3) To what
extent do the forces present in the model manifest in the data? My own sense is that there is very little collaboration between
empiricists and theorists because, when evaluating theory, many empiricists stop at the first question.

AS AN EMPIRICIST, WHY SHOULD I CARE ABOUT FORMAL THEORY?

Daniel J. Taylor (Moderator)

To frame the discussion, it will be useful to differentiate between ‘‘verbal theory’’ and ‘‘formal theory’’ as it is applicable to
empirical papers. Define verbal theory as using words to describe one’s intuition and using this intuition to develop hypotheses,
and define formal theory as using mathematical expressions to formalize one’s intuition and develop hypotheses (e.g., Kahn
and Whited 2016).
When it comes to the role of formal theory in informing empirical work, I have heard many empirical researchers espouse
variations on the following sentiments: (1) ‘‘Why do I need a formal theory if I can describe it in words?’’ And more extreme,
(2) ‘‘I do not understand the role of formal theory work in accounting research. If the results are consistent with the data, then I
did not need the theory. If the results are not consistent with the data, then the theory is wrong.’’ In an empirical paper, what
advantages does invoking formal theory to motivate hypotheses and tests have over invoking verbal theory? Disadvantages?

3
See Hopwood (2007) and Waymire (2012) for greater discussion of these incentive problems and how they manifest in our research.

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52 Chen, Gerakos, Glode, and Taylor

Joseph Gerakos (Panelist)

Theory is important because it forces us to be careful when interpreting conditional correlations, which is basically all that
we do as empiricists. Theory forces a researcher to be explicit about assumptions that underlie these interpretations. Theory
does not, however, require math. For example, the Coase Theorem is important in law and economics, but the math is trivial.
Nevertheless, it is important to differentiate theory from ‘‘storytelling.’’ Too much of the accounting empirical literature is along
the lines of: I have some intuition, I lay out some broad predictions that conform to this intuition, and then I regress away.
It is important to push back against this approach and force empirical researchers to rigorously state the assumptions that
underlie their predictions, analysis, and interpretations. Assumptions and predictions should be laid out in primitives such as
supply, demand, costs, and benefits. I am not saying that you have to use math. Logical calculus can be written out with words.
In fact, I recommend all doctoral students take a class in formal logic. In your research, be explicit about your assumptions and
make sure that they are internally consistent. In workshops and seminars, force presenters to be clear and open about their
assumptions and push them if those assumptions are opaque or internally inconsistent.

Vincent Glode (Panelist)

Whenever I write a theoretical paper, my goal is to change the readers’ priors. I want to surprise people. I have an intuition
that I consider original, yet relevant, and I start building a model to illustrate this intuition. As I formalize the intuition, often I
derive the specific conditions under which my intuition works. These conditions inform us about when we should expect our
verbal theory to work and when it should not work. And going back to the quote, I think that models may contribute to the
literature even when their predictions are later rejected by empiricists. In many cases, it is important to rule out specific
mechanisms, and we cannot rule them out empirically if nobody has developed the relevant theory first.

Qi Chen (Panelist)
When the hypothetical empiricist starts to look at data, s/he must have some idea of what to look for. These ideas are
usually intuitive conjectures and hypotheses, not theory. Intuition should not be confused with formal theory. Take the
Modigliani-Miller Theory for an example. Prior to Modigliani-Miller, a reasonable conjecture would be that paying more
dividends would increase equity value. You can see why it is easily confused as a ‘‘theory,’’ because it appears logically
consistent: investors like getting dividends, thus equity values of dividend-paying firms must be higher. A hypothetical
empiricist might observe a positive stock price reaction to dividend increases and interpret this as empirical evidence in favor of
the ‘‘theory.’’ However, under this ‘‘theory,’’ one would reach the absurd recommendation that it is good for managers to
borrow money or to sacrifice valuable investment opportunities to pay dividends! Formal theory does not reach this logical
absurdity and instead forces researchers to develop new theories (e.g., signaling theory) to understand how and why prices
change upon dividend announcements. Intuition is by its very nature incomplete; formal theory can help complete one’s
intuition.
An accounting example is the Positive Accounting Theory, which is an intuitive conjecture: it conjectures that observed
accounting practices are chosen by self-interested parties. The conjecture was formed and stated under reasonable logical steps.
Under this conjecture, incentives play a role in explaining observed accounting practices. This conjecture suggests the need to
control for incentive-related variables in an analysis of accounting choices. Without diminishing its role in the development of
the accounting profession as a research field, it is perhaps time to ask, ‘‘Is this the only theory that explains accounting
practices?’’ Have we exhausted all alternatives? If the answer is yes, then the obvious next step is that we should quit calling
ourselves researchers because we have identified not just a theory, but a truism that explains everything. If the answer is no,
then what are the alternatives? Why have we not developed a credible alternative over the last 30 years?

Daniel J. Taylor (Moderator)

To summarize and expand, while it is true that verbal theory is useful for motivating empirical analyses—certainly much of
my own work relies on verbal theory—my own sense is that there are two key disadvantages. First, because they are by
definition based on intuitive reasoning, verbal theories are limited by the depth of the researcher’s intuition. While verbal theory
is well suited for articulating predictions that are intuitive, I would argue that—by definition—verbal theory cannot generate a
prediction that is counterintuitive. This would seem to highlight the necessity of grounding empirical work in formal theory.
Consider a world in which all empirical predictions are based solely on authors’ intuition—then as a field, it would seem our
research would only be as deep as our intuition. And if our research is only as deep as our intuition, then are we really a field of
scientific inquiry?
In stark contrast, formal theory can offer predictions that are counterintuitive and can also be useful for extending one’s
intuition in directions that would not have otherwise been apparent. The Capital Asset Pricing Model (CAPM) stands as a

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FIGURE 1
Extent to Which Theory Is Integrated into an Empirical Paper

prominent example. In the absence of a formal model, would intuition suggest not only that the covariance between a firm’s
stock return and the market return is a measure of risk, but the only risk that is priced by the market?
Second, because verbal theories lack mathematical formalism, assumptions and constructs are often not well defined. As a
result, verbal theory is often much more difficult to falsify than formal theory. In this regard, formal theory can be viewed as
enumerating a set of conditions (or assumptions) under which a particular result is definitively true. Here too, the CAPM serves
as an excellent example. The assumptions necessary for the CAPM to hold are generally well understood. In the presence of
explicit assumptions, researchers can test the assumptions and extend the theory. The cycle can then continue. This would seem
to epitomize the scientific process. It is not clear to me that the scientific process can function effectively in a setting where
assumptions and constructs are not well defined.
Go back to the example Qi gave on debt contracting and conservatism. A growing number of empirical studies report
correlations that seem to suggest accounting conservatism is desirable for debt contracting. As scientists, we must be prepared
to admit—however unlikely—that it is possible these correlations are collectively spurious. Mathematically formalizing the
argument that accounting conservatism is desirable for debt contracting adds credibility to the reported correlations because it
defines the world (or set of assumptions) under which conservatism facilitates debt contracting. In other words, it proves
existence—that there exists a world in which conservatism is desirable for debt contracting. One can then ask whether this
hypothetical world and associated assumptions are a reasonable approximation to reality. If the assumptions are reasonable,
then the model adds credibility to how researchers are interpreting the correlations. If the assumptions are unreasonable, then
the model will seem to cast doubt on the interpretation.
So to summarize the discussion to this point, I think it is important to bear in mind that while formal theory is certainly not
a precondition for conducting interesting empirical analyses, it is important to recognize that formal theory can help enrich and
guide empirical work in ways that verbal theory cannot. In other words, motivating empirical work based on formal theory
should be considered value added.

HOW DOES ONE DECIDE THE PROPER MIX OF THEORY AND EMPIRICAL WORK WITHIN A GIVEN
PAPER?

Daniel J. Taylor (Moderator)

To frame the question, imagine the following scale for the extent to which theory is integrated into an empirical paper
(Figure 1):
Type (a) represents a descriptive paper that reports various correlations without any attempt to ground those results in
theory, verbal or formal, Type (b) represents a standard empirical paper that tests predictions motivated by verbal theory, Type
(c) represents a standard empirical paper that tests predictions motivated by formal theory, Type (d) represents a paper that
contains both formal theory and reduced-form empirical tests of comparative statics, and Type (e) represents a paper that
contains both formal theory and structural, or functional form, tests of comparative statics. A key distinction between reduced-
form and structural tests is that the former tests the sign of a comparative static, e.g., ]y=]x . 0, whereas the latter tests the
functional form of the comparative static, e.g., ]y=]x ¼ br2 =Ns. Papers that feature reduced-form tests often assume a linear
data-generating process and estimate regressions where variables of interest are motivated using formal theory and control
variables are motivated using verbal theory or different formal theories. Papers that feature structural tests often involve a
nonlinear estimation of the data-generating process, and require not only that all variables are motivated by formal theory, but

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the same formal theory. When is a particular type appropriate/inappropriate? Should every empirical paper have a formal theory
model associated with it?

Qi Chen (Panelist)
It depends on the profession’s current stock of knowledge on the matter. Fama and French (1993) can be viewed as pure
descriptive, but it saves the profession some trouble in trying to attack/address ten anomalies at a time. Li (2008) is descriptive, but
it discovers and opens up a whole new subfield for accounting researchers to explore, at least data-wise. These papers do not need
models because their contribution lies in documenting useful empirical regularities or discovering intriguing new facts.
A better question to ask is whether you have an idea/insight that can make meaningful contribution. The decision on the
mix of theory and empirics should be secondary to the idea that you want to pursue, and depends on what is the best
approach to communicate your idea and help establish your desired contribution in the best possible way. For example,
Bushman, Chen, Engel, and Smith (2004) do not have a formal model, and the empirical specification is ad hoc. The paper
was, however, among the first empirical analyses on the real consequences of the properties of accounting information,
specifically the asymmetric timeliness in loss recognition (it was published in 2004, but the first draft was circulated around
1999). Before then, under the joint forces of Positive Theory of Accounting and efficient market hypothesis, accountants had
always regressed properties of the accounting system (e.g., earnings management) on something else. Given the amount of
empirical papers published in the last ten years relating different variables to proxies of asymmetric timeliness, it is difficult
to establish significant contribution without theories/models to help develop more precise mechanisms. Another example is
Chen, Goldstein, and Jiang (2007), who are among the first to test the idea that managers learn from prices. Evidence
supporting the learning channel highlights the role of stock markets on the real economy, and has implications for evaluating
the efficiency of market designs. Before then, it is believed by many that managers never needed to learn anything from the
market because they know more about their firms than investors. There is no model in the published version, although the
empirical specification can be derived from an analytical structure. In both cases, the referees and the editors appreciated the
potential implications of the ideas behind the results; they greenlighted the papers so the rest of the profession could explore
and debate about these issues.

Vincent Glode (Panelist)

I agree with Qi: it greatly depends on the contribution you are trying to make to the literature. If you are the first person to
ever look at a specific phenomenon, then Type (a) is probably fine. But as more people work on the topic and more information
becomes available about the topic, you want to start exploring the potential mechanisms that drive this finding. That is usually
when you start seeing papers that use insights from formal theories developed by others. Finally, once we have identified a few
channels that qualitatively help explain a phenomenon, we might want to have a better understanding of their interactions and
their relative importance through the use of Type (e).

Joseph Gerakos (Panelist)

All of these approaches are relevant. As Qi points out, sometimes a purely descriptive piece can spur future theory work,
which can then inform subsequent empirical work. Unfortunately, while many recognize the value of papers on one extreme,
Type (a), my sense is that few people recognize the value of papers on the other extreme, Type (e). I often hear researchers state
that all models are wrong, so why are researchers testing models? Of course, all models are wrong. Nonetheless, some models
are useful for developing intuition and it is worth seeing how these models comport with the data.
Consider Type (c) or Type (d), a reduced-form paper that uses a difference-in-differences design around a quasi-natural
experiment. Such approaches can be useful to test formal theory. Reduced form is great for estimating the direction of an effect,
but less so for estimating the magnitudes of primitives. Every paper does not need to have a formal theory, but we need to see
more papers that incorporate formal theory. Finally, I think that it is worthwhile for an empirical researcher to try multiple
approaches to research. Why would you want all of your papers to look the same?

WHAT ROLE CAN STRUCTURAL MODELING PLAY, IF ANY?

Daniel J. Taylor (Moderator)

Consider papers, or hypothetical papers, in the most extreme right tail of the above scale: structural models. From my
perspective, the primary benefit of structural estimation is that it allows us to formalize our assumptions and estimate latent
variables that we would not otherwise observe. For example, Bertomeu, Beyer, and Taylor (2016) point out that empiricists use
structural estimates all the time without even realizing it. For example, b from the CAPM, Kyle’s k, and Easley and O’Hara’s

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PIN, are all estimates of structural parameters that appear in seminal theory models, and are widely used in empirical research
to measure systematic risk and information asymmetry, respectively. Structural modeling gives meaning to certain correlations
in the data; meanings that might not otherwise be apparent in the absence of formal theory. In many cases, the explicit
assumptions that underlie various formal theory models are known to be violated (e.g., the CAPM assumptions). Nevertheless,
structural estimates of parameters in these models (e.g., b) continue to guide and inform empirical work. Thus, it is important to
recognize that while a formal theory model may not literally hold, structural estimates based on these models can still help
guide empirical research.
Given that empirical researchers regularly use structural estimates in their reduced-form regressions, and given the prevalence
of structural modeling in economics and finance, why are structural models so rare in accounting? Is it simply an issue of
inadequate training? Or is it because of some unique feature of accounting data? Is there a benefit to structural modeling that many
are missing?

Qi Chen (Panelist)
I agree with Dan. A related issue is how to quantify and measure information, where formal models and structural
estimation can really help, as the quantity/flow of information itself is not directly observable and measurable. It would be
helpful for our profession to establish a proper perspective on the pros and cons of these different approaches, and
structural models specifically. They are tools. None of them is perfect. Each has its own advantage in dealing with a
specific question.
I do not know whether structural modeling has a bad rap in accounting. My two cents worth is that the profession has never
really developed the culture (and ability) to practice it. Some of the issues brought up earlier on the training of Ph.D. students
have a lot to do with this.

Joseph Gerakos (Panelist)

While training undoubtedly plays a major role, at the same time, accounting structural researchers need to make the
benefits of structural estimation more transparent. The main benefit of a structural approach is not identification. In fact, a good
structural paper goes through all of the identification exercises that a good reduced-form paper goes through and then layers on
structure. I do not understand comments such as ‘‘I am identifying based on my model.’’ How do I know that you have the right
model? You have infinite degrees of freedom. Good structural papers take a long time because you have to combine
identification with structure.
The benefit of the structural approach is the estimation of economic primitives that can be used in counterfactuals. Anytime
we are interested in magnitudes (as opposed to directions), more structure is the way to go. For example, Gerakos and Syverson
(2015) estimate changes in consumer surplus in the audit market under various market structures. They were interested in
magnitudes so they had to estimate economic primitives, namely client preferences for the characteristics of the Big 4 firms and
the marginal utility of income. They could not have done this with a reduced-form approach. Nonetheless, they followed the
same identification steps as in a reduced-form approach.
There is currently a debate in accounting about whether natural experiments or structural modeling is the ‘‘best’’ approach.
I think that this debate is a deadweight loss. Each approach has its use. Other fields have gone through this debate and nothing
came of it. The approaches are not mutually exclusive. For example, why not combine a natural experiment with a structural
model?

Qi Chen (Panelist)
Heckman (2000) and Heckman and Vytlacil (2007) offer excellent perspectives on the pros and cons of various empirical
paradigms. Natural experiments cannot identify structural parameters. An exogenous loss of analyst coverage may indeed cause
an ex post observable loss in firms’ equity value. But a natural follow-up question is: Why? This relates to the relevance of
mechanisms, and the magnitude of each mechanism. These are questions that theory-based work and structural estimation are
best suited to examine.

WHAT CAN WE DO ABOUT THE DIVIDE BETWEEN THEORY AND EMPIRICAL WORK?

Vincent Glode (Panelist)

I think that people in this room can play a big role in improving the situation. Becoming more rounded as researchers
should make us better referees and we all know that referees can make a big difference in how the game is played.

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Joseph Gerakos (Panelist)

Work with the Ph.D. students and be proactive in the review process. Give editors feedback. Make a point of highlighting
the importance of theory in your recommendations to the editor—both positive and negative. It is easy to grouse about the state
of affairs—the hard part is to effect change. If you see an empirical paper that is devoid of theory, or runs in the face of extant
theory, do not be afraid to raise this point. We need to be direct in order to effect change.

Qi Chen (Panelist)
Journal editors could help by encouraging the submissions and the publications of theoretical papers, taking the long-term
view that an academic profession without theoretical foundations of its own is unlikely to stay strong in the long run (when was
the last time any major accounting journal designated a special issue to the latest advances in theoretical studies in
accounting?).
Given the importance of referees, it is imperative that referees are open to new ideas. Ohlson (1995) and related works
were often viewed by the mainstream theorists as not really a theory but rather a statistical tautology. Yet, the paper had a large
impact on empirical research. Perhaps instead of dismissing it, those who are not happy with it can pick up the good part (which
in my view relates to institutional features about accounting) and improve it by incorporating some economics. A good example
is Zhang (2000), but these sorts of papers do not appear to generate sufficient attention from mainstream theorists. The lack of
attention may be due to the fact that they do not address any agency or information asymmetry problems—which appear to be a
prerequisite for many theorists. There are many difficult and interesting problems other than dealing with a self-interested
manager who manages earnings to shirk, and to hide private information. Perhaps it is time for the accounting profession, both
theorists and empiricists, to jump out of the mindset that agency problems are the only interesting problems.
In this regard, it would be helpful if accounting theorists learn to be ‘‘nicer’’ to each other, to appreciate different
perspectives; and at the same time, to challenge each other in a healthy manner, creating a learning environment. Theorists need
to believe in their own models and try to put themselves in empiricists’ shoes (what are the real empirical implications that I
would spend time to pursue, if I were the empiricist?). Empiricists need to think like theorists: What new idea does this theory
convey that is different from my prior belief? How does it change how I should examine the data?

CONCLUSION
We emphasize the value of a close link between theoretical and empirical research, and encourage authors, referees, and
editors to do the same. Until complementarities between theoretical and empirical research are recognized and valued—until
formal theory grounded in empirical observation is valued higher than theory that is not, and empirical research grounded in
formal theory is valued higher than empirical research that is not—the divide between theory and empirical research will
remain.
We close the panel discussion on an optimistic note. Several observations suggest a new generation of accounting
researchers is interested in bridging the divide between theory and empirical work. For example, an increasing number of junior
researchers have started using structural models to examine economic phenomenon related to earnings management (Gerakos
and Kovrijnykh 2013; Beyer, Guttman, and Marinovic 2015; Zakolyukina 2014; Terry 2015), voluntary disclosure (Bertomeu,
Ma, and Marinovic 2014; Cheynel and Liu-Watts 2015; Zhou 2015), analysts forecasts (Xiao 2015), and the audit market
(Gerakos and Syverson 2015). The organizers of the Junior Accounting Theory Conference recognize the benefit from
integrating theory-minded empirical researchers into their meetings; and importantly, the field’s newest journal has taken the
initiative to facilitate the conversation between theory and empirical researchers.

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APPENDIX A
Time-Series of Theory Papers in Leading Accounting and Finance Journals

Panel A: Accounting Journals

Panel B: Finance Journals

Panel A presents the number of formal theory papers published in leading accounting journals: The Accounting Review (TAR), Journal of Accounting &
Economics (JAE), Journal of Accounting Research (JAR), and Review of Accounting Studies (RAS). Panel B presents the number of formal theory papers
published in leading finance journals: The Journal of Finance (JF), Journal of Financial Economics (JFE), and Review of Financial Studies (RFS). We
cumulate theory papers over rolling five-year intervals and scale by the total number of papers published in the journal over the interval. For example, the
observation for journal j in year t is computed as the number of formal theory papers published in journal j from t4 to t scaled by the total number of
papers published in journal j from t4 to t. We identify formal theory papers by searching the text for one of the following words: ‘‘Proposition 1,’’
‘‘Theorem 1,’’ or ‘‘Lemma.’’ The search algorithm is not case-sensitive and does not distinguish between formal theory papers with or without
accompanying empirical analyses, and does not distinguish between regular research papers, discussion papers, or review papers. The scale in Panel A
ranges from 0 percent to 30 percent in increments of 5 percent, and scale in Panel B ranges from 0 percent to 60 percent in increments of 10 percent.

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