by George Taniwaki

While in school, we often learn about a particular subject through textbooks that make it seem that the body of knowledge for that area is neat and tidy and always has been. As students we may take for granted that the ideas presented by our instructors and textbooks are static, or at least follow a linear progression of always increasing. Rarely is it ever discussed how ideas change over time, the controversies, errors, and long lead time for new information to be incorporated into the body of knowledge.

Even in graduate school, where critical analysis is considered an important skill to teach, very little time is spent on the historical context in which important ideas were formed. Very little time is spent describing how radical new ideas are vetted and if found useful, replace entrenched older ones, a process called a paradigm shift. The term comes from the excellent book by the philosopher Thomas Kuhn entitled The Structure of Scientific Revolutions (1962).

Even rarer than a historical description of how a new idea replaces an old one is a description written by the very people who were responsible for the paradigm shift. That’s why I was interested to read a paper entitled Ball and Brown (1968): A Retrospective. written by Ray Ball and Philip Brown.

Mr. Ball and Mr. Brown were PhD students at the University of Chicago in the 1960s. They were the first researchers to show that on the day that accounting information (like earnings) is released, it will affect stock prices. This seems obvious today and nearly all researchers believe it is true and base their own research on the assumption that it is true. Today this belief even has a well-recognized name, called the semi-strong form of the efficient market hypothesis. But in 1968 the idea was considered radical and many experts dismissed the paper.

The paper was groundbreaking in another respect. The basis of their paper was not theoretical, it was experimental. The authors looked at actual companies and conducted a statistical analysis of the historical stock price data on the days before and after each “event”, in this case the company’s release of accounting information. (This technique was championed by Eugene Fama, also of the U. of Chicago.) Again, this seems obvious today, but was radical in 1968. The story of how they came  to write the paper is quite interesting. (Or it is to me or anyone else interested in the history of economic theory.)

Their original paper is entitled “An empirical evaluation of accounting income numbers” and appeared in J. Acct. Res. 1968. To give you an idea of how important this paper is, below is a citation graph for this paper. It has been cited a total of 941 times since it was published 45 years ago, with the number of citations growing almost every year (the drop at the end is likely due to recent papers not yet indexed).

BallBrownCitations

Citations for Ball Brown (1968). Image from Microsoft Research

Much thanks to my wife, Susan Wolcott, for sharing this paper with me. Her PhD dissertation in accounting is based on a test of the semi-strong form of the efficient market hypothesis.

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As a follow-up to a recent blog post marking the passing of the Nobel prize-winning economist Ronald Coase, I want to feature two fine obituaries.

The first is by the Economist,  in an article entitled “The man who showed why firms exist”.

CoaseJacket

Coase is dead, long live the firm. Photo from U. of Chicago

Another tribute was published by UChicago News, an official publication of Mr. Coase’s employer. The article has a link to a YouTube video that includes short excerpts (3:40) of a longer interview of Ronald Coase from 2012.

CoaseInterview

Accidental Economist. Video still from YouTube

Ronald Coase was active until his death. In 2012, he published a book with a U. of Chicago PhD graduate named Ning Wang. The book entitled How China Became Capitalist describes the economic transformation in China over the past 35 years. It argues that the credit for this change belongs to individual entrepreneurs, not to the central government. China’s new economic freedom has not been matched by the free flow of ideas. Until that changes, China will never reach its full potential.

A short (3:30) discussion of the ideas behind the book by its two authors is posted on YouTube. It is from the same interview from the video described above.

CoaseAndWang

Coase and Wang discuss their book. Video still from YouTube.

Disclosure: George Taniwaki is a graduate of University of Chicago’s Booth School of Business. The opinions expressed in this blog post are his own and do not reflect those of any organization.

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