Many empirical studies (including those of Rajan, Servaes and Zingales [12], Scharfstein [13], and Shin and Stulz [15]) suggest that one of the possible reasons why integrating different segments into a diversified firm can destroy value is that diversified firms tend to overinvest in less productive segments and underinvest in more productive segments (compared to stand-alone industry peers)a phenomenon that is termed ‘socialism in internal capital markets’ (henceforth SICM) by Bolton and Scharfstein [3]. Many theoretical studies, such as those of Rajan, Servaes and Zingales [12] (RSZ) and Scharfstein and Stein [14] (SS), have been motivated to explain SICM. Although there is still much ongoing empirical discussion about whether there really are ‘diversification discounts’ and, if so, whether they are associated with SICM, the current paper takes SICM at face value and aims at refining the theoretical explanation of SICM.
In this chapter, we will review what accounting theory has to say on some controversial topics associated with the measurement of capital. To an outsider with an economics background, the accounting treatment of capital, interest and depreciation seems rather strange. Hopefully, this chapter will help to explain why the accounting profession ended up with the positions that it has taken with respect to these measurement issues.
Sections 2, 3 and 5 look at the accounting treatment of interest on equity capital, on depreciation and on the treatment of capital gains respectively. Section 4 provides an introduction to section 5 and it tries to explain why accountants do not regard capital gains as being “productive”, whether these gains were anticipated or not.
The recent wave of financial crises has renewed the interest in market discipline in banking systems. This interest is not merely academic, but it is also apparent in recent policy initiatives such as the latest capital proposal by the Basel Committee on Banking Supervision.
