Luigi Zingales, director of the PCAOB’s Center for Economic Analysis

By:
CHRIS GAETANO
Published Date:
Jan 23, 2014

In November, the Public Company Accounting Oversight Board (PCAOB) announced that it had created a new Center for Economic Analysis and selected economist Luigi Zingales as the founding director. Zingales, a professor at the University of Chicago, is a faculty research fellow for the National Bureau of Economic Research, a research fellow for the Center for Economic Policy Research and a fellow of the European Corporate Governance Institute. He also serves on the Committee on Capital Markets Regulation, which has been examining the legislative, regulatory and legal issues affecting how public companies function. He recently spoke with The Trusted Professional about his priorities and philosophy for the new center.

In what ways can the PCAOB benefit from an economist’s viewpoint? What does economic analysis add to the PCAOB that it currently lacks?

The PCAOB is already doing economic analysis, in terms of rulemaking and policy. What the board is trying to do with this center is enrich those efforts with the skills and resources that academics like me can provide. The goal is to create baseline analysis and tools that the PCAOB can build upon in the coming years; I think there is a very strong effort by the board to base decisions on a framework that considers efficiency, competition and capital formation. The goal of the center is precisely to help the PCAOB in that direction.

Do you think there are significant differences between the accountant’s viewpoint and the economist’s?

Good accounting is based on good economics, so I don’t think there is a dramatic difference in how the two think and implement structure. When I talk to my accounting colleagues here, I don’t find that there is a cultural divide between us. There is sometimes a big difference in the answers we come up with, as it’s all in the training, but I think fundamentally we regard the problems and look at them in the same way. I do think there is a big difference between practitioners and academics, whether the practitioners are trained in economics or accounting. Practitioners in both fields might be more like engineers who look at fixing the current problems, but may be able to ignore the broader picture. The advantage of an academic perspective is putting things in context and looking at the bigger picture.

What will be your first priorities as head of the Center for Economic Analysis?

To design the work plan of this new center and to work with the board to establish expectations and goals. My role, really, is to set this center up so that within a few years the center will attract the best economists and accountants in the country on an ongoing basis. I think the primary goal is twofold: first, to do high-quality research that will inform both best practices for what the PCAOB does internally and provide guidance for rulemaking. The second role would be to provide an empirical framework to help cost benefit analysis of the decisions the PCAOB makes.

What would you say your specialty is as an economist? How will you apply that specialty to the work of the PCAOB?

If I had to define myself, I’d say there are probably a few characteristics that distinguish me from other talented economists. Number one, I tend to be quite open-minded and cross-disciplinary. I think this will be helpful because I want to bring a lot of research together here, not only from economics and accounting, but also from psychology, sociology and anthropology—audit is a big discipline that needs to be analyzed and studied from different perspectives. Two, I’m very much an empirically minded economist; I want to bring good quality empirical work to the table. And finally, I tend to be a policy-minded economist, so I don’t want this to be a purely academic exercise. I want it to be relevant for policy making.

Will this center use mostly in-house resources, or do you envision it supporting outside research?

I think we would like it to be a bit of both. We want the center to be able to produce its own high-quality research, but also to be able to share some of the data, so that research isn’t just produced within the center, but also by other working academics. I think one of the keystones of modern research is replicability, the sort of competition and confrontation between different people attacking the same issues from different perspectives. We don’t want to produce only research aimed in a particular direction—we want to expand the frontier of knowledge.

What do you see as the foremost problem affecting the quality and reliability of audits today? Or, if there is not a foremost problem, what do you think are the main factors and how do they work together to impact the quality and reliability of the audit?

I don’t come to this job with a lot of prescriptions saying this is right or wrong; I think my role is to do research aimed at establishing what the key concerns are. I think there is too much “this is a problem and let me find evidence for it,” rather than letting the data speak and tell us what problems exist, if any. So I don’t think I am being hired to prove the problems but to do good research. I would be delighted to show that there are no problems.

Getting into a more general realm, how secure do you think the financial system is against a crisis similar to the one in 2008?

First of all, I think every crisis brings a natural healthy reaction, which is to be more careful. There’s less chance of another crisis immediately following because everyone is naturally more cautious. In a sense, the PCAOB was created immediately after WorldCom and Enron, and there is no question that in the two years after those big scandals, everyone was super careful on those dimensions. But as time goes by, people tend to forget, and I think the role of institutions like the PCAOB is to maintain this tension when the memory of a crisis has faded away. The other thing I think the regulators did well is to put an emphasis on more capital requirements for financial institutions. I think financial institutions were operating with too-high leverage and when you operate on too-high leverage a crisis is inevitable, because you cannot prevent losses from the financial system. We’d like to, but that is part of what healthy innovation produces, and sometimes it makes losses. You want a system reliable enough to absorb those losses, so having a higher-equity cushion is definitely important.

As far as economic issues go, what worries you? The European debt crisis? The sustainability of Chinese development? A new dot-com bubble? And why?

I’m definitely worried about the long-term survival of the Euro as it is. I think Mario Draghi, the governor of the ECB, has been excellent in trying to prevent a quick unraveling of the situation, but he does not have the power to introduce the reforms that would make the Euro sustainable in the long run. That problem has not been solved. While it may not be an overnight worry, it does worry me long term. And the other aspect that I’m concerned about is the Chinese financial system. It is a very opaque system that has benefitted from tremendous growth in the economy. When there is a high level of growth, everyone is good and a high tide lifts all boats. Clearly, they have had many years of high tides, but I worry about what will happen when there is a low tide. That’s when you discover who is really naked.

What was the last good book you read?

I’m sort of a wonk, so the kind of book I read will probably not be the kind most people like, but I love this book by Robert Kaiser, So Damn Much Money. I think he gives a very witty and, unfortunately, very honest description of lobbying and corruption in the American government.

The views expressed by Luigi Zingales are his own and should not be attributed to the PCAOB as a whole or to Board members or staff. 

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