11-1 Copyright 2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e

Financial Accounting TheoryCraig Deegan

Chapter 11

Reactions of individuals to financial reporting: an examination of behavioural research

Slides written by Craig Deegan

11-2 Copyright 2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e

Learning objectives

• In this chapter you will be introduced to:– how behavioural research differs from capital market

research– how different accounting-related variables can be

manipulated in behavioural research– how the results of behavioural research can be of

relevance to corporations and the accounting profession for anticipating individual reactions to accounting disclosures

– how the results of behavioural research can form the basis for developing ways to more efficiently use accounting-related data

– the limitations of behavioural research

11-3 Copyright 2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e

Introduction to behavioural research

• Behavioural research examines how individuals react to various accounting disclosures

• Grounded in behavioural decision theory

• Goal is to describe actual decision behaviour, evaluate its quality, and develop and test hypotheses of the underlying psychological processes

• Contrast to capital markets research which examines reactions at a market level

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Brunswick Lens Model

• Used to explain behavioural research

• Perspectives about the environment are generated (observed) through a ‘lens’ of imperfect cues

• Statistical modelling is applied to determine the weighting (importance) of the various cues (independent variables) to the criterion event of success (dependent variable)

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Brunswick Lens Model (cont.)

• Right-hand side models how the individual uses cues to make an ultimate decision about the issue under investigation

• Left-hand side models the relationship between the actual phenomenon or event and the particular cues provided

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Applicability of the Lens Model

• Structure of the Lens Model can be applied to almost any decision-making scheme

– e.g. lending decision– explicitly considers inputs (use of cues), the decision

process and outputs (ultimate decisions)

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Types of issues to be considered

• At input level– scaling characteristics of individual cues– methods of presentation– context

• At the level of processing the information– characteristics of the person making the judgement– characteristics of the decision rule

• At the output or decision level– qualities of the judgement– self-insight

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Input level—use of cues

• How and whether particular cues are used in decision making is particularly relevant to the accounting profession

• If information items in financial statements are not used, then they could be deemed immaterial and therefore not requiring disclosure

• The accounting profession is also interested in whether presentation (in financial statement or in a footnote) impacts decision

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Research evidence—the use of information items

• In making predictions of financial returns, analysts are found to acquire earnings and sales information more often than other types (Pankoff & Virgil 1970; Mear & Firth 1987)

• Studies questioned the provision of current cost information, subjects relied more on historical cost information (Heintz 1973; McIntyre 1973)

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Research evidence—the presentation of information

• Different presentation formats found to influence users’ decisions

– including bar charts, line graphs, pie charts and tables

• Moriarity (1979) found students and accountants using Chernoff faces were able to outperform those using ratios in predicting bankruptcy and models of bankruptcy

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Research evidence—the presentation of information (cont.)

• Studies examining decision making by loan officers, based on whether information is incorporated within the financial statements or included as footnotes, found presentation made no difference (Wilkins & Zimmer 1983)

• Provision of segment information reduced subjects’ reliance on past share prices (Stallman 1969; Doupnik & Rolfe 1989)

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Decision-making process

• Studies have examined how the various cues are weighted

• Judgements have been found to be consistent over time

• Decision makers also have been found to employ simplifying heuristics when making a decision

– A heuristic can be defined as a simplifying ‘rule of thumb’– Simplifying rules may be employed which take a lot less

time but nevertheless generate acceptable predictions or solutions

– It is useful to know about the use of heuristics – particular by ‘successful’ judges/decision-makers

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Decision-making heuristics

• Three main simplifying heuristics have been identified

– representativeness– anchoring and adjustment– availability

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Decision-making heuristics— representativeness

• Decision makers often assess the likelihood of items belonging to a category by considering how similar the item is to the typical member of the category

• An implication is that the subjects typically ignore the base rate of the population in question

– may overstate the number of cases in a particular category

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Decision making heuristics—anchoring and adjustment

• Individuals make an initial judgement or estimate and then only partial adjust their view as a result of additional information

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Decision making heuristics—availability

• Relates to whether recollections of related occurrence or events can easily come to mind

• The actual base rates of occurrence of an event are ignored

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Knowledge of heuristics in research

• Useful to know of heuristics in use– if the heuristic results in inappropriate decisions being

made, the tendency can be highlighted and action taken

– the use of a heuristic by experts could be efficient relative to costly data-gathering and processing

novices could then be advised to use the rule of thumb

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Decision output—decision accuracy

• Research has considered how accurate the predictions are relative to the actual environmental outcomes

– loan officers found to predict bankruptcy fairly regularly (Libby 1975)

– bankers and accounting students also found to correctly predict bankruptcies (Zimmer 1980)

– decision makers working in a team can outperform individual decision makers

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Protocol analysis

• This form of behavioural research requires subjects to verbalise their thought processes while making decisions or judgements

– common in auditing research

• Understanding how judgements are made is important in improving those judgements

• Useful in examining information search

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Protocol analysis (cont.)

• Disadvantages include– the process of verbalising can have an effect on the

decision process– a considerable portion of the information utilised may not

be verbalised– subjects may provide verbalisations which are parallel

but are independent of the actual thought process– criticisms of the coding methods

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The relevance of differencesin culture

• We considered the issue of ‘culture’ in Chapter 4 and we learned that some cultures are considered to be more secretive than others; some cultures seek greater uncertainty avoidance than others; and so forth

• Differences at a national level were then related back to the international differences in accounting practices that existed prior to the International adoption of IFRS

• Culture has also been suggested as a factor in influencing organisational structures, legal systems and so forth

• It is reasonable to argue that an individual’s use of particular cues (information items) will in part be dependent upon the cultural background of the individual

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The relevance of differencesin culture (cont.)

• Studies that investigate decision-making processes in particular countries will perhaps not be generalisable to other countries—particularly if the respective countries have significantly different cultural attributes

• Determining the validity of a particular decision-making model across different cultures would be an important area for future accounting research

• At this point in time there is very little behavioural accounting research which explores how the usage of cues in particular decisions is affected by specific cultural attributes

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Limitations of behavioural research

• Research examining similar issues has generated conflicting results

– difficult to determine causes of inconsistencies

• Settings of studies often different to real-world settings

– implications for generalisability

• Very difficult to replicate cues available in the workplace

• Students often used as surrogates• Small number of subjects often used