deegan fat4e ppt_ch11

2-1Copyright © 2014 McGraw-Hill Education (Australia) Pty Ltd PPTs to accompany Deegan, Financial Accounting Theory 4e

FINANCIAL ACCOUNTING THEORYCraig Deegan

Slides written by Craig Deegan

CHAPTER 11Reactions of individuals to financial reporting: an examination of behavioural research in accounting


Learning objectives11.1 Have a broad understanding of the nature of behavioural

research and its relevance to accounting.

11.2 Understand some of the different approaches to undertaking behavioural research.

11.3 Understand that much of the insights in behavioural research have been developed in the discipline of psychology, and therefore behavioural research in accounting represents a situation where insights from one discipline can usefully be employed in another.

11.4 Know how behavioural research differs from, as well as complements, capital markets research and other research, such as that which applies agency theory and Positive Accounting Theory.

continued


Learning objectives (cont.)11.5 Understand how different accounting-related variables can

be manipulated in behavioural research and appreciate the role that the Brunswik Lens Model has played in behavioural research.

11.6 Understand the meaning of a ‘heuristic’ and why knowledge of heuristics is important to the accounting profession.

11.7 Be aware of how the results of behavioural research can be of relevance to corporations and the accounting profession for anticipating individual reactions to accounting disclosures.

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

11.9 Understand some of the limitations inherent within behavioural research.


Assessing the impacts of financial reporting decisions

There are different ways to assess the impacts that financial reporting decisions have on financial statement users, for example:

1.Determine what impact the release of information had on share price (capital markets research)

2.Determine the impact of the information on the decisions of individual information users (behavioural research)


Introduction to behavioural research• Behavioural research in accounting 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 the broad ‘market’ level

continued


Introduction to behavioural research (cont.)

• According to Birnberg and Shields (1989), behavioural research in accounting can be defined as research that:

– applies theories and methodologies from the behavioural sciences to examine the interface between accounting information and processes and human (including organisational) behaviour.

• In contrast to much research based on economics-based theories, behavioural research typically does not make broad-based simplifying assumptions about how all individuals behave

• Behavioural research typically concerns itself with improving the quality of decision making

• Borrows many insights from psychology

continued


Introduction to behavioural research (cont)

• Behavioural research in accounting has been used to investigate a variety of decision making processes, such as:

– the valuation of market shares by individual analysts,

– the lending decisions of loan officers,

– the assessment of bankruptcy by bankers or auditors, and

– the assessment of risk by auditors.


The role of behavioural research in accounting• According to Trotman (2011), aims of the research include:

– evaluating the quality of the judgments of auditors, preparers and users of accounting reports;

– describing how the judgments are made;

– determining which factors impact these judgments and why;

– developing and testing theories of the underlying cognitive processes by which judgments are made; and

– improving the judgments of auditors, preparers and users of accounting information.

• Answering these questions provides insights for suggesting remedies for any discovered deficiencies, as it is necessary to understand a decision process to improve it.


Behavioural research in accounting is typically undertaken in an ‘experimental setting’

• According to Trotman (2011):

– A major benefit of experiments is that the researcher creates the setting in which the experiment is carried out

– The researcher manipulates the independent variables of their choice and examines the effect on the dependent variable while at the same time controlling for any potential confounding factors

– The researcher can also measure intervening variables (including information search and cue usage) and the knowledge of participants

– Experiments have the advantage of testing the effects of conditions that do not presently exist in practice as well as conditions that already exist but not in sufficient volume to examine archivally

– Experiments can also be used to disentangle inter-related factors that co-exist in the natural environment to examine which of a number of factors cause a change in the dependent variable


Some differences between capital markets research and behavioural research

Capital Markets Research Behavioural Research

Focus of research

Considers the aggregate effect on decision making by investors via an analysis of movements in share price

Considers decision making at the individual level

Subjects Investors in aggregate typically by way of archival (secondary) data

A broad range of users often in a ‘laboratory’ setting

Use of information

Whether information is used by investors in aggregate – is there an aggregated reaction?

How information is used by individual decision makers

When is the research conducted?

Typically undertaken after an accounting method applied or accounting standard released

Before or after accounting method applied or standard released

Similarity Both examine impact of financial reporting upon decision making by users

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Brunswick Lens Model• A common way to conceptualise decision making

processes

– used by many researchers, particularly in the 1970s and 1980s

• 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)

continued


Brunswick Lens Model (cont.)

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

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


Diagrammatic representation of the Brunswik Lens Model


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)


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


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 the financial statements or in a footnote) impacts decision making


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)


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

continued


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)


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


Decision-making heuristics

• That is, rather than fully considering all the potentially relevant factors, a simplifying rule may be employed which takes a lot less time but nevertheless might generate a fairly acceptable (and cost-effective) prediction or solution.

• Three main simplifying heuristics have been identified

– representativeness

– anchoring and adjustment

– availabilitycontinued


Decision-making heuristics (cont.)

• These heuristics have been heavily researched within the psychology literature

• Such heuristics reduce the cognitively complex task of assessing probabilities to simpler judgmental operations

• While these heuristics are quite useful and can lead to efficient decision-making, they can also lead to severe and systematic errors because they omit several factors that should affect the judgments of subjective probabilities


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

– the representativeness heuristic also tends to make decision makers ignore source reliability


Decision-making heuristics—anchoring and adjustment

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


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

• The implication of this heuristic is that the probabilities associated with sensational or widely-reported events will tend to be overstated


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


Decision output—decision accuracy• When looking at the actual output of the decision-

making process (the decision or judgment), some research has considered how accurate the predictions are relative to the actual environmental outcomes

– for example, Libby (1975) investigated the accuracy with which loan officers predict business failure. Research has considered how accurate the predictions are relative to the actual environmental outcomes

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

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


Protocol analysis• This form of behavioural research requires subjects to verbalise

their thought processes while making decisions or judgements

– common in auditing research

• According to Trotman (2011)

– protocol analysis (or process-tracing technique) traces the actual decision-making process of users of financial information and is suited to studying ill-structured tasks. Protocol analysis allows the researcher to identify cues, the sequence in which the cues are utilised and determine their relative importance by the frequency of their use or process modification accounted for by the cue

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

• Useful in examining information search processes

continued


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


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

continued


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


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

deegan fat4e ppt_ch11

Education

nature of behavioural

accounting profession

positive accounting

various accounting disclosures

accountingrelated data

education australia

agency theory

financial statement