Behavioral Decision Research and
Management Accounting:
The Case of Conflicts of Interest
Max Bazerman
Harvard Business School
Based on my collaborations with Mahzarin
Banaji, Dolly Chugh, George Loewenstein, Don
Moore and Lloyd Tanlu
1
Max and Accounting
1)
2)
3)
4)
5)
6)
7)
University of Pennsylvania (Wharton), B.S.E. in
Accounting, 1976
1987-1997: Lots of experience teaching employees of the
Big X accounting firms
Our 1997 paper – Bazerman, Morgan, and Loewenstein
– no more work with the Big X accounting firms
SEC call in 2000
The changes made were weak – focusing on disclosure
Bazerman, Loewenstein and Moore 2002 HBR paper
A few talks to accounting and psychology departments on
the prior work and some initial empirical data
2
Max and Accounting
1)
2)
3)
4)
5)
6)
7)
University of Pennsylvania (Wharton), B.S.E. in
Accounting, 1976
1987-1997: Lots of experience teaching employees of the
Big X accounting firms
Our 1997 paper – Bazerman, Morgan, and Loewenstein
– no more work with the Big X accounting firms
SEC call in 2000
The changes made were weak – focusing on disclosure
Bazerman, Loewenstein and Moore 2002 HBR paper
A few talks to accounting and psychology departments on
the prior work and some initial empirical data
4
Core Argument on Auditor Independence
Psychologists have known for a long time that individuals
with a vested self-interest, even honest ones, are
incapable of unbiased (independent) judgment.
•
a) Auditors have made tremendous profit from
selling other services to their audit clients.
•
b) Auditors want to be rehired.
•
c) The personnel on the audit often take jobs with the
client firm.
As long as these other motives are present, auditors are not
independent.
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Management Accounting Wikipedia
Management accounting or managerial
accounting is concerned with the provisions
and use of accounting information to managers
within organizations, to provide them with the
basis to make informed business decisions that
will allow them to be better equipped in their
management and control functions.
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Bounded Decision Making
• Bounded Rationality – March and
Simon
• Bounded Willpower - Thaler
• Bounded Self-Interest – Thaler
• Bounded Awareness – Chugh and
Bazerman
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Bounded Decision Making
• Bounded Rationality – March and Simon
• Bounded Willpower - Thaler
• Bounded Self-Interest – Thaler
• Bounded Awareness – Chugh and
Bazerman
• Bounded Ethicality – Banaji, Bazerman,
and Chugh; Banaji and Bhaskar
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Bounded Decision Making
• Bounded Rationality
• Bounded Willpower
• Bounded Self-Interest
• Bounded Awareness
• Bounded Ethicality
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Bounded Ethicality
(Chugh, Bazerman, and Banaji, 2005)
Bounded ethicality refers to the systematic and
predictable ways in which humans act
unethically beyond their own awareness.
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Bounded Ethicality
1) Boundedness in your ethicality
2) Boundedness in noticing the ethicality
of others
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A: Boundedness in Your Ethicality
(Overviews: Banaji, Bazerman, and Chugh, 2003:
Chugh, Bazerman, and Banaji, 2005)
1)
2)
3)
4)
5)
6)
Implicit Attitudes (lots of work by Banaji, Greenwald et al.)
In-group/Out-group Biases (Messick op-ed)
Discounting the Future (Wade-Benzoni, 1999, 2002;
Bazerman and Watkins, 2008)
Overclaiming Credit (Ross and Sicoly, 1979; Caruso,
Epley, and Bazerman, 2006; Epley, Caruso, and
Bazerman, 2006)
Moral Disengagement: (Bandura, 1986, 1990; Paharia
and Deshpande, 2009; Shu, Gino, and Bazerman, 2010)
Greater Unethical Behavior under a Loss Frame than
under a Gain Frame (Kern and Chugh, 2009)
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B: Boundedness in Noticing
the Ethicality of Others
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B: Boundedness in Noticing
the Ethicality of Others
1) Conflicts of Interest (Chugh and Bazerman, 2007; Moore,
Tanlu, and Bazerman, 2010)
2) Outcome bias in judging ethics (Baron and Hershey, 1988;
Gino, Moore, and Bazerman, 2009)
3) Slippery slope (Gino and Bazerman, 2009)
4) Indirect blindness in judging unethical behavior (Paharia,
Kassam, Greene, and Bazerman, 2009; Coffman, in
preparation)
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B: Boundedness in Noticing
the Ethicality of Others
1) Conflicts of Interest (Chugh and Bazerman, 2007;
Moore, Tanlu, and Bazerman, 2010)
2) Outcome bias in judging ethics (Baron and Hershey, 1988;
Gino, Moore, and Bazerman, 2009)
3) Slippery slope (Gino and Bazerman, 2009)
4) Indirect blindness in judging unethical behavior (Paharia,
Kassam, Greene, and Bazerman, 2009; Coffman, in
preparation)
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Surgeons versus Non-Surgeons:
Should We Operate?
Surgeons
Non-Surgeon
Physicians
Operate
Lots
0
Don’t
Operate
0
Lots
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The Case
(Moore, Tanlu, and Bazerman, 2010)
E-Settle is an Internet-based dispute resolution firm that
is interested in being acquired.
Crilley is an established player in the field of alternative
dispute resolution services. Crilley is interested in
acquiring E-Settle.
Participants are given a variety of information regarding
E-Settle’s revenues, earnings, market share, and
competition, as well as information about prices for other
pre-IPO Internet-based service firms in related industries.
How much is E-Settle worth?
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The Case
Price-to-earnings
Price-to-earnings
ratio
ratiofor
forall
all
acquisitions
E-Settle’s
E-Settle’s
acquisitionsofof
market
market professional
professionalservice
service
dot-coms
share
share
dot-coms
6:1
44%
44%
6:1
E-Settle’s
E-Settle’s
revenues
revenues
$854,000
$854,000
E-Settle’s
E-Settle’s
earnings
earnings
$150,000
$150,000
1998
$2,324,000
1998 $2,324,000
$400,000
$400,000
31%
31%
10:1
10:1
$6,216,000
1999
1999 $6,216,000
$1,100,000
$1,100,000
26%
26%
14:1
14:1
$11,597,000
2000 $11,597,000
2000
$2,000,000
$2,000,000
24%
24%
7:1
7:1
??
??
4:1
4:1
Year
Year
1997
1997
2001
2001
??
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COI
Experimental Design (Expt. 1)
•
2 X 2 X 3 between-subjects design:
– Played role of principal vs. auditor
– Represented buyer vs. seller
– Auditors’ pay:
Fixed fee
Pay for perf.
Future business
Flat $9 payment
Auditors paid like principals:
based on negotiated
outcomes, $3-18
Base payment of $3. After negotiation,
principal can choose to reward auditor
with $0-10 in future business
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COI2
Experimental Procedure (Expt. 1)
Principals
Read case materials
Auditors
Read case materials
1) Complete report appraising E-Settle’s
value
2) Review principal’s report, provide
recommendations and corrections
3a) Review auditors’ reports, negotiate
with other principal
3b) Complete private appraisal. $3
reward for being within $3MM. Bet
opportunity.
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COI2
Principals’ Public Valuations
Private valuation (in $MM)
25
20
Buyer
15
Seller
10
5
0
Fixed payment
Pay-forperformance
Future business
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COI2
Auditors’ Recommendations
100%
90%
More moderate
80%
70%
Neutral
60%
50%
40%
30%
20%
More extreme
Unconditional
endorsement
10%
0%
Fixed payment
Pay-forperformance
Future
business
COI2
Private valuation (in $MM)
Auditors’ Private Valuations
20
18
16
14
12
10
8
6
4
2
0
Auditor for Buyer
Auditor for Seller
Fixed payment
Pay-forperformance
Future business
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COI2
Use of Experiments
1) Used by fields where causal evidence is central
2) Primary method of behavioral decision researchers
3) Recent move toward field experiments
4) Early critiques: incentives, sophomores, context
5) Generalizability has been outstanding
6) When you question the generalizability of experiments,
I believe that it should be based on the interaction
between what the scholar is studying and a difference
that you assess between the lab and the real world
context that is the focus on the generalization
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Conflict of Interest
How could Arthur Andersen vouch for the
financial health of Enron, concealing billions
of dollars in debt from its shareholders?
Enron was not unique: Adelphia, Cendant,
Global Crossing, Haliburton, Tyco. Xerox,
Worldcom, and Lehman (?)
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Chief Justice Warren Burger wrote on behalf
of a unanimous U.S. Supreme Court (1984):
By certifying the public reports that collectively depict a
corporation’s financial status, the independent auditor
assumes a public responsibility transcending any
employment relationship with the client. The independent
public accountant performing this special function owes
ultimate allegiance to the corporation's creditors and
stockholders, as well as to the investing public. This
“public watchdog” function demands that the accountant
maintain total independence from the client at all times
and requires complete fidelity to the public trust.
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Which makes more sense?
1) In order to maintain auditor independence, auditors
are prohibited from establishing durable long-term
cooperative partnerships with their clients, from
providing non-audit services to their clients, and
from taking jobs with their clients.
2) Start by creating a variety of incentives that lead
auditors to want to please their clients, and then try
to identify a complex set of legislative and
professional incentives to counteract the corrupting
influences creating by the desire to please the client.
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The Failure of
the Sarbanes-Oxley Act of
2002
Auditor rotation – but not firm rotation
Limited non-audit services – but some
non-audit services remain
Leaders cannot move between firms –
but much of the audit team can
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Conflict of Interest
Other examples:
1) Trusting Audited Financial Statements
2) Trusting Ratings from Security Rating Agencies
3) Investment Advisers
4) Trusting Your Doctor to Give You the Best Possible
Medical Advice
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The Misspecification of the
Conflict of Interest Problem
Intentional Corruption
Vs.
Intentional and Unconscious Corruption
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Conflict of Interest
Upton Sinclair: “It is difficult to get a man to
understand something when his salary
depends on his not understanding it."
And, I would add: integrity is not a good
enough solution.
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