Financial Accounting Theory
Craig Deegan
Chapter 11
Reactions of individuals to financial reporting:
an examination of behavioural research
Slides written by Craig Deegan
Copyright  2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Deegan, Financial Accounting Theory 3e
11-1
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
Copyright  2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Deegan, Financial Accounting Theory 3e
11-2
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
Copyright  2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Deegan, Financial Accounting Theory 3e
11-3
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)
Copyright  2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Deegan, Financial Accounting Theory 3e
11-4
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
Copyright  2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Deegan, Financial Accounting Theory 3e
11-5
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)
Copyright  2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Deegan, Financial Accounting Theory 3e
11-6
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
Copyright  2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Deegan, Financial Accounting Theory 3e
11-7
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
Copyright  2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Deegan, Financial Accounting Theory 3e
11-8
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)
Copyright  2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Deegan, Financial Accounting Theory 3e
11-9
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
Copyright  2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Deegan, Financial Accounting Theory 3e
11-10
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)
Copyright  2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Deegan, Financial Accounting Theory 3e
11-11
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
Copyright  2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Deegan, Financial Accounting Theory 3e
11-12
Decision-making heuristics
• Three main simplifying heuristics have been
identified
– representativeness
– anchoring and adjustment
– availability
Copyright  2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Deegan, Financial Accounting Theory 3e
11-13
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
Copyright  2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Deegan, Financial Accounting Theory 3e
11-14
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
Copyright  2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Deegan, Financial Accounting Theory 3e
11-15
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
Copyright  2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Deegan, Financial Accounting Theory 3e
11-16
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
Copyright  2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Deegan, Financial Accounting Theory 3e
11-17
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
Copyright  2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Deegan, Financial Accounting Theory 3e
11-18
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
Copyright  2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Deegan, Financial Accounting Theory 3e
11-19
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
Copyright  2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Deegan, Financial Accounting Theory 3e
11-20
The relevance of differences
in 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
Copyright  2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Deegan, Financial Accounting Theory 3e
11-21
The relevance of differences
in 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 decisionmaking 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
Copyright  2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Deegan, Financial Accounting Theory 3e
11-22
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
Copyright  2009 McGraw-Hill Australia Pty Ltd
PPTs t/a Deegan, Financial Accounting Theory 3e
11-23