FINANCIAL ACCOUNTING THEORY
Craig Deegan
CHAPTER 11
Reactions of individuals to financial
reporting: an examination of
behavioural research in accounting
Slides written by Craig Deegan
Copyright © 2014 McGraw-Hill Education (Australia) Pty Ltd
PPTs to accompany Deegan, Financial Accounting Theory 4e
2-1
Learning objectives
11.1 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
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11-2
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.
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11-3
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)
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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
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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 broadbased 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
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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.
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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.
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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
Copyright © 2014 McGraw-Hill Education (Australia) Pty Ltd
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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 A broad range of users
by way of archival (secondary) often in a ‘laboratory’ setting
data
Use of
information
Whether information is used by How information is used by
investors in aggregate – is
individual decision makers
there an aggregated reaction?
When is the Typically undertaken after an
research
accounting method applied or
conducted? accounting standard released
Similarity
3/21/2016RMIT
Before or after accounting
method applied or standard
released
Both examine impact of financial reporting upon decision
making by users
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10
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
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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
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Diagrammatic representation
of the Brunswik Lens Model
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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 the financial statements or
in a footnote) impacts decision making
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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
continued
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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
• 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
– availability
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continued
11-21
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
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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
– the representativeness heuristic also tends to make
decision makers ignore source reliability
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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
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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
• The implication of this heuristic is that the
probabilities associated with sensational or widelyreported events will tend to be overstated
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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
• When looking at the actual output of the decisionmaking 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
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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
• 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
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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 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
continued
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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 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
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