11b reactions-of-individuals-to-financial-reporting-an-examination-of-behavioural-research

Copyright © 2000 McGraw-Hill Book Co. Aust. PPT t/a Financial Accounting Theory by Deegan 11.1
Financial Accounting TheoryFinancial Accounting Theory
Craig DeeganCraig Deegan
Chapter 11Chapter 11
Reactions of individuals to financialReactions of individuals to financial
reporting: An examination ofreporting: An examination of
behavioural researchbehavioural research
Slides written by Michaela RankinSlides written by Michaela Rankin

Chapter 11: Behavioural research
Copyright © 2000 McGraw-Hill Book Co. Aust. PPT t/a11.2
Learning ObjectivesLearning Objectives
• In this chapter you will be introduced toIn this chapter you will be introduced to
– how behavioural research differs from capitalhow behavioural research differs from capital
market researchmarket research
– how different accounting-related variables canhow different accounting-related variables can
be manipulated in behavioural researchbe manipulated in behavioural research
– how the results of behavioural research can behow the results of behavioural research can be
of relevance to corporations and the accountingof relevance to corporations and the accounting
profession forprofession for anticipatinganticipating individual reactionsindividual reactions
to accounting disclosuresto accounting disclosures

Learning ObjectivesLearning Objectives
– How the results of behavioural research can formHow the results of behavioural research can form
the basis for developing ways to more efficientlythe basis for developing ways to more efficiently
use accounting-related datause accounting-related data
– the limitations of behavioural researchthe limitations of behavioural research

Introduction to behaviouralIntroduction to behavioural
researchresearch
• Behavioural research examines howBehavioural research examines how
individuals react to various accountingindividuals react to various accounting
disclosuresdisclosures
• grounded in behavioural decision theorygrounded in behavioural decision theory
• goal is to describe actual decisiongoal is to describe actual decision
behaviour, evaluate its quality and developbehaviour, evaluate its quality and develop
and test hypotheses of the underlyingand test hypotheses of the underlying
psychological processespsychological processes

Brunswick Lens ModelBrunswick Lens Model
• Used to explain behavioural researchUsed to explain behavioural research
• perspectives about the environment areperspectives about the environment are
generated (observed) through a ‘lens’ ofgenerated (observed) through a ‘lens’ of
imperfect cuesimperfect cues
• to determine the weighting (importance) ofto determine the weighting (importance) of
the various cues (independent variables) tothe various cues (independent variables) to
the criterion event of success (dependentthe criterion event of success (dependent
variable) statistical modelling is appliedvariable) statistical modelling is applied

Brunswick Lens Model—Brunswick Lens Model—
continuedcontinued
• right-hand side models how the individualright-hand side models how the individual
uses cues to make an ultimate decisionuses cues to make an ultimate decision
about the issue under investigationabout the issue under investigation
• left-hand side models the relationshipleft-hand side models the relationship
between the actual phenomenon or eventbetween the actual phenomenon or event
and the particular cues providedand the particular cues provided

Applicability of the Lens ModelApplicability of the Lens Model
• Structure can be applied to almost anyStructure can be applied to almost any
decision-making schemedecision-making scheme
– eg. lending decisioneg. lending decision
– explicitly considers inputs (use of cues), theexplicitly considers inputs (use of cues), the
decision process and outputs (ultimatedecision process and outputs (ultimate
decisions)decisions)

Types of issues to be consideredTypes of issues to be considered
• At input level:At input level:
– scaling characteristics of individual cuesscaling characteristics of individual cues
– methods of presentationmethods of presentation
– contextcontext
• At the level of processing the information:At the level of processing the information:
– characteristics of the person making thecharacteristics of the person making the
judgementjudgement
– characteristics of the decision rulecharacteristics of the decision rule

Types of issues toTypes of issues to
be considered—continuedbe considered—continued
• At the output or decision level:At the output or decision level:
– qualities of the judgementqualities of the judgement
– self-insightself-insight

Input level—use of cuesInput level—use of cues
• How and whether particular cues are usedHow and whether particular cues are used
in decision-making is particularly relevantin decision-making is particularly relevant
to the accounting professionto the accounting profession
• if information items in financial statementsif information items in financial statements
are not used, then they could be deemed notare not used, then they could be deemed not
material and therefore not requiringmaterial and therefore not requiring
disclosuredisclosure
• the accounting profession is also interestedthe accounting profession is also interested
in whether presentation (in financialin whether presentation (in financial
statement, or in a footnote) impacts decisionstatement, or in a footnote) impacts decision

Research evidence—theResearch evidence—the
use of information itemsuse of information items
• In making predictions of financial returns,In making predictions of financial returns,
analysts are found to acquire earnings andanalysts are found to acquire earnings and
sales information more often than othersales information more often than other
types (Pankoff and Virgil 1970; Mear andtypes (Pankoff and Virgil 1970; Mear and
Firth 1987)Firth 1987)
• studies questioned the provision of currentstudies questioned the provision of current
cost information, subjects relied more oncost information, subjects relied more on
historical cost information (Heintz 1973;historical cost information (Heintz 1973;
McIntyre 1973)McIntyre 1973)

Research evidence—theResearch evidence—the
presentation of informationpresentation of information
• Different presentation formats found toDifferent presentation formats found to
influence users’ decisionsinfluence users’ decisions
– including bar charts, line graphs, pie charts andincluding bar charts, line graphs, pie charts and
tablestables
• Moriarity (1979) found students andMoriarity (1979) found students and
accountants using Chernoff faces were ableaccountants using Chernoff faces were able
to outperform those using ratios into outperform those using ratios in
predicting bankruptcy, and models ofpredicting bankruptcy, and models of
bankruptcybankruptcy

Research evidenceResearch evidence——thethe
presentation of information cont’dpresentation of information cont’d
• Studies examining decision making by loanStudies examining decision making by loan
officers based on whether information isofficers based on whether information is
incorporated within the financial statementsincorporated within the financial statements
or included as footnotes found presentationor included as footnotes found presentation
made no difference (Wilkins and Zimmermade no difference (Wilkins and Zimmer
1983)1983)
• provision of segment information reducedprovision of segment information reduced
subjects’ reliance on past share pricessubjects’ reliance on past share prices
(Stallman 1969; Doupnik and Rolfe 1989)(Stallman 1969; Doupnik and Rolfe 1989)

Decision-making processDecision-making process
• Studies have examined how the variousStudies have examined how the various
cues are weightedcues are weighted
• judgements have been found to bejudgements have been found to be
consistent over timeconsistent over time
• decision-makers also have been found todecision-makers also have been found to
employ simplifying heuristics when makingemploy simplifying heuristics when making
a decisiona decision

Decision-making heuristicsDecision-making heuristics
• Three main simplifying heuristics haveThree main simplifying heuristics have
been identified:been identified:
– representativenessrepresentativeness
– anchoring and adjustmentanchoring and adjustment
– availabilityavailability

Decision-making heuristics—Decision-making heuristics—
representativenessrepresentativeness
• Decision makers often assess the likelihoodDecision makers often assess the likelihood
of items belonging to a category byof items belonging to a category by
considering how similar the item is to theconsidering how similar the item is to the
typical member of the categorytypical member of the category
• an implication is that the subjects typicallyan implication is that the subjects typically
ignore the base rate of the population inignore the base rate of the population in
questionquestion
– may overstate the number of cases in amay overstate the number of cases in a
particular categoryparticular category

Decision making heuristics—Decision making heuristics—
anchoring and adjustmentanchoring and adjustment
• Individuals make an initial judgement orIndividuals make an initial judgement or
estimate and then only partial adjust theirestimate and then only partial adjust their
view as a result of additional informationview as a result of additional information

Decision making heuristics—Decision making heuristics—
availabilityavailability
• Relates to whether recollections of relatedRelates to whether recollections of related
occurrence or events can easily come tooccurrence or events can easily come to
mindmind
• the actual base rates of occurrence of anthe actual base rates of occurrence of an
event are ignoredevent are ignored

Knowledge of heuristics inKnowledge of heuristics in
researchresearch
• Useful to know of heuristics in use:Useful to know of heuristics in use:
– if the heuristic results in inappropriate decisionsif the heuristic results in inappropriate decisions
being made, the tendency can be highlightedbeing made, the tendency can be highlighted
and action takenand action taken
– the use of a heuristic by experts could bethe use of a heuristic by experts could be
efficient relative to costly data-gathering andefficient relative to costly data-gathering and
processingprocessing
• novices could then be advised to use the rule ofnovices could then be advised to use the rule of
thumbthumb

Decision output—decisionDecision output—decision
accuracyaccuracy
• Research has considered how accurate theResearch has considered how accurate the
predictions are relative to the actualpredictions are relative to the actual
environmental outcomesenvironmental outcomes
– loan officers found to predict bankruptcy fairlyloan officers found to predict bankruptcy fairly
regularly (Libby 1975)regularly (Libby 1975)
– bankers and accounting students also found tobankers and accounting students also found to
correctly predict bankruptcies (Zimmer 1980)correctly predict bankruptcies (Zimmer 1980)
– decision-makers working in a team candecision-makers working in a team can
outperform individual decision-makersoutperform individual decision-makers

Protocol analysisProtocol analysis
• This form of behavioural research requiresThis form of behavioural research requires
subjects to verbalise their thought processessubjects to verbalise their thought processes
while making decisions or judgementswhile making decisions or judgements
– common in auditing researchcommon in auditing research
• understanding how judgements are made isunderstanding how judgements are made is
important in improving those judgementsimportant in improving those judgements
• useful in examining information searchuseful in examining information search

Protocol analysis—continuedProtocol analysis—continued
• Disadvantages include:Disadvantages include:
– the process of verbalising can have an effect onthe process of verbalising can have an effect on
the decision processthe decision process
– a considerable portion of the informationa considerable portion of the information
utilised may not be verbalisedutilised may not be verbalised
– subjects may provide verbalisations whichsubjects may provide verbalisations which
parallel but are independent of the actualparallel but are independent of the actual
thought processthought process
– criticisms of the coding methodscriticisms of the coding methods

Limitations of behaviouralLimitations of behavioural
researchresearch
• Research examining similar issues hasResearch examining similar issues has
generated conflicting resultsgenerated conflicting results
– difficult to determine causes of inconsistenciesdifficult to determine causes of inconsistencies
• settings of studies often different to real-settings of studies often different to real-
world settingsworld settings
– implications for generalisabilityimplications for generalisability
• very difficult to replicate cues available invery difficult to replicate cues available in
the workplacethe workplace
• students often used as surrogatesstudents often used as surrogates
• small number of subjects often usedsmall number of subjects often used

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