Financial Accounting Theory Craig Deegan

Chapter 11 Reactions of individuals to financial reporting: an examination of behavioural research Slides written by Craig Deegan and Michaela Rankin
Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting Theory 2e by Deegan

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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

Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting Theory 2e by Deegan

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Learning objectives (cont.)

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 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting Theory 2e by Deegan

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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

Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting Theory 2e by Deegan

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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 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting Theory 2e by Deegan

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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 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting Theory 2e by Deegan

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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)

Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting Theory 2e by Deegan

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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

Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting Theory 2e by Deegan

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Input leveluse 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 not material and therefore not requiring disclosure The accounting profession is also interested in whether presentation (in financial statement or in a footnote) impacts decision

Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting Theory 2e by Deegan

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Research evidencethe 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 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting Theory 2e by Deegan

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Research evidencethe 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 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting Theory 2e by Deegan

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Research evidencethe 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 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting Theory 2e by Deegan

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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

Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting Theory 2e by Deegan

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Decision-making heuristics
Three main simplifying heuristics have been identified
representativeness anchoring and adjustment availability

Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting Theory 2e by Deegan

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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

Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting Theory 2e by Deegan

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Decision making heuristicsanchoring and adjustment

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

Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting Theory 2e by Deegan

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Decision making heuristicsavailability

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 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting Theory 2e by Deegan

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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

Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting Theory 2e by Deegan

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Decision outputdecision 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 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting Theory 2e by Deegan

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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

Understanding how judgements are made is important in improving those judgements Useful in examining information search

Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting Theory 2e by Deegan

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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

Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting Theory 2e by Deegan

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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

Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting Theory 2e by Deegan

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