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BEHAVIORAL RESEARCH IN ACCOUNTING

BEHAVIORAL RESEARCH IN ACCOUNTING. Prepared by: MS. NARIMAH HASHIM Jabatan Perakaunan & Kewangan Fakulti Ekonomi & Pengurusan, UPM. BEHAVIORAL ACCOUNTING RESEARCH (BAR). Defined (Hofstedt & Kinard 1970):

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BEHAVIORAL RESEARCH IN ACCOUNTING

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  1. BEHAVIORAL RESEARCH IN ACCOUNTING Prepared by: MS. NARIMAH HASHIM Jabatan Perakaunan & Kewangan Fakulti Ekonomi & Pengurusan, UPM NHashim...UPM....07.03.2007

  2. BEHAVIORAL ACCOUNTING RESEARCH (BAR) • Defined (Hofstedt & Kinard 1970): The study of the behavior of accountants or of non-accountants as they are influenced by accounting functions and reports • BAR borrows from behavioral sciences, observing people as individuals or in groups in the accounting context, either in the field or under experimental conditions NHashim...UPM....07.03.2007

  3. BAR • BAR is a subset Financial accounting & auditing • Known as Human Judgment Theory (HJT) or Human Information Processing (HIP) • This subset dealing with the judgment & decision making of accountants & auditors & the influence of the output of this function on users’ judgments & decision making NHashim...UPM....07.03.2007

  4. BAR SIMILARITIES • Like many other accounting research have: • A basic research question or theory • Intended audience in mind • Relies on observations as the methodology, and • Selected variables for measurement NHashim...UPM....07.03.2007

  5. BAR’S DIFFERENCES • Unlike capital market studies, it does not rely on archival data nor focuses on aggregate market forces, but on individual & group behavior NHashim...UPM....07.03.2007

  6. BAR’S DIFFERENCES 2. Unlike the agency paradigm in positive accounting research, that describe how shareholders, managers & debt holders are expected to behave under certain circumstances or assumptions, BAR observes people 3. Unlike the normative paradigm, it does not seek a theoretical blueprint, but places importance on users’ needs as perceived by the users NHashim...UPM....07.03.2007

  7. DEVELOPMENT OF BEHAVIORAL ACCOUNTING RESEARCH • Bar first appeared in literature in Becker, 1967 • HJT research with its foundation in psychology in Edwards , 1954 • Application of the research to accounting & auditing to Ashton 1974 • Since then (the last 30 years) explosion of BAR & HJT research especially in auditing since judgment plays an important role in the audit process NHashim...UPM....07.03.2007

  8. DEVELOPMENT OFBEHAVIORAL ACCOUNTING RESEARCH • The development of BAR in financial accounting have been overshadowed by the dominance of the contracting theory since 1980’s • HJT research in accounting grew because of the adaptation of the research method utilized in psychology called the Brunswik lens model. (Refer page 345) NHashim...UPM....07.03.2007

  9. RESEARCH METHODOLOGY • Another research approach important to the development of BAR is the statistical decision theory known as the probabilistic judgment or subjective expected utility (SEU) paradigm (Refer page 348) • Both this methodologies requires decision modeling and emphasizes the relationship between intuitive decisions and those describe by the formal models NHashim...UPM....07.03.2007

  10. BAR’S METHODOLOGY • Ashton (1974) was the first man to utilize this technique and Libby (1975) the first to employ it in a user-oriented context • Both continue to play a dominant role in the development of BAR NHashim...UPM....07.03.2007

  11. THE BRUNSWIK LENS MODEL • Studies in the mid-seventies, uses the Brunswik Lens model as an analytical framework & a basis for most judgment involving prediction (e.g. bankruptcy) and evaluation (e.g. internal control) • Researchers uses the lens model to investigate the relationships between multiple cues (or pieces of information) and decisions, judgments or predictions, by looking for irregularities in the responses to those cues NHashim...UPM....07.03.2007

  12. The Brunswik Lens Model • Examples: • The decision maker (e.g. the investor) looks at financial ratios (as looking through a lens of cues), to reach a conclusion of the likelihood of the company’s failure or non-failure (the cues are probabilistically related to this event) NHashim...UPM....07.03.2007

  13. The Brunswik Lens Model • A linear model describing the relationship between the ratios (cues) and likelihood of failure (responses) is then constructed as a means of representing the way information is processed by individuals • How humans actually processed the information is still unknown & the lens model provided researchers with no help to penetrate this ‘black box’ NHashim...UPM....07.03.2007

  14. RESULTS • However valuable insights were discovered: • Patterns of cue utilization evident in various tasks • Weights that decision makers implicitly place on a variety of information cues • The relative accuracy of decision makers of different expertise levels in predicting and evaluating a variety of tasks NHashim...UPM....07.03.2007

  15. Results • The circumstances under which an expert system and / or ‘model of man’ outperforms humans • The stability of human judgment over time • The degree of insight decision makers possess regarding their pattern of use of data • The degree of consensus displayed in a variety of group decision tasks NHashim...UPM....07.03.2007

  16. Results • All these information is useful in understanding decision-making processes • Researchers are still attempting to ascertain the entire decision model or the decision processes utilized by various classes of users. NHashim...UPM....07.03.2007

  17. THE EVIDENCE – LENS MODEL STUDIES • Many studies have used the lens model framework to examine the accuracy of humans’ predictions of business failures • Important to investors, bank loan officers, other money lenders & auditors • Using archival data, a number of numerical cues were researched across repetitive cases of actual business success and failures NHashim...UPM....07.03.2007

  18. THE EVIDENCE – LENS MODEL STUDIES • A correct solution is used as a bench mark against which human performance is compared. • Using the lens model as a research tool in this way allows analysis of the consistency of judgments of whether a ‘model of a man’ can predict more accurately than a human NHashim...UPM....07.03.2007

  19. THE EVIDENCE – LENS MODEL STUDIES • It also enables analysis of the ability of the cues to predict the event • It also provide insights regarding the degree of consensus between decision makers • The ‘model of human behavior’ is developed using mathematical representation of an individual ‘s pattern of use of cues NHashim...UPM....07.03.2007

  20. THE EVIDENCE – LENS MODEL STUDIES • The model is then applied to the cases in question • The evidence consistently shows humans are reasonably more proficient at developing principles or models to solve the success or failure task of using financial ratios • But are outperformed when their own models are applied mathematically NHashim...UPM....07.03.2007

  21. FAILURE MATHEMATICALLY • Because of 2 reasons: • They mis-weigh cues • They inconsistently apply their decision rules due to factors such as fatigue & boredom • Mathematical application of either the environmental model or the ‘model of man’ is perfectly consistent over time, eliminating random errors NHashim...UPM....07.03.2007

  22. APPLIED RESEARCH • Libby 1975 carried out the first study of assessing business failure • The over-riding issue was whether to disclosed to the subject the actual rate of failure to achieve realism in the study • The actual business rate of failure is very low, less than 5% NHashim...UPM....07.03.2007

  23. APPLIED RESEARCH • Therefore subjects have the prior expectation that the number of failure is already small • If researchers do not divulge the failure rate, then materials in the research may have to contain a number of actual failure cases • Results: • Evidence -inconclusive in terms of the extent to which prior disclosure /nondisclosure of the sample failure rate matters • Evidence – there is task predictability and information representativeness NHashim...UPM....07.03.2007

  24. APPLIED RESEARCH • Abdel Khalik & El-Sheshai (1980) research on observing the impact of allowing subjects to choose their own ratios, impact of information overload and analyzing confidence level that decision makers placed on their judgment and whether confidence influences accuracy • Research conclusion: Its the subject choice of information rather than his or her processing of the chosen cues that limits accuracy NHashim...UPM....07.03.2007

  25. APPLIED RESEARCH • Simnett & Trotman (1989) found that although subjects were able to utilize all the information from ratios they themselves selected, they were unable to improve performance when asked to apply an optimally selected cue weighting model • Their conclusion: That subjects ‘information-processing performance declines when they are unable to choose their own ratios ‘ NHashim...UPM....07.03.2007

  26. Applied Research • The information overload literature has implications for the presentation & disclosure issue in financial accounting • Research objective: • As the amount of information increases, the utilization & integration of information increases • Research evidence • That individuals experiencing overload shows lower consensus and lower decision-making consistency NHashim...UPM....07.03.2007

  27. Research Evidence 2. Beyond a certain point, additional information results in a decrease in the amount of information integrated into the decision-making task. • Chewning & Harrell (1980) • Research evidence: Subjects not capable being given more than 8 cues (financial ratios) NHashim...UPM....07.03.2007

  28. APPLIED RESEARCH • Libby’s research evidence (1981): Found that adding less valid cues to a set containing more valid cues decreases performance • Other studies evidence: • Found no such relationship • The judgment confidence literature evidence (Solomon, Ariyo & Tomassini 1985): That both expert & non-expert subjects are over confident of their ability in specific judgment tasks NHashim...UPM....07.03.2007

  29. Solomon, Ariyo & Tomassini (1985) • Their overconfidence stem from 3 factors: • The tendency for humans to seek out and overweight positive feedback • The limited nature of feedback in many instances (Example in failure or distress prediction the correctness of a decision not to lend is rarely evaluated) NHashim...UPM....07.03.2007

  30. APPLIED RESEARCH RESULTS 3. The interdependence of actions & outcomes (Example the act of lending/not lending itself influences success or failures) • Libby( 1976) & Zimmer (1980) evidence: The accuracy of judgments increased with increasing confidence • Other studies evidence: Confidence & accuracy is not related NHashim...UPM....07.03.2007

  31. Research Conclusion • Libby’s (1981) conclusion: • In many important decision-making situations, the environmental predictability of available information is low • Even in situations where environmental predictability is relatively high, poor judgment achievement is the norm NHashim...UPM....07.03.2007

  32. Research Conclusion • Factors that contribute to the poor achievement: • Inconsistency • Mis-weighting of cues • Combining quantitative information in repetitive tasks is not a function that people perform well NHashim...UPM....07.03.2007

  33. Recommendations • Replacing people in these situations with models (environmental regression models, models of man, & equal weighting models) shows promise for the increasing predictive accuracy • Other studies evidence since 1981: Have not violated the thrust of Libby’s conclusion above NHashim...UPM....07.03.2007

  34. FORMAT & PRESENTATION OF FINANCIAL STATEMENTS • Libby (1976): 3 options available to improve decision-making: • Changing the presentation & amount of information • Educating the decision makers • Replacing decision makers either with a model of themselves or with an optimal weighting model NHashim...UPM....07.03.2007

  35. FORMAT & PRESENTATION OF FINANCIAL STATEMENTS • Little research have been undertaken in ascertaining optimal accounting presentation format • Studies undertaken: Examined radical changes to financial statement presentation in the form of multidimensional graphics (See page 354 Figure 11.4) • The lens model is useful in examining presentation issues as well as an analysis of predictive judgments NHashim...UPM....07.03.2007

  36. Lens Model Usefulness • It permits analysis of human judgment accuracy in terms of determining the extent to which the individual detects essential properties of the judgment task and consistently applies judgment policy • If changing the report format of information results in improving either the above characteristics, human judgment should increase. NHashim...UPM....07.03.2007

  37. Chernoff Faces • The multidimensional graphics most researched = In the form of schematic or Chernoff faces • The faces (on page 354) are constructed by mapping transformed financial variables onto facial features. • Mathematical precision in terms of nose length, brow angle & mouth curvature is used to represent changes in financial position from one period to another NHashim...UPM....07.03.2007

  38. Graphic Presentation • Interest in this mode of presentation arose • Moriarity (1979): • Using financial information represented by such graphics, outperformed a well accepted financial distress model • Consistent research findings: Models generally outperformed humans and so this form of presentation offered promise. NHashim...UPM....07.03.2007

  39. Stock & Watson (1984): • Provided weak confirmation of Moriarity’s result • Their research found that accuracy performance using multidimensional graphics was superior to that attained with a conventional tabular presentation • To date financial statement prepares have not been prepared to publish graphics as radical as the Chernoff faces but the use of color and more conventional graphs is common NHashim...UPM....07.03.2007

  40. Graphic Representations • Researchers in statistics, information systems & education have investigated the relative advantages of various graphic and tabular forms of visual presentation for displaying both financial & non-financial information. • Others studies evidence: Shows conflicting & equivocal (ambiguous results) • Research in accounting: Found presentation does influence decision-making NHashim...UPM....07.03.2007

  41. Blocher, Moffie & Zmud (1977): • Studied the effects of different forms of presentation (tables & color graphics) on accuracy and bias of internal auditors’ decisions • Results: The relative effectiveness of different forms of presentation is a function of the amount of information that is presented to & must be processed by the decision-maker. • Graphic reports seem better for low level of complexity and tabular reports for higher level of complexity NHashim...UPM....07.03.2007

  42. Davis (1989) • Subjects were MBA students, • Investigated the impact of 3 graphical formats of financial statement (line graph, bar chart & pie chart) & the conventional table • Results: • The question the decision maker sought to answer from the statements and the forms of presentation interactively affect performance • No one form of presentation was best in all situations NHashim...UPM....07.03.2007

  43. Desanctis & Jarvenpaa (1989) • Assess the impact of bar graphs compared with tables in the financial forecasting task • Results: A modest improvement in the accuracy of forecast judgments associated with graphical formats & only after practice in using these formats were provided to the subjects NHashim...UPM....07.03.2007

  44. Wright (1989) & Garson & Nagel (1989) • The above findings seem surprising given the assumption that graphs were valuable for detecting trends & relationships • These authors’ warned that when accounting data are presented in a graphical format, users may go through an adjustment or learning process before the graphical information becomes meaningful NHashim...UPM....07.03.2007

  45. Ricchiute (1984) • In an auditing context, found that judgments regarding necessary adjustments to the accounts may be affected by the mode of presentation of information to the auditor, visual and/or auditory • Since most audit research presents written materials to subjects, he warned that this findings may threaten the generalization of results NHashim...UPM....07.03.2007

  46. Wainer & Thiessen (1981) • Claimed that there is no well-developed and tested theory that can be used to specify the circumstances under which different forms of presentation are most appropriate • In part their findings is at least true • It is attributable to the concentration of HJT research in an auditing context over the last decade. NHashim...UPM....07.03.2007

  47. PROBABILISTIC JUDGMENT • The probabilistic judgment paradigm is useful in studies where initial beliefs about a prediction or evaluation need to be revised when more evidence becomes available • The paradigm suggests using Bayers’ theorem i.e. a basic tenet of conditional probability theory is able to do the above NHashim...UPM....07.03.2007

  48. Bayes’s Theory • States that the revised (posterior) probability in the light of additional evidence is equal to the original belief (base rate) multiplied by the amount by which prior expectations should be revised • Posterior odds (revised probability) = Likelihood ratio (amount by which prior expectation should be revised) X Prior odds (initial probability or base rate) NHashim...UPM....07.03.2007

  49. Bayes's Theory • While the paradigm has a certain logic appeal, both psychology & accountingresearch suggests that human decision makers are not good intuitive statisticians • The evidence suggests that accountants & auditors invoke a series of simplifying heuristics or rules of thumb • Because of the implicit complexity of the types of judgments they need to make & their own information-processing limitations NHashim...UPM....07.03.2007

  50. Libby (1975) • For example Assume you are in charge of security of a large departmental store. • A recent audit indicated that losses due to theft by employees have risen by 10% • You decided to install a mandatory lie detector screening program for the employees NHashim...UPM....07.03.2007

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