Financial Accounting Theory

Craig Deegan

Chapter 11
Reactions of individuals to financial
reporting: An examination of
behavioural research
Slides written by Michaela Rankin

Copyright 2000 McGraw-Hill Book Co. Aust.

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Chapter 11: Behavioural research

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 2000 McGraw-Hill Book Co. Aust.

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Chapter 11: Behavioural research

Learning Objectives
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 2000 McGraw-Hill Book Co. Aust.

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Chapter 11: Behavioural research

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
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Chapter 11: Behavioural research

Brunswick Lens Model

Used to explain behavioural research
perspectives about the environment are
generated (observed) through a lens of
imperfect cues
to determine the weighting (importance) of
the various cues (independent variables) to
the criterion event of success (dependent
variable) statistical modelling is applied
Copyright 2000 McGraw-Hill Book Co. Aust.

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Chapter 11: Behavioural research

Brunswick Lens Model

continued
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

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Chapter 11: Behavioural research

Applicability of the Lens Model

Structure can be applied to almost any
decision-making scheme
eg. lending decision
explicitly considers inputs (use of cues), the
decision process and outputs (ultimate
decisions)

Copyright 2000 McGraw-Hill Book Co. Aust.

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Chapter 11: Behavioural research

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
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Chapter 11: Behavioural research

Types of issues to
be consideredcontinued
At the output or decision level:
qualities of the judgement
self-insight

Copyright 2000 McGraw-Hill Book Co. Aust.

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Chapter 11: Behavioural research

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 2000 McGraw-Hill Book Co. Aust. 11.10
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Chapter 11: Behavioural research

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 and Virgil 1970; Mear and Firth
1987)
studies questioned the provision of current
cost information, subjects relied more on
historical cost information (Heintz 1973;
McIntyre 1973)
Copyright 2000 McGraw-Hill Book Co. Aust. 11.11
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Chapter 11: Behavioural research

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
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Chapter 11: Behavioural research

Research evidencethe
presentation of information contd
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 and Zimmer
1983)
provision of segment information reduced
subjects reliance on past share prices
(Stallman 1969; Doupnik and Rolfe 1989)
Copyright 2000 McGraw-Hill Book Co. Aust. 11.13
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Chapter 11: Behavioural research

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 2000 McGraw-Hill Book Co. Aust. 11.14
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Chapter 11: Behavioural research

Decision-making heuristics
Three main simplifying heuristics have
been identified:

representativeness
anchoring and adjustment
availability

Copyright 2000 McGraw-Hill Book Co. Aust. 11.15

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Chapter 11: Behavioural research

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
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Chapter 11: Behavioural research

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 2000 McGraw-Hill Book Co. Aust. 11.17

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Chapter 11: Behavioural research

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

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Chapter 11: Behavioural research

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 2000 McGraw-Hill Book Co. Aust. 11.19

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Chapter 11: Behavioural research

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 2000 McGraw-Hill Book Co. Aust. 11.20
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Chapter 11: Behavioural research

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 2000 McGraw-Hill Book Co. Aust. 11.21
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Chapter 11: Behavioural research

Protocol analysiscontinued
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 parallel
but are independent of the actual thought process
criticisms of the coding methods
Copyright 2000 McGraw-Hill Book Co. Aust. 11.22
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Chapter 11: Behavioural research

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 2000 McGraw-Hill Book Co. Aust. 11.23
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