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. PPT t/a Financial Accounting Theory by Deegan 11.1
 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. 11.2

PPT t/a
 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. 11.3

PPT t/a
 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
Copyright © 2000 McGraw-Hill Book Co. Aust. 11.4
PPT t/a
 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. 11.5
PPT t/a
 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

Copyright © 2000 McGraw-Hill Book Co. Aust. 11.6

PPT t/a
 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. 11.7

PPT t/a
 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

Copyright © 2000 McGraw-Hill Book Co. Aust. 11.8

PPT t/a
 Chapter 11: Behavioural research

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

Copyright © 2000 McGraw-Hill Book Co. Aust. 11.9

PPT t/a
 Chapter 11: Behavioural research

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 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
PPT t/a
 Chapter 11: Behavioural research

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 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
PPT t/a
 Chapter 11: Behavioural research

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
Copyright © 2000 McGraw-Hill Book Co. Aust. 11.12
PPT t/a
 Chapter 11: Behavioural research

Research evidence—the
presentation of information cont’d
• 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
PPT t/a
 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

PPT t/a
 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

PPT t/a
 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

Copyright © 2000 McGraw-Hill Book Co. Aust. 11.16

PPT t/a
 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

PPT t/a
 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

Copyright © 2000 McGraw-Hill Book Co. Aust. 11.18

PPT t/a
 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

PPT t/a
 Chapter 11: Behavioural research

Decision output—decision
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
PPT t/a
 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

PPT t/a
 Chapter 11: Behavioural research

Protocol analysis—continued
• 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
PPT t/a
 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
PPT t/a