Lecture-14 Behavioural Research in Accounting 7 Lecture-14 Behavioural Research in Accounting Readings Reference : Text chapter 13 Behavioural Research in Accounting; Accounting Theory; John Wiley and Sons; 6th edition, 2006; pp 445-472.

The Process Tracing Model/ Veriable protocol methods Explanation about how a decision is made HJT modelling ‘process tracing’ or ‘verbal protocol’ ‘decision tree’ Process tracing is a method used to evaluate and develop theories in psychology,[1] political science[2] or usability studies. In process tracing studies multiple data points are collected in comparison to simple input-output methods, where only one measurement per task is available. In this method variable descriptions are recorded by the researchers and then analyzed to produced a ‘decision tree, diagram to represent the decision processes of the decision maker.

The Process Tracing Model/ Verble protocol methods Is debit To equity>3? No Yes Is size >$10m Default No Yes Is current Ratio >2 ? Is sales to net assets>2 Yes No Yes No Non-Default Default Non-Default Default Hypothetical decision tree for a bank loan officer

The Process Tracing Model/ Veriable protocol methods In general terms, the decision tree derived from process tracing methods are intuitively good descriptors of people decision process. However, relative to Brunswik lens models, process tracing methods are not always good predictors of the event of interest. Some researchers have tried to overcome the general limitations of both the lens and process tracing methods by combing the predictives and descriptive powers of the two approaches. By alternative statistical techniques knows as ‘classification and regression tree’ (CART)

Probabilistic judgement The probabilistic judgement model is useful for looking at situations in accounting where initial beliefs about a prediction or evaluation need to be revised once further evidence become available. An investor’s revision of an investment decision in the light of new evidence concerning the outcome of a lawsuit against a firm . The model has been extensively researched in the area of psychology . While the model has a certain logical appeal, the body of researchers suggests that human decision makers are not good intuitive statisticians. Initial beliefs need revision Use of ‘rules of thumb’ by accountants and auditors

Probabilistic judgement Bayes’ Theorem Bayes’s theorem 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; that is ,by the informativeness Posterior odds= Likelihood ratio x Prior odds ( revised probability)= ( amount by which prior expectations should be revised) x initial probability or base rate)

Probabilistic judgement and Bayes’ Theorem The basic question examined in the early research in probabilistic judgement is whether probabilities are revised in the direction indicated by Bayes’ Theorem The findings suggest that this occurs to a lesser extent than Bayes’ Theorem suggests Financial accounting researcher have accumulated much evidence that these rule of thumb or biases are also pervasive among accountants, auditors and users of financial statements.

Lens model studies – the evidence Using the lens model as a research tool in this way allows analysis of the consistency of judgement, of whether a ‘model of human behaviour’ can predict more accurately than human. It also enables analysis of the ability of the cues to predict the event in question( the ‘environmental predictability’ using an ideal cue weighting). In addition, it can gives insights regarding the degree of consensus between decision makers. The evidence consistently shows that humans are reasonably proficient at developing principles or models( inferred from the pattern of use of cue) are applied mathematically for two reasons: they misweigh cues, and they inconsistently apply their decision rule to factors such as fatigue and boredom. Mathematical application of either the environmental model( using ideal cue weighting ) or the’ model of human behaviour’ is perfectly consistent over time, eliminating random error.

Process tracing studies – the evidence Brunswik lens models and process tracing style studies are different technologies with the same objective of modelling decision processes as completely as possible. The relative predictive power of lens and process tracing models has been studies in business context by Larcker and Lessig & Selling and Shank. In a share selection scenario, Larcker and Lessig found that process tracing models outperformed the statistical linear models, but Selling & Shank found the opposite when the two approaches were compared in a task involving the prediction of bankruptcy

Probabilistic Judgement Studies – the evidence .Three rules of thumb are defined in the literature Representativeness:--This rule of thumb states that when judging the probability that a particular item comes from a particular population of items, people's judgement will be determined by the extent to which the items is representative of the population. Availability :-- The availability rule of thumb refers to the assessment of the probability of an event based on the ease with which instance of that event come to mind. The consequences of use of this rule of thumb is that probability related to ‘ sensational’ events are likely to be overestimated.

Probabilistic Judgement Studies – the evidence 3. Anchoring and adjustment:-- This rule of thumb refers to a general judgement process in which an initially generated or given response serves as an anchor, and other information is used to adjust that response. This consequence of this rule of thumb is the possibility of insufficient adjustment in that light of changing circumstances. 4. Expert judgement and rule of thumb:- The research involve expert judgement is concerned with examining the thought process of expert and the determinants of expertise provide the analytical framework with their theory of bounded rationality .

Format and presentation of financial statements Libby (1976) – Three basic options for improved decision making changing presentation and amount of information educating decision makers replacing decision makers with a model of themselves or with an ideal cue-weighting model Little research has been undertaken regarding ideal presentation formats e.g. Graphs versus tables Colour versus black & white Mixed results No well developed and tested theory

Format and presentation of financial statements The lens model is useful in examining financial statement presentation issued as well as in analysis of predictive judgements. It permits analysis of human judgement accuracy in terms of determining the extent to which the individual detects essential properties of the judgement task and consistently applies judgement policy. If changing the report format of information results in improving either of the above characteristics, human judgement accuracy should increase. The decision-usefulness objectives, adopted in the conceptual framework, depends partly on the users ability to interpret the data for a given investment or credit decision. The impact of change in the report format on subjects ability within a lens model framework.

Limitations of BAR Behaviourial accounting research deal about how different decision makers use accounting information and it raveled that there is significantly more to learn in this area. The major limitation of BAR is the lack of a single underlying theory which helps in the unification of the diverse research questions and findings of BAR. Studies on the same topic have produced conflicting results, preventing conclusive guidance for policy decisions. The experimental subjects and setting used in these studies often differ from those found in real judgement setting. Accounting researchers have questioned whether policy should be influenced by research on individual decision makers

Thanks for kind participation Issues For Auditors Behavioural auditing research investigates characteristics of high-performing auditors and the factors that affect auditor judgement. Result have shown that industry specialist auditors outperform other auditors when they are in their specialist industry environment. They appear to process multiple pieces of information more efficiently and effectively to determine the existence of financial misstatements. Experimental research also shows that there are complex interactions between experience and context in auditors reporting decisions. Additionally, this research shows that investors reaction as though they perceive auditor independence is impaired when auditors receive non-audit service revenue from their audit client even if actual auditor independence is not affected. Experimental researchers dace a challenges when they attempt to balance realism and simplicity in research design. End of topic-7 Thanks for kind participation