1. 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

2. 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

3. 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

4. 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

5. 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

6. 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

7. 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

8. 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

9. 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  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting Theory 2e by Deegan

10. 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 & 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

11. 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  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting Theory 2e by Deegan

12. Research evidence—the 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

13. 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

14. 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

15. 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

16. 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  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting Theory 2e by Deegan

17. 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  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting Theory 2e by Deegan

18. 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

19. 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  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting Theory 2e by Deegan

20. 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

21. 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

22. 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