1. Steven Huddart & Hong QU
Rotten apples and sterling examples: Moral reasoning and peer influences on honesty in budget reporting
Erasmus University March 13, 2014
Steven Huddart & Hong QU

2. Why do accountants care about norms and honesty?
Accounting, at its foundation, concerns the reporting of private information.
The analysis of private information communication in agency theory assumes pure self-interest maximization.
BUT, the reporting behavior of others may affect one’s own reporting behavior.

3. Importance and application
Sorting employees according to moral characteristics and promoting good norms within organizations may be underused ways to improve performance
Art Wyatt argued in an AAA plenary address that Arthur Andersen was brought low by bad corporate culture.

4. Guides to behavior Traditional economic models incorporate
contractual incentives
legal incentives
reputational considerations
Individuals also have innate preferences to conform to the behavior of their peers.
injunctive norms of behavior
empirical norms of behavior

5. Norms for all kinds of acts: Empirical evidence
Desirable action: Kim, Morse, and Zingales (2006):
Academics’ research productivity is influenced by the cultural norm of the department that houses them.
Undesirable action: Fisman and Miguel (2006):
Differing propensities of Nigerian and Norwegian diplomats posted to New York City to accumulate unpaid parking tickets
Social norms related to corruption are significant and persistent because diplomats behave like others in their home countries.
Undesirable action: Chen and Sandino (2011)
Retail theft and collusive retail theft by employees is lower when pay is higher.
higher wages have the direct effect of curbing employee theft and also promote an ethical environment among coworkers

6. Norms for all kinds of acts: Experimental evidence
moral development affects decisions
Arnold and Ponemon (1991): internal auditors with high moral development are more likely than those with low moral development to suggest whistle blowing
social norms influence decisions
Ponemon (1992a): peer pressure increases the likelihood that audit staffers will under-report the time spent on an audit task.
Lord and DeZoort (2001): peer pressure increases the likelihood that auditors sign off on financial statements that are materially misstated.
Ponemon (1992b): public accounting firms select and promote individuals who demonstrate a low but homogenous stage of moral development.

7. Kohlberg’s (1969) Theory of Moral Reasoning
Pre-conventional: responds to individual rewards and penalties
Conventional: desire to respect group norms of behavior
Post-conventional: motivated by personal principles and values

8. Neo-Kohlbergian Schema
People have three traits in varying degrees
Personal interest
Machiavellian (like Hartmann & Maas 2010, Cristie and Gies, 1970)
Maintaining norms (or conformity)
Fischer & Huddart (2008)
Post conventional
Lord & DeZoort (2001)

9. Formalizing Kohlberg: Fischer & Huddart (2008)
Risk-neutral agent maximizes pay net of personally cost of actions
wi + bi r(ai ) – f(ai – Nai )
where
f(x) is the cost of the act
Nai is psychic cost to i due to norm for action a

10. Structure Norm of behavior, Nai = (1 – li)Pi – liS, where
Pi represents the personal standard of agent i, i.e., the injunctive norm
S is the endogenous average behavior of the peer group, i.e., the empirical norm
li  [0,1) represents extent to which agent is conventional

11. Features
Action, ai, influences performance measure used for contracting.
Action is beneficial to the principal.
Action choice is influenced by a personal norm of behavior, Pi, and a social norm of behavior, S.
The weight on the social norm, li, measures the extent to which the agent is conventional.
Social norm of behavior is endogenous—it depends upon how agents behave within the organization.

12. Motivation Theory of moral reasoning (Kohlberg, 1969)
Research Questions
Experiments
Results
Conclusions
Motivation
Theory of moral reasoning (Kohlberg, 1969)
Pre-conventional: responds to individual rewards and penalties
Conventional: desire to respect group norms of behavior
Post-conventional: motivated by personal principles and values
A model with endogenous social norms (Fischer and Huddart 2008)
Behavioral assumptions
Economic self-interest
AND
a personal standard for behavior
a desire to conform to the average behavior of a peer group

13. Motivation
Research Questions
Experimental Setup
Results
Conclusions
Contributions
Probe the validity of assumptions about about the behavioral roots of honesty that underlie such models as Fischer & Huddart (2008) regarding.
Examine how individual traits explain heterogeneous reporting behavior in vacuo, and subsequent to social influence.
Challenge the importance of the p-score relative to the maintaining norms score.
Extend ethics research in accounting by linking practical reporting outcomes to neo-Kohlbergian schemas.

14. Budget Reporting Experiment
Motivation
Research Questions
Experimental Setup
Results
Conclusions
Budget Reporting Experiment
Experimental setup
Participants play the role of managers
Observe private cost C perfectly
Submit budget report R to headquarters
Maximum cost is 6 and minimum cost is 4.
Economic Incentive (in Lira)
Fixed salary+budget slack: *(Report-Cost)
Prior experimental evidence(Evans et al. 2001)
Reports are partially honest
Reporting Honesty=1.00- (Report-Cost)/(6-Cost)
Average honesty is 0.45.

15. Budget Experiment with Peers
Motivation
Research Questions
Experimental Setup
Results
Conclusions
Budget Experiment with Peers
subject to social pressure
Peer group
Half the subjects are managers of Division A
Observe own cost and submit budget reports
Treatment group
Half the subjects are managers of Division B
Stage 1: observe own division’s cost and submit a report (uninformed report)
Stage 2: observe Division A’s cost and report, submit a second report ( informed report)
subject to social influence

16. Experimental procedure
Motivation
Research Questions
Experimental Setup
Results
Conclusions
Experimental procedure
Peer 1: see own cost and report
(Peer Honesty)
Manager: see own cost and report
(Uninformed Honesty)
Period 1
Within-Period Change
Manager: see peer 1’s cost & report, and report (Informed Honesty)
Between-Period Change
Peer 2: see own cost report
(Peer Honesty)
Manager: see own cost and report
(Uninformed Honesty)
Period 2
Manager: see peer 2’s cost & report, and report (Informed Honesty)

17. Injunctive Norm Hypotheses 1a & 1b
Maintaining Norms Schema: In the absence of social information about other’s reporting behavior, individual reporting honesty is increasing in Maintaining Norms schema.
Post-conventional Schema: In the absence of social information about other’s reporting behavior, reporting honesty is increasing with in Post-conventional schema.

18. Descriptive Norm Hypotheses 2a & 2b
Maintaining Norms Schema: Managers’ responses to social information about peers are increasing with the Maintaining Norms schema.
Post-conventional Schema: Managers’ responses to social information about peers are unrelated to the Post-conventional schema.

19. Subjects choices: early

20. Subject choices: Late

21. Subject Honesty

22. Neo-Kohlbergian Classification from DIT2

23. DIT Schema Scores

24. Injunctive Norm

25. Descriptive Norm (between)

26. Descriptive Norm (within)

27. Responses to social influence

28. Findings
Adherence to injunctive norms increases with the personal significance of the maintaining norms schema.
Responses to peers vary systematically with neo-Kohlbergian schemas.
The maintining norms schema leads to strong responses to peer behavior.
Both “bad apples” and “sterling examples” affect other’s behavior.
Norms and pay together shape outcomes

29. Extensions What is most salient in forming norms?
the most recent example
the most extreme behavior
the most consistent behavior
How does an empirical norm evolve?
option backdating
earnings management

30. Heinz Dilemma
Heinz's wife was near death, and her only hope was a drug that had been discovered by a pharmacist who was selling it for an exorbitant price. The drug cost $20,000 to make, and the pharmacist was selling it for $200,000. Heinz could only raise $50,000 and insurance wouldn't make up the difference. He offered what he had to the pharmacist, and when his offer was rejected, Heinz said he would pay the rest later. Still the pharmacist refused. In desperation, Heinz considered stealing the drug.
Would it be wrong for him to do that? Should Heinz have broken into the store to steal the drug for his wife? Why or why not?[

31. Summary of DIT2 responses

32. Old stuff

33. Average Changes in Honesty Conditional on Peer Behavior
Motivation
Research Questions
Experimental Setup
Results
Conclusions
Average Changes in Honesty Conditional on Peer Behavior
Peer More Honest
(Peer Honesty - Uninformed Honesty > 0.1)
Peer Less Honest
(Peer Honesty - Uninformed Honesty < -0.1)

34. Personal standards: Reporting honesty without social information
Motivation
Research Questions
Experimental Setup
Results
Conclusions
Personal standards: Reporting honesty without social information
Average honesty of uninformed reports in period 1, by Kohlbergian type

35. Between-period change in honesty by moral types
Motivation
Research Questions
Experimental Setup
Results
Conclusions
Between-period change in honesty by moral types
Averages computed from responses in periods 1–4, by Kohlbergian type.

36. Within-period change in honesty by moral types
Motivation
Research Questions
Experimental Setup
Results
Conclusions
Within-period change in honesty by moral types
Averages computed from responses in periods 1–4, by Kohlbergian type.

37. T3a–Evolution of honesty (within)

38. T3b–Evolution of honesty (between)

39. REVISION
Neo-Kohlbergian approach
Simplify the analysis

40. Kohlberg’s (1969) Theory of Moral Reasoning
Pre-conventional: responds to individual rewards and penalties
Conventional: desire to respect group norms of behavior
Post-conventional: motivated by personal principles and values

41. Neo-Kohlbergian Theory: degrees of three type of behavior
Self interest
Maintaining norms
Principled reasoning

42. Absent social information, what makes people honest, social norms or moral reasoning?

43. Changes in Response to Peers: Norms or Principles?

44. Changes in Response to Peers: Norms or Principles? (late)

45. T2: Summary Statistics on Honesty Measure