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Abstract:

Addresses the issue of how behavioral accountants can contribute to the

establishment of standards in financial accounting policy research. Discussion of

comparative advantages provided by behavioral accounting research in standard

formation; Focus on how communication can be improved between behavioralresearchers and the US Financial Accounting Standards Board (FASB).

Full Text Word Count:

3286

ISSN:

1050-4753

Accession Number:

9510180844

Database:

Business Source Premier

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The Role of Behavioral Accounting Research in

Contents

1. COMPARATIVE ADVANTAGES OF BEHAVIORAL ACCOUNTANTS

2. BEHAVIORAL ACCOUNTING RESEARCH AND THE STANDARD SETTING

PROCESS

3. EXAMPLES OF EX ANTE FINANCIAL RESEARCH

4. CONCERNS ABOUT AND OBSTACLES TO EX ANTE BEHAVIORAL ACCOUNTING

RESEARCH

5. Questions about the FASB's Research Preferences


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6. Potential Obstacles to Ex Ante Financial Research

7. Implications of Ex Ante Behavioral Research for the FASB

8. COMMUNICATION BETWEEN THE FASB AND THE ACADEMIC COMMUNITY

9. REFERENCES

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This essay addresses the issue of how behavioral accountants can contribute to ex

ante financial accounting policy research. In the essay, I discuss the comparative

advantages of behavioral accounting researchers, specific ways in which behavioral

accounting research can contribute to financial accounting standard setting,

concerns about and potential obstacles to this research, and ways to improvecommunication between behavioral researchers and the Financial Accounting

Standards Board (FASB). Although I have attempted to be broad in my definition of

behavioral research, my comments are naturally colored by my training and own

research, which examines individuals judgments and decisions using a cognitive

psychology framework and experimental methodology.

COMPARATIVE ADVANTAGES OF BEHAVIORAL ACCOUNTANTS

Compared to academic accountants pursuing other types of research (e.g., capital

markets, analytical research), behavioral accountants possess two types of

knowledge that are advantageous in pursuing ex ante financial accounting policyresearch. First, behavioral accountants typically have substantial knowledge of the

psychology and/or sociology literature, as opposed to other accounting researchers

who are most familiar with economic theory. The psychology and sociology

literature provides insight into how people, individually or in combination, actually

use and are affected by accounting information, rather than how people should use

or be affected by such information if they behave according to "rational man"

economic theories.[1] These literatures provide a framework for providing

"descriptive explanations of the world as it is," as suggested by Beresford (1994).

Second, behavioral researchers are trained in research methods, such as

experiments, surveys, and field tests, which are often the best, if not the only,

methods available for ex ante research. For example, it often is difficult to use

archival data to evaluate the effect of several alternatives for recognizing or

disclosing a particular item since this data will have been generated under only one

reporting regime.[2] The experimental method allows for creation of "what if"

scenarios in which the effects of alternative accounting methods on decisions can
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be examined. Behavioral accountants' expertise in experimental methodology also

can be helpful in designing field tests for particular accounting standards.

The experimental methodology also provides researchers with a mechanism to

understand the judgments and decision processes underlying a particular

documented outcome. While the capital markets literature can document whetherthe stock market reacts to a particular piece of accounting information, the process

underlying the reaction remains somewhat of a "black box." Individual laboratory

experiments coupled with experimental markets can provide insight into both

individual decisions and how these decisions are aggregated to arrive at market

prices.[3]

BEHAVIORAL ACCOUNTING RESEARCH AND THE STANDARD SETTING PROCESS

In his paper prepared for the ABO conference (Beresford 1994), Dennis Beresford

describes the standard setting process as involving three primary steps: (1) defining

and framing issues for consideration by the FASB, (2) fashioning alternative

methods of recognizing or disclosing information, and (3) choosing among the

alternatives and implementing one alternative. My understanding is that, in this

process, the FASB considers both the coherence of alternatives with its conceptual

framework and practical implications of alternatives, such as the effect of each

alternative on the decisions and behavior of the FASB's many constituent groups.

I believe that behavioral accounting research can contribute to all three phases of

the standard setting process; however, in all phases, it is better equipped to provide

insight on consequences of alternatives to individuals' decisions and behavior than

on the coherence of alternatives with the conceptual framework. This is not to say

that behavioral researchers do not have valuable opinions on the coherence ofalternatives to the conceptual framework; rather this statement reflects the belief

that behavioral research is designed to answer descriptive rather than normative

questions.[4]

I see two potential avenues for behavioral accounting researchers to play a role in

the standard setting process. First, in some instances, the psychology and sociology

literatures may be sufficiently relevant to provide direct insights for the three

standard-setting steps described above. Academic accountants potentially could

extract and synthesize relevant psychological and/or sociological literature to form

opinions about the costs and benefits to users of existing standards and proposed

alternatives. I put forth this idea with some trepidation since there are numerousreasons why results in the psychology or sociology literature may not apply to

different contexts, such as accounting settings (see Abdel-khalik 1994) for further

discussion of this issue). My personal preference is that psychological and

sociological theory be used as the basis for hypotheses about the consequences of

reporting/disclosure alternatives, which then can be tested using experimental or

other research methods. As noted in my review of judgment and decision-making


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research in financial accounting (Maines 1995), some early ex ante research on

financial accounting policy used the experimental method to examine the effects of

accounting alternatives without the guidance of any theory. While this approach

may be necessary if no applicable theory exists, the use of psychological or

sociological theory to guide research enhances the ability to understand the

research's results. In turn, this improves academic accountants' ability to providethe FASB with useful insights.

Psychological and sociological research may be most productively used to guide

behavioral accounting research on general issues that underlie many different

accounting standards, rather than focusing on issues relevant to only one standard.

Some examples of these general issues include recognition versus disclosure of

financial information, the effect of measurement alternatives on earnings volatility,

and the precision, reliability, and verifiability of measurement alternatives. I discuss

the first two examples further in the following section.

EXAMPLES OF EX ANTE FINANCIAL RESEARCH

In this section, I describe two general topics, recognition versus disclosure of

financial information and earnings volatility, that either have been or could be

addressed by behavioral research. These two examples focus on judgments and

decisions made by external users of accounting information, such as investors and

creditors. Such decisions also have implications for judgments and decisions of

preparers of financial information if perceptions of how investors or creditors use

accounting information affect either the manner in which financial statements are

prepared or decisions that affect the cash flows of the corporation.

Recognition versus disclosure of information underlies many topics facing the FASB.For example, this issue is specifically mentioned in the discussion of unconsolidated

entitles in Beresford (1994). A substantial body of psychological research on

information presentation and "flaming" clearly documents that the manner in which

information is presented affects judgments and decisions (Tversky and Kahneman

1981). Behavioral accounting research has examined recognition versus disclosure

issues with respect to lease and pension liabilities (Wilkins and Zimmer 1983;

Harper et al. 1987; Sami and Schwartz 1992). Although the results of these studies

are mixed, evidence seems to indicate that recognition may result in more

conservative judgments by external users than disclosure. Given the mixed results,

further investigation of this issue seems warranted.

In Victor Brown's commentary on the economic and social consequences of

accounting standards (Brown 1990), he alludes to preparers' beliefs that the

volatility of earnings has an effect on investors' decisions.[5] These arguments

suggest that an accounting standard which increases the volatility of earnings

without having an effect on cash flows is undesirable from a preparer's viewpoint

due to its negative effects on investment decisions. Barth et al. (1993) find


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evidence which can be interpreted as being consistent with this belief. Using stock

price data, they find that the market assigns a premium to firms with consistent

patterns of increasing earning for five years. I suggest that experimental research

could supplement and provide additional insight into the results in Barth et al.

(1993). In capital markets research, conclusions are often conditional due to the

inability to perfectly control for concomitant factors which may be the underlyingcause of the results. In comparison, the experimental methodology allows for

control or manipulation of these factors. In the case of earnings volatility, individual

or laboratory market experiments could separately manipulate the volatility of

earnings and cash flows to examine whether investors react to the volatility of

earnings independent of the volatility of underlying cash flows. This research could

provide insight on the validity of preparers' beliefs that would useful in many

standard setting cases.

CONCERNS ABOUT AND OBSTACLES TO EX ANTE BEHAVIORAL ACCOUNTING

RESEARCH

In this section, I discuss some questions and concerns about undertaking ex ante

financial policy research and the implications of such research for the FASB in its

policy setting process. Some of the issues raised are simply questions about the

direction in which the FASB would like the research to proceed, while others focus

on potential problems to undertaking ex ante behavioral research and its

implications for the standard setting process.

Questions about the FASB's Research Preferences

In this section, I pose several general questions about the FASB's opinion regarding

certain types of research. In particular, I have chosen issues that ex ante behavioralresearch is capable of addressing, but which have fallen out of favor in the research

world for reasons discussed below. If the FASB is interested in such issues, it would

be helpful for this interest to be communicated to the academic community.

My first question relates to the role of accounting policy in allocating wealth in

society. As noted by Griffen (1987), accounting information affects the allocation of

society's wealth in two ways. First, it directs resources to productive uses, often

within a market setting, and second, it allocates current wealth among individuals in

society. Many academic accountants have argued that accounting research should

be concerned with only the first allocation since conclusions about the second

allocation require assumptions about preferences about wealth distribution whichare outside the scope of accounting research. These researchers have argued that

any "errors" in judgments of specific individuals due to accounting standards are

unimportant if the market price is unaffected by these errors.[6] Much of the early

behavioral research on financial policy was dismissed on these grounds.

If distributional wealth effects are important to the policy-setting process (and it

seems that they may be given the diverse constituents of the FASB), this needs to
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be communicated to the academic community to increase the value of research on

specific groups of individuals. Behavioral research in this area need not make direct

normative conclusions about the desirability of wealth distributions, but could

provide descriptive facts about the impact of alternatives on different groups which

can be used as an input to the standard-setting process.

A related question has to do with the effects of public versus private information.

Many accounting standards increase disclosure requirements. In some cases, the

disclosure represents information that was privately available to some individuals

(e.g., analysts who received information from corporate management) but wasn't

easily available to the public as a whole. Since the information was available to

some individuals, it could have had an effect on market price. There has been much

analytical accounting research on public versus private information and some

experimental markets research on this issue. Most of the experimental research

focuses on the effect of private information on market prices. Although this research

has provided many insights, I believe there are many interesting issues still

remaining. In addition, to my knowledge, there has been little research on the

distributional wealth effects of public versus private information.

A final question in this area deals with transition versus equilibrium effects.

Typically, capital markets research has focused on ex post equilibrium results, e.g.,

the effects of a standard after it has been in place for a while and individuals have

had an opportunity to understand it. Criticisms were levied against some early

behavioral research because it only examined how "naive" subjects who were

unfamiliar with new standards made judgments and decisions, rather than how

individuals who understand the standard would make judgments and decisions.

Given that the FASB appears to take consequences of new standards into account in

their transition rules (Brown 1990), I think there may be an opportunity for research

that examines how "naive" individuals use new standards and the costs involved in

moving to full understanding of the new information.

Potential Obstacles to Ex Ante Financial Research

Behavioral researchers have consistently faced difficulty in obtaining appropriate

subjects for ex ante financial research. There are two ways the FASB can help in this

area. First, if the FASB has preferences about the types of subjects (e.g., small

investors, financial analysts, preparers) to be used in such research, communicating

these preferences would be helpful to researchers. A related question is how to

convince subjects, once identified, to participate in experiments. Any help on the

part of the FASB in obtaining subjects would be greatly appreciated by the

academic community.

In a similar vein, once subjects are obtained, questions arise concerning the specific

tasks, decisions, etc. to use in an experiment. Comparison of results from different

studies is hampered when different decisions, tasks, etc. are used across studies


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(this may partially explain the mixed results mentioned above for the recognition

versus disclosure issue). I believe that at least some of the confusion stems from

the fact that there is little descriptive work on the judgment and decision-making

processes of many of the FASB's constituent groups, including small investors,

professional analysts and preparers. Descriptive studies are needed to understand

better what judgments and decisions these individuals make and the processesinvolved. This descriptive work then would guide the design of experiments.[7]

Implications of Ex Ante Behavioral Research for the FASB

I sympathize with Dennis Beresford's comments (Beresford 1994) on the difficulty of

drawing conclusions or inferences from academic research. It may be of some

comfort that accountants are not alone in this position; the conflicting results of

economic, social, and medical research also hamper decisive policy actions. I

believe there are several underlying causes, two of which I will discuss.

First, as noted above, behavioral research often has produced conflicting results.

These conflicts are caused in part by the use of different subjects, different

experimental designs, and different tasks. Resolution of the problems noted above

relating to appropriate subjects, tasks, etc. hopefully will reduce the number of

conflicting results in the future. However, there still will be heterogeneity in the

underlying quality of studies, particularly if the FASB relies on working papers which

have not been through a journal's review process. As noted by Katherine Schipper

(1994b) in her comments on Beresford (1994), this heterogeneity requires some

intuitive knowledge on the part of FASB members of threats to both internal and

external validity in research studies. The FASB could also consider getting input

from academic accountants on the quality of a study before relying on the study's

results in the standard setting process.

Beresford (1994) also notes that academics often seem reluctant to draw

conclusions about the policy implications of their research. In her comments on

Beresford (1994), Schipper suggests that "accountants are reluctant to draw

standard-setting conclusions in their research papers . . . because they believe

drawing such conclusions is more properly left to those who can apply the

normative criteria." I agree with this statement; however, if the FASB specifically

communicates information about their normative criteria, accounting researchers

will be better able to discern the types of descriptive research that are relevant to

the FASB. As indicated previously, behavioral researchers need not draw normative

conclusions from their research, but they could provide the FASB with descriptive

"facts" that would play a role in making normative conclusions.

COMMUNICATION BETWEEN THE FASB AND THE ACADEMIC COMMUNITY

I applaud the steps taken by the FASB and other groups in recent years to improve

communication with academics. I believe panel discussions and speeches at various

academic conferences are an excellent method for general communication of the


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