ACT301 Week 10 Tutorial

Chapter 11: Reactions of individuals to financial reporting: an

examination of behavioural research in accounting

11.3 Behavioural research can be used to investigate the individual reactions of

different categories of individuals. In accounting-related studies this could
involve investigating how a variety of financial statement users (including, but
not restricted to, investors) react to a variety of accounting information, often
presented in different forms. Capital market research, on the other hand, is used
to investigate the aggregate reactions of investors to particular events, typically
explored by reviewing movements in share prices around the time of particular
events. Capital market research ignores the information demands of people who
do not participate in the capital market and it relies on an assumption that the
capital market is efficient (usually, the semi-strong-form efficiency assumption).
Behavioural research typically makes no assumptions about the efficiency of the
subjects. Behavioural research often uses a fairly restricted number of
observations (due to the ‘costs’ involved in getting subjects) whereas capital
market studies can use large numbers of observations given the availability of
share price data.

Behavioural research can be particularly useful to accounting standard-setters as

it can enable them to investigate how different classes of financial statement
users will react to proposed accounting standards. That is, this form of research
can enable standard-setters to investigate possible reactions in advance of the
rules being put in place. Again, this can be contrasted to capital market research
which looks at the aggregate reaction of investors to actual releases made by the
accounting standard-setters (although, reactions can be investigated in relation to
the release of draft accounting standards).

11.7 It would seem reasonable to believe that management would be interested in

knowing how various categories of financial statement users are likely to react to
particular disclosures that the organisation is contemplating making, particularly
when the disclosures are made on a voluntary basis. Behavioural research can be
used to provide information of this nature. Behavioural research can be used to
see how particular categories of financial statement users are likely to respond to
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 particular types of disclosures. It could be useful to make this determination in
advance of issuing documents such as the annual report. Of course, whether
management should rely upon the results of the behavioural research will be
dependent upon how well the subjects represent the actual users of the financial
statements and the realism of the task assigned to the subjects.

11.10 There could be a number of reasons for modelling the decision-making

processes of different financial statement user groups, including the following:

• To find out how users are making decisions and to see if they are using
all available information, or whether they are employing any simplifying
heuristics. If information which is considered to be relevant is ignored, or
if heuristics are being employed that could lead to wrong decisions being
made, then knowledge of this would be useful for subsequent training
initiatives. Audit firms are often interested in this form of research if it
shows that auditors, or trainee auditors, are inclined to make poor
judgements in particular circumstances.
• To understand the differences in the information demands and
information processing of different financial statement user groups.
• If the research shows that decisions made by way of simplifying
heuristics are as good as decisions made from costly information
searches then such heuristics may be identified and implemented within
an organisation.
• Information about how people make decisions could be useful to
organisations when they are considering whether to disclose particular
information. Perhaps the models indicate that people are not likely to
take such information into account. In such a case, the organisations
might elect not to make specific disclosures.
• The model developed might indicate that the form of disclosure makes a
difference to how people use information. If this is the case then this has
direct implications for how organisations disclose information.
• Accounting standard-setters would be interested to know how financial
statement users react to particular types and forms of disclosure when
developing disclosure requirements. For example, does it matter whether
information is provided in notes to the accounts, or in the main body of

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 the financial statements? It would also be relevant when developing
educational programs. If it appears that information that should be
important to decision making (and this is a matter of opinion) is being
ignored, then particular efforts might be made to highlight the relevance
of the information.
• If models are developed from studying the decision-making process of
‘expert’ subjects, these ‘expert models’ may be used to train less-
experienced people (or perhaps the models could be commercially
marketed).

11.13 Protocol analysis typically requires subjects to ‘think aloud’ when they are
making decisions, and what they say is typically taped for subsequent analysis.
Trotman (1996) identifies a number of advantages and disadvantages of protocol
analysis, including the following.

Advantages
• A useful way to find out about previously unknown decision-making
processes – very useful for developing theory.
• The sequence in which information is used can be determined.
• A useful way to confirm previous theories about how people make
decisions.
• Useful for people to learn about how they themselves make decisions.
Without the results of protocol analysis, this might not be obvious.

Disadvantages
• The process of ‘thinking aloud’ may actually affect how decisions are
made—it is quite different to how decisions are normally made.
• Subjects will not always verbalise all the processes involved in making a
decision, hence resulting in omitted data.
• Protocol analysis often generates considerable data (perhaps many
hundreds of pages) for the researcher and what data is selected or utilised
can be quite subjective.