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Abstract:
We experimentally examine how employees' employment horizons (long or short) and the performance measures in their incentive contracts (forward-looking or contemporaneous) affect employee effort allocation and performance. Consistent with economic theory, we find that the decision-influencing benefits of forward-looking contracts decrease as employees' employment horizons increase toward the firm's profitability horizon. Importantly, we extend this theory to predict decision-facilitating benefits for employees with long employment horizons. Holding feedback constant, we find that employees with long employment horizons exert more farsighted effort and are more efficient in task execution when they are compensated with contracts that incorporate forward-looking measures rather than those with only contemporaneous measures. Further analysis indicates that this increase in efficiency is mediated by a reduction in experimentation across various task strategies. Thus, contracting on forward-looking performance measures provides benefits to firms regardless of employment horizons.

Performance Measurement, Incentives, Effort Allocation, Employment Horizon

Abstract:
We experimentally examine how employees' employment horizons and the performance measures in their incentive contracts affect employee effort and performance. Economic models suggest that contracts that incorporate leading measures of firm performance mitigate the shortsighted efforts of employees whose employment horizons are not aligned with the firm's profitability horizon, but have less influence on effort choices as employment horizons approach the firm's profitability horizon. We argue that incorporating forward-looking measures in incentive contracts influences employee effort allocation regardless of employment horizon because these measures have both decision-influencing and decision-facilitating benefits. Results show that employees with short employment horizons exert more farsighted effort when their incentive contracts incorporate forward-looking measures than when they incorporate only contemporaneous measures, consistent with decision-influencing benefits. However, employees with long employment horizons not only exert more farsighted effort but are also more efficient in task execution with contracts that incorporate forward-looking measures because of decision-influencing benefits.

Performance Measurement, Incentives, Effort Allocation, Employment Horizon

Abstract:
We experimentally examine how employees' employment horizons (long or short) and the performance measures in their incentive contracts (forward-looking or contemporaneous) affect employee effort allocation and performance. Consistent with economic theory, we find that the decision-influencing benefits of forward-looking contracts decrease as employees' employment horizons increase toward the firm's profitability horizon. We extend this theory to predict decision-facilitating benefits for employees with long employment horizons. Results support our predictions. Employees with long employment horizons exert more farsighted effort and are more efficient in task execution when they are compensated with contracts that incorporate forward-looking measures rather than those with only contemporaneous measures. Further analysis indicates that this increase in efficiency is mediated by a reduction in experimentation across various task strategies. Thus, contracting on forward-looking performance measures provides benefits to firms regardless of employment horizons.

Performance Measurement, Incentives, Effort Allocation, Employment Horizon

Abstract:
Company managers frequently provide explanations in response to auditor inquiries about unexpected earnings fluctuations. Client-inquiry is particularly common when the financial statement account causing the fluctuation is subjective and involves estimates, as the ability to obtain reliable evidence from other sources often is limited in these situations. In this study, we examine two factors that we expect to affect how auditors evaluate client-provided explanations for an important account that requires significant estimation (i.e., revenue): the client manager's incentives to manage earnings and whether the explanation is quantified (i.e., put into numbers). We expected that auditors' evaluations of client-provided explanations would be a joint function of management's incentives and the type of explanation provided to the auditor. Instead, we found that auditors' views of the persuasiveness of client explanations are primarily affected by the manager's incentives to manage earnings. Focus on client manager incentives is consistent with auditors' and regulators' recent and vociferous concerns about earnings management. However, such a focus implies that when the likelihood of earnings management is low, auditors may underestimate the reliability of quantified explanations that demonstrate how the client's explanation fully accounts for the earnings fluctuation.

Earnings management; Quantification; Auditing

Abstract:
Accounting involves assigning numbers to events - quantifying them. Conventional wisdom holds that putting numbers to an argument enhances its persuasive power. However, little scholarly evidence exists to support or refute this claim, in accounting or elsewhere. In this paper, we develop an original process-based model of how quantification influences persuasion. We posit that including a high-quality quantified analysis in a proposal enhances its persuasive power by increasing both the perceived competence of the proposal preparer and the perceived plausibility that a favorable outcome could occur. However, under some conditions, quantification also encourages criticism of the details of the proposal, which potentially offsets these effects. We experimentally test implications of our model in a managerial decision setting, investigating conditions in which quantification is more and less likely to result in criticism of the quantified proposal and, thus, less and more likely to be persuasive. We also test the model, itself, using structural equations methods. Results largely support the model, which should prove of value to researchers interested in the effects of quantification on judgments and to those interested in persuasion.

Quantification, accounting, persuasion, measurement

Abstract:
Accounting involves assigning numbers to events - quantifying them. Conventional wisdom holds that putting numbers to an argument enhances its persuasive power. However, little scholarly evidence exists to support or refute this claim, in accounting or elsewhere. In this paper, we develop an original process-based model of how quantification influences persuasion. We posit that including a high-quality quantified analysis in a proposal enhances its persuasive power by increasing both the perceived competence of the proposal preparer and the perceived plausibility that a favorable outcome could occur. However, under some conditions, quantification also encourages criticism of the details of the proposal, which potentially offsets these effects. We experimentally test implications of our model in a managerial decision setting, investigating conditions in which quantification is more and less likely to result in criticism of the quantified proposal and, thus, less and more likely to be persuasive. We also test the model, itself, using structural equations methods. Results largely support the model, which should prove of value to researchers interested in the effects of quantification on judgments and to those interested in persuasion.

Quantification, accounting, persuasion, measurement

Abstract:
Accounting involves assigning numbers to events-quantifying them. Conventional wisdom holds that putting numbers to an argument enhances its persuasive power. However, little scholarly evidence exists to support or refute this claim, in accounting or elsewhere. In this paper, we develop an original process-based model of how quantification influences persuasion. We posit that including a high-quality quantified analysis in a proposal enhances its persuasive power by increasing both the perceived competence of the proposal preparer and the perceived plausibility that a favorable outcome could occur. However, under some conditions, quantification also encourages criticism of the details of the proposal, which potentially offsets these effects. We experimentally test implications of our model in a managerial decision setting, investigating conditions in which quantification is more and less likely to result in criticism of the quantified proposal and, thus, less and more likely to be persuasive. We also test the model, itself, using structural equations methods. Results largely support the model, which should prove of value to researchers interested in the effects of quantification on judgments and to those interested in persuasion.

Quantification, accounting, persuasion, measurement

Abstract:
Prior research demonstrates that forecast optimism is, in part, a consequence of analysts' cognitive reactions to the scenarios managers use to communicate future plans. In two experiments, we examine whether counter-explanation (explaining why managers' plans could fail) reduces scenario-induced optimism. We find that when compared to analysts not asked to generate counter-explanations, analysts who complete the relatively easy task of generating few counter-explanations make less optimistic forecasts, but analysts who complete the relatively difficult task of generating many counter-explanations do not. Results demonstrate the usefulness of a cognitive, theory-based mechanism for reducing forecast optimism and suggest a boundary condition for the use of that mechanism.

counter-explanation, availability, EPS, forecast optimism

Abstract:
Prior research demonstrates that forecast optimism is, in part, a consequence of analysts' cognitive reactions to the scenarios managers use to communicate future plans. In two experiments, we examine whether counter-explanation (explaining why managers' plans could fail) reduces scenario-induced optimism. We find that when compared to analysts not asked to generate counter-explanations, analysts who complete the relatively easy task of generating few counter-explanations make less optimistic forecasts, but analysts who complete the relatively difficult task of generating many counter-explanations do not. Results demonstrate the usefulness of a cognitive, theory-based mechanism for reducing forecast optimism and suggest a boundary condition for the use of that mechanism.

Counter-explanation, availability, EPS, forecast optimism

Abstract:
We perform a detailed analysis of how audit seniors respond to cues that signal high fraud risk when modifying a standard audit program. Using an actual fraud case, we experimentally examine auditors’ planning judgments and decisions in three conditions that vary in the extent to which they make fraud cues salient. Consistent with prior studies, we find that auditors receiving information expected to make fraud risk cues most salient (a material weakness in the cycle they are auditing) can identify high fraud risk and that their heightened perceptions of fraud risk in this condition result in the auditor proposing more audit work. However, the responses we collected allow us to go beyond the extent of work measures used in most prior research and examine the specific procedures that auditors propose, as well as evaluate their effectiveness and efficiency. We find that when audit seniors must specify which procedures to modify and how to modify those procedures, they cannot discriminate which procedures require changes, and they tend to propose more ineffective procedures for fraud detection in conditions in which fraud cues are most salient. This occurs because most of the proposed modifications are increases in sample size, which are ineffective in detecting the seeded fraud. In sum, the results show that audit seniors can recognize the risk of fraud when it is highly salient, but, on average, they have difficulty appropriately responding to the risk of fraud. Further analyses indicate that auditors who propose the highest quality programs are those who identify more fraud-specific risk factors.

Audit planning, Fraud detection, Fraud risk factors, Audit seniors, Risk assessments

Abstract:
Tax professionals are responsible for objectively evaluating tax authorities and evidence relevant to their application and for serving as client advocates. We predict that practice risk, i.e., exposure to monetary and nonmonetary costs of making inappropriate recommendations, will affect tax professionals' ability to meet these responsibilities by influencing the manner in which they process information about a tax situation as well as their resulting recommendations for clients. We conduct an experiment in which we manipulate practice risk through client characteristics. We also manipulate provision and nature of outcome information. We find that tax professionals process information differently for clients of different risk levels. Specifically, tax professionals weight negative outcome information more heavily when forming likelihood assessments underlying recommendations for a high-risk client, relative to a low-risk client. Further, risk directly affects recommendations in that tax professionals more strongly recommend an aggressive position for a low-risk client. Differential processing of information for clients with identical transactions but different risk levels may protect the tax professional from the higher expected costs of making inappropriate recommendations to high-risk clients. However, it indicates that tax professionals do not evaluate evidence objectively for all types of clients.

Tax professionals, Hindsight, Practice risk, Accumulated earnings tax

Abstract:
Tax professionals are responsible for objectively evaluating tax authorities and evidence relevant to their application and for serving as client advocates. We predict that practice risk, i.e., exposure to monetary and nonmonetary costs of making inappropriate recommendations, will affect tax professionals' ability to meet these responsibilities by influencing the manner in which they process information about a tax situation as well as their resulting recommendations for clients. We conduct an experiment in which we manipulate practice risk through client characteristics. We also manipulate provision and nature of outcome information. We find that tax professionals process information differently for clients of different risk levels. Specifically, tax professionals weight negative outcome information more when forming likelihood assessments underlying recommendations for a high-risk client, relative to a low-risk client. Further, risk directly affects recommendations in that tax professionals more strongly recommend an aggressive position for a low-risk client. Differential processing of information for clients with identical transactions but different risk levels may protect the tax professional from the higher expected costs of making inappropriate recommendations to high-risk clients. However, it indicates that tax professionals do not evaluate evidence objectively for all types of clients.

Abstract:
This paper reports the results of an experiment that examines how analyst forecast accuracy (i.e., how close an analyst's forecast is to realized earnings) and forecast boldness (i.e. how far the analyst's forecast is from the consensus forecast) affect the analyst's perceived credibility and investors' willingness to rely on and purchase the analyst's future reports. We hypothesize and find that forecast boldness magnifies the effect of forecast accuracy on these variables. That is, analysts who provide accurate, bold forecasts experience more positive consequences than those who provide accurate, non-bold forecasts, and analysts who provide inaccurate, bold forecasts experience more negative consequences than those who provide inaccurate, non-bold forecasts. We also find that these effects are not symmetric - the negative consequences of being bold and inaccurate exceed positive consequences of being bold and accurate. Our results are not sensitive to the level of the analyst's prior reputation.

financial analysts, herding, forecast accuracy, attribution theory

Abstract:
Avoiding continued investment in poorly performing projects is an important function of management control systems. However, prior research suggests that managers fail to use accounting information indicating that a project is performing poorly to discontinue it; that is, they escalate commitment to the project. We perform two experiments to investigate the efficacy of a potential control mechanism, third-party consultation, in preventing managerial escalation of commitment. We hypothesize that the information-processing objective (i.e., purpose) assigned to consultants influences the mental representations they construct to process and store information, which ultimately influences their recommendations regarding the continuation of a poorly performing project. Results suggest that consultants will not construct mental representations amenable to making high-quality project-continuation recommendations unless they are assigned that specific purpose. Results further suggest that applying additional effort likely will not overcome the adverse effects of having inappropriate mental representations when making project-continuation recommendations. An implication of our study is that third-party consultants likely will not prevent managerial escalation of commitment unless consultants have a specific mandate of making a project-continuation recommendation in mind when they encounter relevant accounting information.

Escalation of commitment; Mental representations; Justification; Accountability

Abstract:
Avoiding continued investment in poorly performing projects is an important function of management control systems. However, prior research suggests that managers fail to use accounting information indicating that a project is performing poorly to discontinue it; that is, they escalate commitment to the project. We perform two experiments to investigate the efficacy of a potential control mechanism, third-party consultation, in preventing managerial escalation of commitment. We hypothesize that the information-processing objective (i.e., purpose) assigned to consultants influences the mental representations they construct to process and store information, which ultimately influences their recommendations regarding the continuation of a poorly performing project. Results suggest that consultants will not construct mental representations amenable to making high-quality project-continuation recommendations unless they are assigned that specific purpose. Results further suggest that applying additional effort likely will not overcome the adverse effects of having inappropriate mental representations when making project-continuation recommendations. An implication of our study is that third-party consultants likely will not prevent managerial escalation of commitment unless consultants have a specific mandate of making a project-continuation recommendation in mind when they encounter relevant accounting information.

escalation of commitment, mental representations, justification, accountability

Abstract:
Prior research indicates that audit and tax professionals' judgments are influenced by their client's preferences, both directly and indirectly (via information search). In an experiment with tax professionals as participants, we examine whether high practice risk (i.e., exposure to monetary and nonmonetary costs of making inappropriate recommendations) mitigates these effects. We find that, when facing a client with low practice risk, professionals' search is biased in a manner that leads judgments to be consistent with client preference; however, search is less biased when facing a client with high practice risk, and resulting judgments are less consistent with client preference. We also find that, after controlling for the impact of information search, professionals tend to adjust their recommendations away from the client-preferred position, regardless of practice risk. This study sheds light on the direct and indirect paths by which client preference and practice risk affect professionals' judgments.

Confirmation bias, information search, practice risk, path analysis

Abstract:
Audit and tax professionals tend to make judgments consistent with their client's preference, even when that preference is aggressive. Client preference affects judgments directly and indirectly, via information search. In particular, professionals focus their search on information that supports the client's preferred position at the expense of considering information that does not. Biased search is associated with inflated assessments of the likelihood that a client's preferred position will be supported in court and recommendations that are inappropriately aggressive (Cloyd and Spilker 1999). In an experiment with tax professionals as participants, we examine whether high practice risk (i.e., exposure to monetary and nonmonetary costs of making inappropriate recommendations) mitigates these effects. We find that when facing a client with high (versus low) practice risk, professionals perform a more balanced search and this reduces the indirect impact of client preference on judgments. We also find that after controlling for the impact of information search, client preference has a direct, negative impact on recommendations for both high and low practice risk clients, indicating that professionals adjust their recommendations away from the client-preferred position. We interpret this as a conservative reaction to increased environmental risk for all client types. This study sheds light on the direct and indirect paths by which client preference effects occur and demonstrates that high practice risk serves as a boundary condition on confirmation bias and on client preference effects.

Confirmation bias, information search, practice risk, path analysis

Abstract:
This paper reports the results of an experiment that examines how analyst forecast accuracy (i.e., how close an analyst's forecast is to realized earnings) and forecast boldness (i.e. how far the analyst's forecast is from the consensus forecast) affect the analyst’s perceived credibility and investors' willingness to rely on and purchase the analyst's future reports. We hypothesize and find that forecast boldness generally magnifies the effect of forecast accuracy on these variables. That is, analysts who provide accurate, bold forecasts generally experience more positive consequences than those who provide accurate, non-bold forecasts, and analysts who provide inaccurate, bold forecasts experience more negative consequences than those who provide inaccurate, non-bold forecasts. We also find that these effects are not symmetric - the negative consequences of being bold and inaccurate exceed the positive consequences of being bold and accurate. This asymmetry helps explain why analysts are hesitant to deviate from the consensus forecast (i.e., why analysts herd).

Financial analysts, Herding, Credibility, Attribution

Abstract:
Previous research demonstrates that auditors' directional goals influence their reporting decisions. For example, when auditors have goals of accepting client-preferred accounting methods, they tend to exploit ambiguity in reporting standards to justify those methods, even when they are aggressive (Hackenbrack and Nelson 1996). We report an experimental investigation of the likely effectiveness of regulation designed to curb this tendency. Specifically, regulators suggest that having auditors identify benchmarks or assess the quality of various methods will "raise the bar" for method acceptability, thereby reducing auditor acceptance of aggressive reporting methods. However, this reasoning ignores the fact that ambiguity typically surrounds quality assessment. Following motivated reasoning theory, we argue that, in order to meet the increased standard for acceptability, auditors with high commitment to directional goals will exploit the ambiguity surrounding the quality of various methods when making quality assessments, with the result that the client-preferred method will be deemed best, or at least of high enough relative quality to be used. This theory suggests that auditor acceptance will increase with goal commitment, and that the increase will be most dramatic when quality assessment is performed. Results of our experiment support our hypotheses that performing a quality assessment amplifies the effects of auditors' directional goals on their acceptance of a client-preferred method and on their ratings of the quality of that method. Moreover, auditors making quality assessments are more likely to identify the client's method as the most appropriate method when they are more committed to their directional goals. An implication of our theory and results is that regulation (such as SAS No. 90) that requires auditors to make quality assessments may decrease auditors' objectivity when auditors have directional goals to accept client methods.

objectivity, motivated reasoning, financial reporting, earnings quality

Abstract:
Prior research indicates that individuals acting as jurors experience outcome effects in audit negligence litigation. That is, jurors evaluate auditors more harshly in light of negative outcomes, even when audit quality is constant. I posit that outcome effects in this setting are caused by jurors using their negative affect (i.e., feelings) resulting from learning about negative audit outcomes as information relevant to auditor blameworthiness. I tested this hypothesis in an experiment in which I manipulated audit quality, outcome information and provision of an attribution instruction. The attribution instruction was designed to discredit negative affect as a cue to auditor blameworthiness. Consistent with expectations, attribution participants' evaluations of auditors exhibited less reliance on outcome information and more reliance on audit quality information than did evaluations made by control participants. In fact, outcome effects were eliminated for attribution participants. Courts may be able to improve the quality of jurors' decisions in such cases by employing an attribution instruction.

Audit litigation; Audit quality; Outcome effect; Affect as information

Abstract:
This study investigates whether providing higher quality audits increases auditors' chances of avoiding legal liability. Negligence rules hold auditors responsible for plaintiff losses only when the quality of the audit provided fails to meet standards of care. The results of my experiment suggest that the ex post observed consequences of audit failure can affect the standards of care to which jurors hold auditors. Specifically, participants serving in the role of jurors assessed higher standards of care for auditors when the consequences of audit failure were more severe. Furthermore, when the consequences of audit failure were more severe, participants' evaluations of the auditor did not depend on the quality of the audit provided-auditors who provided higher quality audits were evaluated just as negatively as those who provided lower quality audits. In contrast, when audit failure led to only moderately negative consequences, auditors who provided higher quality audits received more favorable evaluations. These results suggest that providing higher quality audits will not necessarily protect auditors from legal liability when the consequences of audit failure are severe.