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Abstract:
The AICPA's Special Committee on Financial Reporting has urged disclosure of relevant forward-looking and non-financial information to supplement conventional financial statements. We conduct an experiment consisting of 20 laboratory security markets with eight participants each to assess the effects of such disclosures on capital allocation decisions. We observe four markets in each of five accounting information conditions: a baseline condition with an income statement and balance sheet only and four conditions that combine this baseline with supplemental disclosures of proved reserves (a best estimate), total reserves (an upper bound), and minimum reserves (a lower bound). We find first that proved reserve disclosures improve capital allocation decisions, even though these disclosures are redundant with information in the primary financial statements. Second, disclosures of the upper bound (total reserves) in the absence of lower bound (minimum reserves) has the potential to bias security prices upwards, while disclosures of both total and minimum reserves remove this bias. Third, a comparison of individual price predictions to actual market prices reveals both a systematic prediction error and a differential effect of supplemental disclosures on security prices, suggesting that experimental investigations of capital allocation decisions should include market settings. The paper concludes with a discussion of implications for accounting standard setters.

Abstract:
Evidence from an interactive experiment indicates that the tendency of users to anchor on one-sided disclosures of risk (i.e., disclosing upside potential or downside risk, but not both) is robust to whether disclosures are determined randomly or chosen strategically by opportunistic agents with known preferences for higher valuations. This study therefore addresses qualifications in prior research about the generalizability of cognitive disclosure phenomena to a strategic disclosure environment. One implication supported by the data is that if cognitive biases such as the anchoring effect for one-sided risk disclosures are robust to a strategic environment, strategic agents can capitalize on these biases, extending the menu of strategic opportunities beyond those typically considered in economic models of disclosure.

risk, strategic disclosure, anchoring

Abstract:
We design an experiment to examine the influence of prior audit experience on subsequent reporting decisions when auditors become managers of audited firms. In contrast to the independence issues that can arise when auditors and their clients are related by prior affiliation, we focus this study on the more common case in which auditors assume subsequent employment with other firms' clients. In a bi-matrix experimental game that captures key features of the tension between auditors and reporters, we find that reporters who have experience as an auditor are more sensitive to large penalties for misreporting than are reporters who have the same amount of experience exclusively in the reporter role. This finding is particularly strong among reporters who were relatively diligent in their former role as auditors. These results suggest implications for regulators in predicting the effects of changes in the consequences of aggressive reporting behavior, and for firms in deciding whether to employ individuals who have CPA experience in positions with corporate reporting responsibility.

Experiments, reporting, auditing, experience, own-payoff effect

Abstract:
We examine how worker productivity differs when compensation is based on quantity, creativity, or the product of both measures. In an experiment in which participants design rebus puzzles, we find that combining quantity and creativity measures in a creativity-weighted pay scheme results in creativity-weighted productivity scores that are significantly lower than those generated by participants with quantity incentives alone. Follow up analysis indicates that relative to participants in the quantity-only condition, participants in the creativity-weighted condition produce approximately the same number of high-creativity puzzles, but produce significantly fewer puzzles overall. Thus, while participants rewarded for creativity-weighted output tend to restrict their production to high-creativity efforts, they are unable to translate this focus into a greater volume of high-creativity output. Implications address a possible explanation for firms' reluctance to incorporate creativity measures within multi dimensional performance measurement systems, notwithstanding published suggestions to do so.

managerial accounting, incentives, creativity

Abstract:
We examine how worker productivity differs when performance-based compensation is based on measures of quantity, creativity, or the product of both measures. In an experimental task in which participants design rebus puzzles, we find that quantity-based compensation increases the number of puzzles produced, and that creativity-based compensation improves average creativity ratings, as evaluated by an independent panel of raters. However, a weighted compensation scheme that rewards the product of quantity and average creativity ratings results in weighted productivity scores that are significantly lower than those generated by participants with quantity incentives alone. Follow-up analysis indicates that relative to participants compensated solely for quantity, participants in the weighted condition produce approximately the same number of high-creativity puzzles, but produce significantly fewer puzzles of mediocre creativity. This finding is consistent with the premise that participants rewarded for creativity-weighted output simplify their objective by restricting their production to high-creativity ideas, but are unable to translate this focus into a greater volume of high-creativity output. Implications address a possible explanation for why firms are reluctant to incorporate creativity measures within multi dimensional performance measurement systems, notwithstanding published suggestions to do so.

managerial accounting, incentives, creativity

Abstract:
We replicate an influential study of monetary incentive effects by Jamal and Sunder (1991) to illustrate the difficulties of drawing causal inferences from a treatment manipulation when other features of the experimental design vary simultaneously. We first show that the Jamal and Sunder (1991) conclusions hinge on one of their laboratory market sessions, conducted only within their fixed-pay condition, that is characterized by a thin market and asymmetric supply and demand curves. When we replicate this structure multiple times under both fixed pay and pay tied to performance, our findings do not support Jamal and Sunder's (1991) conclusion about the incremental effects of performance-based compensation, suggesting that other features varied in that study likely account for their observed difference. Our ceteris paribus replication leaves us unable to offer any generalized conclusions about the effects of monetary incentives in other market structures, but the broader point is to illustrate that experimental designs that attempt to generalize effects by varying multiple features simultaneously can jeopardize the ability to draw causal inferences about the primary treatment manipulation.

experimental design, monetary incentives, market power

Abstract:
Using an experiment in which participants design rebus puzzles, we extend recent research on creativity-weighted productivity (i.e., quantity weighted by creativity ratings) by allowing participants to choose between a contract that rewards creativity-weighted productivity or one that rewards quantity only. As such, we examine both of the factors that agency theory suggests can arise from contingent compensation: (1) influencing effort (to address the moral-hazard problem of hidden action) and (2) attracting ability (to address the adverse-selection problem of hidden information). We find that participants who choose a creativity-weighted pay scheme have greater self-perceived creativity than those who choose a quantity-only scheme, and that this perceived creativity advantage manifests itself in significantly higher creativity-weighted productivity scores in initial production. For production as a whole, however, we observe a different pattern. Namely, whether compensation contracts are randomly assigned or self-selected, participants operating under a quantity-only scheme eventually produce just as many high-creativity puzzles as their creativity-weighted counterparts, and also produce significantly more puzzles overall. Thus, the implications of contract selection on creativity-weighted productivity hinge on the importance of the head start attained by participants who self-select a creativity-weighted contract.

Creativity, incentives, contingent compensation, multi-dimensional performance measurement, adverse selection

Abstract:
Questionnaire responses reported by Luft and Libby (1997) reveal that transfer price negotiators expect fairness-based price concessions that moderate the influence of an outside market price when the outside market price strongly favors one of the parties. We examine whether these expectations of fairness extend to the actual prices that result from real-cash negotiations. Findings indicate that expectations of fairness-based price concessions do not survive actual negotiations when participants negotiate over a computer network with no communication other than bids, asks, and acceptances. Conversely, both expectations and actual negotiated outcomes reflect fairness-based price concessions when participants negotiate in a face-to-face setting with unrestricted communication. Together, these results imply that the extent to which questionnaire-based judgments of social behavior generalize to actual behavior depends on the whether the competitive environment suppresses or reinforces the social presence necessary to sustain phenomena such as preferences for fairness.

Transfer pricing; Fairness; Negotiation

Abstract:
The AICPA Special Committee on Financial Reporting has urged disclosure of relevant forward-looking information on risks and opportunities to supplement conventional financial statements. We conduct a laboratory market experiment to assess the effects of such disclosures on capital allocation decisions. We develop two sets of competing hypotheses regarding how capital markets react to supplemental disclosures. One set is based on the assumption of semi-strong market efficiency, while the other posits that the bounded rationality of individual traders leads to inefficient market prices. We find that explicit disclosure of management's best estimate of an uncertain quantity improves market efficiency, even though this disclosure is redundant with information in financial statements. Second, we find disclosure of an upper bound of management's estimate has the potential to bias security prices upward, while informationally equivalent disclosure of both upper and lower bounds removes this bias. These results suggest that experimental market reactions to these supplemental disclosures are inconsistent with market efficiency. Supplemental analyses of individuals' price predictions and trading behavior support our conclusion that inefficiencies are at least partially attributable to individual information processing biases.

Abstract:
Taxpayers remit through withholding and estimated tax payments substantially more than the amounts assessed upon filing of returns. Some excess payments may reflect involuntary institutional features (e.g., default withholding rules), but there may also be voluntary excess remittances reflecting taxpayer preferences. Our study uses a case-based experiment administered to 162 work-experienced MBA student volunteers to investigate such preferences in an environment stripped of transaction costs and sources of confusion regarding minimum payment provisions. In addition, we use a factorial design to explore the sensitivity of taxpayer interim payment preferences to tax policy considerations involving uncertainty, payment form, and experience.

We present three related arguments for why taxpayers might prefer interim payment patterns that violate strict adherence to the time value of money. First, if taxpayers adopt a reference point of covering the end-of-year tax bill with their interim payments, the alternative of delaying payment in order to receive a larger sum now may be perceived as an unattractive prospect (Shelley 1993; Loewenstein 1988). Second, the dread phenomenon may explain why people often express preferences to get a negative outcome over with rather than anticipate its future occurrence (Loewenstein and Thaler 1992; Loewenstein 1987). Finally, taxpayers may view excess interim payments as a form of forced savings, anticipating their limited self-control (Shefrin and Thaler 1992; Thaler and Shefrin 1981; Schelling 1984). All three arguments offer consistent predictions in our setting, offering theoretical reasons why policy makers should consider taxpayers' preferences when formulating policies involving interim tax remittances.

The experiment involved asking participants to indicate desired quarterly tax remittances for a hypothetical case in which a taxpayer expected $16,000 of tax on an annual income of $80,000. We manipulated the uncertainty associated with the end-of-year tax liability by adding a description of the annual tax liability in a worst-case scenario. The form of payment was either withholding from wages or estimated tax installments. We also assessed the effects of self-reported taxpaying experience on taxpayer preferences. In all treatment conditions, case information indicated a minimum quarterly payment that would avoid any underpayment penalty (based on the prior-year tax liability). Participants basing decisions strictly on the time value of money would prefer to remit only this minimum amount in each of our treatment conditions.

We find that 43 percent of the participants indicate a preference to pay more tax on an interim basis than the minimum necessary to avoid an underpayment penalty. Because participants are screened for case comprehension, we interpret this frequency as reflecting genuine preferences, not ignorance or confusion. We also find that participants' overpayment preferences are significantly more pronounced in cases where the current-year tax liability is more uncertain. This effect is different from risk aversion, because even the most risk averse taxpayer would be better off economically by paying the minimum possible to the government and investing any desired provision for taxes in a risk-free account. In contrast to the effect of uncertainty, we find that preferences for overpayment are robust to whether the payment form is withholding from wages or estimated tax installments. Finally, we find that taxpayer experience mitigates the general propensity to overpay and also mutes the influence of uncertainty.

Abstract:
Towards the goal of merging psychological and economic insights in accounting experimentation, we categorize four ways that contextual richness in experimental materials can affect decisions. First, INFORMATION EFFECTS occur when context provides enhanced or clearer cues. Second, SALIENCE EFFECTS capture the potential for context to highlight certain cues over others. Third, MOTIVATION EFFECTS reflect the ability of context to reinforce the consequences of a decision. Fourth, MEMORY-CODING effects capture the interaction between context and the setting-specific expertise of the decision-maker. Several examples from the accounting literature are provided for each category, including studies that vary contextual richness as a separate treatment factor. Attuning to these sources of contextual sensitivity can help the accounting experimentalist to choose a level of contextual richness that is grounded more in case-specific theory than in the methodological dogma of either cognitive psychology or experimental economics.