Accuracy in Judging the Nonlinear Effects of Cost and Profit Drivers

Posted: 12 Jul 2007

See all articles by Anne M. Farrell

Anne M. Farrell

Miami University Farmer School of Business - Department of Accountancy

Joan L. Luft

Michigan State University - Department of Accounting & Information Systems

Michael D. Shields

Michigan State University - Department of Accounting & Information Systems

Abstract

Managers often make judgments about cost-driver and profit-driver relations using subjective analysis rather than statistical analysis of accounting data. We provide theory-consistent experiment evidence that, even when the strength and temporal contiguity of the relation between financial performance and its driver are held constant, the prediction task is relatively simple, and individuals have relevant training and experience, individuals' differing mental representations of the cost-driver and profit-driver relations result in significantly different judgment accuracy. In the experimental setting in this study, judgment accuracy is higher when performance is measured as cost rather than profit. Judgment accuracy tends to be higher for more direct relations, and individuals mentally represent the cost-driver relation in the experimental task as a more direct causal chain than the profit-driver relation. We present supplementary evidence supporting the theory that accounting prompts individuals to adopt cause-and-effect mental representations of varying directness between performance measures, rather than attending only to the sign and strength of the relation. Thus, an important consideration in the choice of performance measures should be cognitive properties as well as statistical properties of the measures - in particular, the directness of the cause-and-effect mental representation that the performance measures prompt.

Keywords: Performance measurement, Judgment performance, Causal relations, Nonlinearity

JEL Classification: D83, D84, M10, M40, M46

Suggested Citation

Farrell, Anne M. and Luft, Joan and Shields, Michael D., Accuracy in Judging the Nonlinear Effects of Cost and Profit Drivers. Contemporary Accounting Research, Vol. 24, No. 4, 2007. Available at SSRN: https://ssrn.com/abstract=999971

Anne M. Farrell (Contact Author)

Miami University Farmer School of Business - Department of Accountancy ( email )

800 East High Street
3094 Department of Accountancy / MSC 1002
Oxford, OH 45056
United States

Joan Luft

Michigan State University - Department of Accounting & Information Systems ( email )

270 North Business Complex
East Lansing, MI 48824-1034
United States
517-432-2917 (Phone)
517-432-1101 (Fax)

Michael D. Shields

Michigan State University - Department of Accounting & Information Systems ( email )

270 North Business Complex
East Lansing, MI 48824-1034
United States

Register to save articles to
your library

Register

Paper statistics

Abstract Views
992
PlumX Metrics