09 Behavioral Research

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    How Following Regulatory Guidance Can Increase Auditors’ Litigation Risk Exposure
    ( 2018-09-01) Joe, Jennifer ; Sanderson, Kerri-Ann ; Luippold, Benjamin
    This study investigates how following explicit regulatory guidance can result, unintentionally, in increased litigation risk exposure for auditors. We do so by examining the unique and specific context where the PCAOB directly instructs auditors how to apply professional judgment - to rely on a client’s competent and objective internal audit function (IAF) during multi-location audits. Consistent with theoretical predictions based on numerosity heuristic processing and norm theory, we find that holding all other factors constant, following explicit regulatory advice not only fails to limit auditors’ litigation risk but can actually increase jurors’ assessments of auditor negligence. Because the numerosity heuristic leads jurors to believe that there is a higher likelihood of misstatement on multi-location compared to single location audits, jurors perceive that auditor reliance on the IAF during multi-location audits is not normal. Accordingly, they judge auditors to be more negligent when they rely on the IAF in multi-location audits than when they do not, but IAF reliance does not impact negligence assessments on single location audits. Our results suggest auditor reluctance to use a qualified IAF, despite client and regulatory pressure, can be a rational and defensible strategy to limit their litigation risk exposure.
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    The Joint Effect of Narrative Structure, Medium Interactivity, and Readability on Investors' Investment Decisions
    ( 2018-08-29) Xu, Tu
    We conduct an experiment to investigate how narrative structure (the extent to which good news is dispersed), the interactivity of disclosure medium (interactive versus non-interactive), and readability (high versus low) jointly influence investors’ investment decisions. We find that a disclosure with good news that is more dispersed leads to a higher investment amount. This narrative-structure effect is evident when a disclosure is easy to read and non-interactive or when it is hard to read and interactive. This effect disappears when a disclosure is hard to read and non-interactive or when it is easy to read and interactive. Our study extends accounting literature by showing how interactivity and readability moderate the narrative- structure effect and how readability moderates the interactivity effect. Our findings suggest that managers’ discretions over narrative structure should be constrained and that high readability is essential for interactivity to benefit investors.
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    Does Employee Substance Abuse Predict Fraud?
    ( 2018-08-29) Millar, Melanie ; White, Roger ; Zheng, Xin
    Motivated by survey evidence, we examine the relation between worker substance abuse and workplace fraud. In our sample of white-collar professionals, nearly 10% of all frauds occur in the 0.01% of worker-years where the worker receives a professional sanction for substance abuse. Workers receiving such a sanction are between 40 and 50 times more likely to commit fraud in the current year relative to their peers. These results are consistent with prior research suggesting that substance abuse creates financial pressures and impairs neural functioning of self-regulatory mechanisms, both of which make fraud more appealing. We also find that there is no increased likelihood to commit fraud among workers with past or future substance abuse sanctions. This suggests that (1) workers with past but not current substance problems are not a fraud risk, and (2) the results we observe are driven by actual substance abuse, as opposed to stable personality traits predictive of both fraud and substance abuse. This study has implications for employers and policymakers as they consider both how to prevent fraud and how to reduce the negative impact of substance abuse in the workplace through internal control systems and practices like Employee Assistance Programs.
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    Psychophysiological Responses to Data Visualization and Visualization Effects on Auditors’ Judgments and Audit Quality
    ( 2018-08-29) Rose, Anna M. ; Rose, Jacob M. ; Rotaru, Kristian ; Sanderson, Kerri-Ann ; Thibodeau, Jay C.
    We conduct experiments with practicing Big 4 auditors and business students in order to investigate the psychophysiological responses to Big Data visualizations and the effects of different visualization techniques on auditor judgment and ultimately audit quality. More specifically, the first experiment with students examines whether visualizations can be designed to increase the level of a users’ arousal. Such increases in arousal have the capacity to yield significant benefits to the audit profession by drawing auditors’ attention to important patterns in data and promoting the evaluation of these patterns during evidence evaluation. Results of the first experiment using cognitive pupillometry and eye gaze measurement indicate that different visualization techniques produce significant differences in the level of arousal without interfering with information evaluation efficiency. The second experiment then investigates whether visualizations that were shown to promote higher and lower levels of arousal have differential effects on auditor judgments and audit quality. In addition, the second experiment investigates whether the reliability of the data sources underlying visualizations affect auditors’ judgments. Results from the second experiment indicate that visualizations that increase arousal enhance auditors’ ability to recognize disconfirming evidence and incorporate this evidence into their decisions. That is, auditors who view visualizations of disconfirming evidence that are designed to promote arousal recommend greater reductions to management estimates of reported revenue and increase their budgeted audit hours more than auditors who view visualizations that promote less arousal. In addition, auditors who view visualizations that increase arousal are more likely to attend to the reliability of data used to create the visualizations. Overall, the experiments reveal that understanding the root causes of different visualization techniques on arousal and auditor judgment present multiple opportunities to enhance audit quality.
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    The Accrual Anomaly: Accrual Originations, Accrual Reversals, and Resolution of Uncertainty
    ( 2018-05-02) Fedyk, Tatiana ; Singer, Zvi ; Sougiannis,Theodore
    We combine a fundamental property of accruals and a behavioral phenomenon to provide an explanation for the accrual anomaly. The fundamental property is: accruals that originate must subsequently reverse. The behavioral phenomenon is: individuals tend to underestimate the variance of noisy signals in various domains of decision-making. We argue that originating accruals represent a noisier signal than reversing accruals because the uncertainty of whether originating accruals will eventually convert into cash is high, while there is no uncertainty regarding reversing accruals. If investors underestimate the variance of originating accruals but understand reversing accruals, then originating accruals will be mispriced while reversing accruals will not. To test this prediction, we first develop and empirically validate a novel method for ex-ante detecting accrual originations and their reversals. Then we document that investors face increased uncertainty when accruals originate and decreased uncertainty when accruals reverse, and we provide evidence that only originating accruals are mispriced. We further demonstrate that our findings can be useful for improving the accrual-based trading strategy by ex-ante detecting and removing accrual reversals from extreme accrual portfolios. Overall, we provide a behavioral explanation for the accrual anomaly that is consistent with the mispricing of originating accruals only.