BEHAVIORAL RESEARCH IN MANAGERIAL ACCOUNTING RANJANI KRISHNAN HARVARD BUSINESS SCHOOL & MICHIGAN STATE UNIVERSITY 2008

WHAT IS PSYCHOLOGY? Birnberg, Luft and Shields (2007) Psychology is the science of the human mind and behavior – Mind: Attention, memory, comprehension, learning, judgments, decisions, motivation – Behavior: Action, communication Distinctive features of psychology are its focus on – Individual rather than organizational or social behavior – Subjective phenomena such as mental representations, rather than objective phenomena like market prices or organizational size

SUBJECTIVE REPRESENTATIONS OF OBJECTIVE PHENOMENA Behavior depends on individuals mental representations, which can differ in important ways from objective indicators. Effects of MA practice on individuals behavior can depend not only on how objectively informative the MA practice is about factors that affect their welfare but also on how understandable the MA practice is – how well individuals can form usable mental representations of it and connect it to their other mental representations and how it stimulates individuals attention, cognition, and/or motivation

SUBFIELDS OF PSYCHOLOGY IN MA RESEARCH Cognitive: Psychological processes that influence human thinking – Attention, memory, comprehension, learning, judgments, decisions Motivation: Psychological processes that influence behavior – Direction, intensity, and persistence of effort Social: How other people influence individuals minds and behavior – Understanding people (attribution, person impression, social cognition), attitudes and social influence, social interaction and relationships

USE OF PSYCHOLOGY THEORY IN MA RESEARCH Primary use has been to explain effects of MA practice on individuals minds and behavior – Much less research on how individuals minds and behavior influence MA practice

Example : GOAL SETTING THEORY Primary findings in psychology literature Performance is a positive function of goal difficulty Specific goals reduce variation in performance Incentives indirectly influence performance via its effect on goal commitment Goal-performance relation is influenced by goal commitment, goal importance, feedback, task complexity, self-efficacy HIRST AND YETTON (1999) Budget goal specificity increases the level of performance and decreases the variance in performance HANNAN, KRISHNAN, NEWMAN (2008) Disordinal interaction between incentive scheme (tournament/piece rate), which influences the goal, and the precision of feedback

Example : ORGANIZATIONAL JUSTICE THEORY Individuals are motivated to maintain a balance in exchange relations by comparing their and others ratio of inputs to outcomes (e.g., pay) – If individuals believe their ratio is inequitable, then they experience negative emotions, which they minimize by changing their inputs and/or outcomes Fairness beliefs can be about – Distributive justice = fair allocation of outcomes – Procedural justice = fair process used to allocate outcomes LIBBY (2001) Under imposed budgeting, performance is lower only when both budgeting and the budget goal are believed to be unfair

Example : SOCIAL PSYCHOLOGY THEORIES How individuals minds and behavior are influenced by other people – Understanding people – Attribution, person impression, social cognition – Attitudes and social influence – Social interaction and relationships – FREDERICKSON (1992): Individuals have higher effort level when compensation is based on relative performance evaluation compared to profit sharing

Example : SOCIAL IDENTITY THEORY Assumes individuals categorize their social world into in- & out-groups and get self- esteem from their identity as a member of an in-group TOWRY (2003) When team identity is strong, members behave cooperatively but directional effect of cooperation on effort depends on monitoring and incentive system

Example : RELATIONAL FRAMING Assumes individuals motivation depends on how they understand their social situation or how their social situation is framed ROWE, BIRNBERG AND SHIELDS (2008): Boundaries of responsibility centers can structure managers as being in the same or different centers, which motivates them to have cooperative or competitive behavior

COGNITIVE PSYCHOLOGY Cognition consists of mental processes and states Processes: Attention, memory, comprehension, learning, judging, deciding States: Attitudes, beliefs, knowledge, preferences Assumes cognition is boundedly rational How and how well individuals make judgments and decisions Judgment: comparison of a stimulus to another stimulus or evaluation of a stimulus in relation to a standard Decision: choice of a stimulus from a set of stimuli

TWO THEORETICAL PERSPECTIVES 1.Behavioral decision theory Use optimizing models from economics and statistics as benchmarks to assess how and how well individuals typically make judgments and decisions 2.Judgment and decision performance Identifying sources of variation in how and how well individuals make specific judgments and decisions – Ability, knowledge, motivation

PROBABILISTIC JUDGMENT: HEURISTICS AND BIASES Individuals use heuristics, which can result in biased judgments from those implied by optimizing models LUFT (1994): Individuals choice of incentive contract depends on how payoffs are framed: While expected pay is the same, individuals prefer incentive contract framed as bonus because penalties (losses) are more aversive than missed bonuses (reduced gains)

JUDGMENT AND DECISION PERFORMANCE How psychological variables affect how and how well individuals make specific judgments and decisions Cognitive ability, knowledge, motivation – Vera-Muñoz (1998): When making a resource- allocation decision in a business context, as individuals financial accounting knowledge increases, they ignore more opportunity costs

KNOWLEDGE: MENTAL MODELS Subjective representations of systems of causal relations that support judgments and decisions Differ from formal scientific models: Qualitative, incomplete, substitute variables in formal model Basis to predict how judgments and decisions will differ from outputs of optimizing models KRISHNAN, LUFT AND SHIELDS (2005): In making performance-measure weighting decisions for incentive compensation, most individuals use PMs precision, but whether they are used as predicted by agency theory depends on their mental models

CONCLUSION What has been learned from using psychology theory in MA research? Numerous cognitive, motivational and social psychology theories have been used What has been learned can be summarized by a limited number of themes, grouped as motivational and informational effects of MA practices What are implications for research?

MOTIVATIONAL EFFECTS Motivation is influenced by performance relative to a reference point (e.g., budget, prior performance, others pay), not absolute performance Individuals are less motivated to achieve an outcome if it is beyond their reference point Reference points can be influenced by MA practices

INFORMATIONAL EFFECTS OF MA PRACTICES Influence attention by affecting salience of information Influence how information is mentally represented and linked with other information in memory Influence heuristic information search and use Influence on the bias of heuristic judgments

FUTURE RESEARCH Integrating psychology theories with theories from other theoretical perspectives such as economics or sociology.