Chandra Kanodia

Escalation Errors And The Sunk Cost Effect - An Explanation Based On Reputation And Information Asymmetries

This paper is concerned with explaining a paradox of human behavior. Consider the following example. A department manager makes a large investment in new production equipment and, soon after, learns of different equipment that could perform the same operations at lower cost. Incremental analysis favors switching, but the manager refuses saying he does not want to waste the investment already made. Such real-world examples have been extensively documented and studied by social scientists (see Thaler [1980] and Staw [1981]). In these examples, the decision maker, having commited to a course of action, subsequently discovers new information that indicates that continuing the earlier commitment would likely result in worse consequences than switching. In spite of this he clings to and even escalates his earlier

A Real Effects Perspective to Accounting Measurement and Disclosure: Implications and Insights for Future Research

Accounting measurement and disclosure rules have a significant impact on the real decisions that firms make. In this essay, we provide an analytical framework to illustrate how such real effects arise. Using this framework, we examine three specific measurement issues that remain controversial: (1) How does the measurement of investments affect a firms investment efficiency? (2) How does the measurement and disclosure of a firms derivative transactions affect a firms choice of intrinsic risk exposures, risk management strategy, and the incentive to speculate? (3) How could marking-to-market the asset portfolios of financial institutions generate procyclical real effects? We draw upon these real effects studies to generate sharper and novel insights that we believe are useful not only for the development of accounting standards, but also for guiding future empirical research.

Risk Sharing And Transfer Price Systems Under Uncertainty

The objectives of decentralization in business organizations through the creation of profit centers are most likely to be achieved when the managers of various profit centers acting in their own self-interest also maximize central managements preferences. In a world of certainty, this ideal trivially holds when there are no interactions between the various decision centers (i.e., when there are no flows of goods and services between decision centers and no cost or demand interdependencies). In such a situation, each division can be given free rein to pursue its own policies and maximize its own profits without concern for the policies adopted by other divisions. Frequently, however, decentralization is carried to a point where goods or services flow between profit centers. Here, there is a need for coordinating the decisions of the various divisions in the overall interests of the firm. Hirshleifer [1956] characterizes a system of transfer prices that achieves this coordination. The Hirshleifer analysis assumes that divisional decisions are made in an environment of certainty. The objective of this paper is to extend the Hirshleifer analysis to uncertain environments. The introduction of uncertainty considerably complicates the coordination problem because of differences in risk aversion both locally, among divisional managers, and between divisional managers and the central authority. Risk-sharing possibilities arise and Pareto optimality becomes an issue. This paper characterizes and analyzes several transfer price systems, in terms of such issues, but does not formulate mechanisms for achieving them. The

Assessing the Information Content of Mark-to-Market Accounting with Mixed Attributes: The Case of Cash Flow Hedges

We examine how outsiders rationally interpret a reported loss on derivatives when the application of mark-to-market accounting to cash flow hedges creates a mixed attribute problem. We find that because of the mixed attribute problem, the information content of mark-to-market accounting is related to the information content of historical cost accounting in a very specific way. This relationship allows us to identify the circumstances under which mark-to-market accounting facilitates and when it detracts from the objective of providing an early warning of potential financial distress. We show that the reporting of an impending derivative loss by a distressed firm can actually lead outsiders to infer that the firm is in a better financial position than what they would have inferred under the silence associated with historical cost accounting. Without the mixed attribute problem, mark-to-market accounting would always yield more accurate assessments of the firms financial position.

Does Information Transparency Decrease Coordination Failure

This study experimentally tests the effect of information transparency on the probability of coordination failure in global games with finite signals. Prior theory has shown that in global games with unique equilibrium, the effect of information transparency is ambiguous. We find that in global games where the signal space is finite, increased transparency has two effects. First, increasing the level of transparency usually destroys uniqueness and precipitates multiple equilibria, so that the effect of transparency on coordination depends crucially upon which equilibrium is actually attained. Second, the level of transparency determines which of these equilibria is risk dominant. We find that increased transparency facilitates coordination only if it switches the risk-dominant equilibrium from the secure equilibrium to the efficient equilibrium. When the converse is true, improved transparency can be dysfunctional because it increases the probability of coordination failure.

Game Theory Models in Accounting

Accounting from a game-theoretic view posits that accounting data affects, and is affected by, strategic interaction within and across firms. This view holds that the accounting process alters the strategic interaction among agents, by impinging on their incentives and on the contracts they make to constrain their behavior.

Discussion of Models in Managerial Accounting

Anyone attempting a review and critique of past research in managerial accounting would be forced to paint with a broad brush. There has been such a variety of papers with little or no connecting links that synthesis and discernment of direction are hopeless tasks. These facts are reflected in the Demski and Kreps (DK) survey, but it is difficult to fault the authors in this regard. Given this state of affairs, a discussion of a review paper runs a substantial risk of being trivial. Rather than face this risk by commenting on DKs comments, I prefer to add some direction and substance of my own. I shall attempt to narrow the scope of managerial accounting and discuss research issues in the light of this narrower scope. I do this in the hope that if problems are approached from a common perspective, we can build a body of knowledge that hangs together and can be identified as a theory. There are three elements in the DK paper. First, the paper presents a classification scheme for classifying research in managerial accounting. Second, it contains a loose survey and critique of past research. Last, the authors offer some speculations on future research directions. I would like to add to the DK paper by elaborating on this last element. In particular I shall describe in some detail some specific research issues which appear promising to me. Before I do this I would like to comment briefly on the first two elements of the DK paper, since they provide a useful perspective for a discussion of research in managerial accounting. The classification scheme used by DK corresponds to the twin objectives of managerial accounting commonly acknowledged by textbook writers in this field. Managerial Accounting is an information system that provides information useful for two purposes: (i) facilitating operating decisions, and (ii) evaluation and control of subordinate managers and