Donald V. Moser

Bonus versus Penalty: Does Contract Frame Affect Employee Effort?

We conducted an experiment in which participants acted as employees under either a bonus contract or an economically equivalent penalty contract. We measured participants’ contract preference, their degree of expected disappointment about having to pay the penalty or not receiving the bonus, their perceived fairness of their contract, and their effort level. Consistent with Luft (1994), we find that employees generally preferred the bonus contract to the penalty contract. We extend Luftŕss work by demonstrating that loss aversion caused employees to expend more effort under the penalty contract than under the economically equivalent bonus contract. That is, employees were more averse to having to pay the penalty than they were to not receiving the bonus, and consequently they chose a higher level of effort under the penalty contract to avoid paying the penalty. However, we also find evidence of reciprocity in that employees who considered their contract to be fairer chose a higher level of effort. Because our participants generally considered the bonus contract fairer than the penalty contract, reciprocity predicts higher effort under the bonus contract, a result opposite to our finding. Our overall result that employee effort was greater under the penalty contract is explained by the fact that, while higher perceived fairness did increase effort, this effect was dominated by the more powerful opposing effect of loss aversion. We discuss the implications of these results for explaining why in practice most actual contracts are bonus contracts rather than penalty contracts.

The Effects of Biases in Probability Judgments on Market Prices

Experimental Markets were used to examine whether individual probability judgment biases affect market prices. This issue is important to accountants because users of accounting information (especially investors) face competitive market environments. The expectation was that it would be more difficult for prices to be unbiased in markets where biased traders had the highest expected payoffs than in markets where unbiased traders had the highest expected payoffs. This expectation arose from the observation that competitive forces would produce biased prices when biased traders had the highest expected payoffs unless either (1) biased traders learned to be unbiased as a result of market experience, or (2) biased traders were inactive, thus allowing unbiased traders to set prices. Consistent with expectations, prices were biased in a market where biased traders had the highest expected payoffs, with prices moving toward unbiased prices but remaining more biased than biased overall. The results of this study suggest that individual judgment biases can have a substantial effect on market prices, and, consequently, demonstrations of individual investor judgment biases should be of concern to accountants.

Do Asset Market Prices Reflect Traders' Judgment Biases?*

The existence of base rate fallacy (BRF) bias is explored employing: (i) a context treatment with a narrative story applied to asset markets and (ii) an isomorphic abstract setting using balls-and-bingo cages. Probability estimates reflect a BRF bias in both treatments, but is stronger with context. Prices track highest expected dividend values (HEDVs) with context, resulting in strongly biased prices relative to the Bayesian norm when biased traders have HEDVs. In the abstract treatment prices do not track HEDVs nearly as closely, resulting in prices closer to the BRF bias only when most traders hold biased beliefs.

The effect of constrained processing on auditors’ judgments

Abstract This study examines whether constraining experienced auditors’ processing by having them process evidence in a pre-established sequence (an experimental control technique used in previous studies) prevents them from using their usual processing strategies and thereby affects their judgments. We compare the relative attention to evidence and judgments of experienced and inexperienced auditors in a constrained versus an unconstrained processing condition. Consistent with expectations, experienced auditors’ going-concern judgments differed from inexperienced auditors’ judgments only when processing was unconstrained. This difference in judgments was the result of differential attention to evidence. These results demonstrate that the failure to consider how experienced auditors process evidence can result in inadvertently adopting control techniques that limit the generalizability of experimental findings. Although our study used a going-concern task, our conclusions are likely to apply to a variety of ill-structured audit tasks that require a goal-oriented, directed evaluation of evidence.

Managers’ Green Investment Disclosures and Investors’ Reaction

We use experimental markets to examine whether preferences for societal benefits lead managers to invest in unprofitable green projects, what information they disclose regarding such investments, and how investors react to those disclosures. We find that managers who are also shareholders in their company make green investments even when they know this reduces shareholder value, thereby decreasing their own and other current shareholders’ payoffs. Moreover, managers voluntarily disclose to potential investors that they have made such unprofitable green investments and tend to focus their disclosures on the societal benefits of their green investment rather than on the cost to the company. Finally, the cost of making a green investment that is borne by the managers and the other current investors is lower when the managers disclose their green investment because potential investors’ standardized bids for the company are higher when managers disclose their green investments than when they do not. Moreover, this result is stronger when managers’ disclosures focus on the societal benefits of their investment rather than on the cost to the company. Overall, these results are consistent with both managers and potential investors trading off personal wealth for societal benefits and help explain why, given the current voluntary reporting environment, company managers often focus their disclosures of green investments on the benefits to society and to the company rather than on the cost to the company. In addition to these specific findings, our study demonstrates the benefits of using experiments to study important corporate social responsibility issues that are difficult to address using archival data.

A similarity strategy for decisions involving sequential events

Abstract When providing users with data, accountants often must choose the proper level of aggregation. Research in accounting has shown that the level of aggregation can effect the behavior of decision makers. For example, decision makers choices between alternatives, each of which involves the occurence of two independent events, often are made on the basis of the probabilities associated with the separate events rather than a comparison of the joint probabilities as prescribed by normative theory. Most evidence from prior studies in consistent with the sequence effect hypothesis, which suggests that people prefer the alternative with the higher probability of success for the first of the two events. This study provides the first evidence that people often use a different strategy which we call the “similarity strategy” to choose between two alternatives. This strategy involves choosing the alternative for which the event probabilities are more similar (i.e. the alternative for which the difference between the probability of success for the two independent events is small relative to the other alternative). The similarity strategy applies to a much broader set of managerial accounting and investment decision settings than the choice strategies identified in previous studies. Thus, an important contribution of this study is that it expands considerably the potential scope of accounting research in the area.

Investment Professionals’ Use of Corporate Social Responsibility Disclosures

We conduct an experiment to examine investment professionals’ use of corporate social responsibility (CSR) disclosures when making personal investment decisions or investment recommendations to clients. We predict and find that investment professionals are more willing to personally invest and recommend investment to a client when a firm discloses positive CSR performance than when it makes no CSR disclosures. Investment professionals’ decisions and recommendations are influenced by CSR disclosures both because, on average, they believe that better CSR performance results in better current and longer-term financial performance and because they value the societal benefits of CSR activities. We also find that investment professionals’ general beliefs regarding whether CSR activities benefit society affect how they assess firms’ CSR performance and their view of the relation between CSR performance and financial performance. Finally, investment professionals’ experience appears to protect them from the potential biasing effect of appealing pictures that accompany many CSR disclosures.

Performance Measurement and Pay Dispersion

Prior research suggests that pay dispersion among employees can cause lower-paid employees to feel unfairly treated and thus lower their effort. Recently, some firms have reduced pay dispersion by raising lower-paid employee’s wages in an attempt to mitigate this effect. However, popular press articles suggest that reducing pay dispersion could also cause higher-paid employees to leave the firm. We conduct a series of experiments to examine the effect of reduced pay dispersion on lower-paid employees’ effort and higher-paid employees’ turnover intentions. In Experiment 1, we find that reducing pay dispersion can increase lower-paid employees’ effort by increasing their perceived pay fairness. We also show that it is the reduction in pay dispersion rather than merely the increase in the lower-paid employees’ wages that yields these results. In Experiment 2, we replicate the results of our first experiment without collecting data on perceptions of pay fairness to ensure that the results of the first experiment were not the result of demand effects. Finally, in Experiment 3 we find that, contrary to concerns expressed in the popular press, higher-paid employees indicate that they are not more likely to leave the firm for a comparable job when lower-paid employees’ wages are increased, and may even be less likely to leave. Our results suggest that firms should consider whether the benefit of increased effort from the lower-paid employees is worth the extra cost they incur by increasing their wages.