Jeffrey Hales

Who Believes the Hype? An Experimental Examination of how Language Affects Investor Judgments

This paper investigates the effect of vivid language on investor judgments. Recent research finds that investor judgments are significantly influenced by disclosure tone (positive versus negative). Holding tone constant, we investigate investors’ reactions to vivid versus pallid information. Drawing on theories from psychology, we predict that investors will be sensitive to the differences between vivid and pallid language when the underlying information is preference-inconsistent, but not when the information is preference-consistent. Results of two experiments support our prediction. Vivid language significantly influences the judgment of investors who hold contrarian positions (i.e., short investors in a bull market and long investors in a bear market). Interestingly, vivid language has limited influence on the judgment of investors who hold positions consistent with the general tenor of the market. Our results provide evidence regarding when vividness matters and when it does not in financial contexts, thereby contributing to both psychology and a growing literature on disclosure tone in financial reporting. In addition, our results also speak to concerns raised by regulators and academics asserting that vivid language can inflate bubbles and incite panics.

Beyond a One-Size-Fits-All Mentality: An Experimental Investigation of How Narcissistic Employees Respond to Relative Performance Information

We extend prior research on performance reporting by examining how individual traits and environmental features affect the willingness of managers to report honestly. Drawing on research in psychology, we expect narcissism and the desire for social status to compete with preferences for honesty. To test our predictions, we use an experimental research design that orthogonalizes financial incentives (cash compensation) from non-financial incentives (social status). Consistent with our predictions, we find that narcissism, a stable and measurable personality trait, induces participants to inflate reported performance, but only when the participant views the task as important. We also provide evidence that these influences are especially pronounced when managers feel challenged to be the top performer. In addition, we find that even non-narcissistic participants are prone to inflate reported performance in settings that reward high reported performance with social status. Together, these results have several implications related to hiring practices and the design of control systems, as well as audit planning.

Experimental Evidence of How Prior Experience as an Auditor Influences Managers' Strategic Reporting Decisions

We design an experiment to examine the influence of audit experience on subsequent reporting decisions when auditors become managers of audited firms. In contrast to the independence issues that can arise when auditors and their clients are related by prior affiliation, we focus this study on the more common case in which auditors assume subsequent employment with other firms’ clients. In a bi-matrix experimental game that captures key features of the strategic tension between auditors and reporters, we find that reporters who have prior experience as an auditor, particularly the experience of having been a diligent auditor, are more sensitive to large penalties for aggressive reporting than are reporters whose experience is exclusively as a reporter. Our results suggest implications for regulators in predicting the effects of reporting penalties and for firms in considering the effects of CPA experience when hiring for reporting positions.

Predicting Relative Performance in Economic Competition

Recent research in psychology has challenged the notion of a systematic “better-than-average” bias in predicted relative performance. Extending this research, we show that in an incentive-compatible experimental competition with widespread variation in abilities, those who are better than average tend to overestimate their actual performance, while those who are worse than average tend to underestimate their actual performance. We then demonstrate that this symmetric miscalibration at both sides of the relative performance distribution can facilitate optimal choices of costly insurance to mitigate performance-based risks. In contrast to the findings of prior research, we find that, after taking this insurance into account, participants are no worse off when economic risks are based on relative performance than when risks are assigned randomly in a similarly structured control setting.

Can Capital Constraints Restrain Creativity? The Spillover Effect of Budget Constraints on Employee Creativity

When setting budgets, managers may place constraints on how resources can be used in an effort to mitigate opportunistic behavior by subordinates. These restrictions can affect the ability of the subordinate to succeed in the budgeted task, but may also have an unintended spillover effect on the ability to innovate. Using an experiment, we find that individuals working under higher budgetary constraints are more efficient in their use of budgeted resources, but are less successful in the budgeted tasks, than their counterparts working under lower budgetary constraints. Importantly, we find that imposing budgetary constraints also causes employees to subsequently generate fewer highly original and creative ideas in an unrelated activity. These findings suggest that budget structures can have unintended consequences on the innovative capabilities of organizations. This paper contributes to the expansive budgeting literature by showing budgetary control design has organizational performance implications beyond the specified budgeted activity.