Jeffrey W. Schatzberg

Heterogenous demand for public goods: Behavior in the voluntary contributions mechanism

Numerous laboratory experiments have investigated the performance of several processes for providing public goods through voluntary contributions. This research has been able to identify features of the institution or environment which are reliably likely to produce outcomes “close” to the free riding outcome or “substantially” greater than the pessimistic prediction of standard models. One such feature is the “marginal per-capita return” (MPCR) from the public good. Various authors have altered MPCR between groups or for an entire group at the same time. The experiments reported here address a different question, “What would happen if, within a group, some persons faced a ‘high’ MPCR while others faced a ‘low’ MPCR?”

The Impact of Legal Liability Regimes and Differential Client Risk on Client Acceptance, Audit Pricing, and Audit Effort Decisions

This study uses experimental methods to examine client acceptance, auditor pricing and effort decisions for clients of varying risk under two legal rules, joint and several liability, and proportionate liability. We predict greater availability of audit services for high-risk clients, lower audit prices, and lower audit effort under proportionate liability relative to joint and several liability. Our experimental evidence does not strongly support predicted prices due to underpricing behavior, but prices do reflect risk differences across client groups for both liability regimes. The results also exhibit some support for the predictions that auditors select low effort for the lowest-risk clients, and a lower effort level under proportionate liability relative to joint and several liability for moderate-risk clients. As predicted for the highest-risk clients, high effort is selected under proportionate liability, and there is some evidence of a substantial reduction in contracting under joint and several liability.

A Reexamination of Behavior in Experimental Audit Markets: The Effects of Moral Reasoning and Economic Incentives on Auditor Reporting and Fees*

This study uses experimental markets to investigate how moral reasoning influences auditor reporting under different levels of economic incentives. In each multiperiod market, auditor subjects could either (1) misreport low observed outcomes as high and thereby reap economic advantages at the expense of third-party investors, or (2) truthfully report low observed outcomes as low but thereby forgo the economic advantages of misreporting. We extend the Calegari, Schatzberg, and Sevcik 1998 experimental-markets setting to incorporate moral reasoning, and test hypotheses based on the economic model of Magee and Tseng 1990 and the neo-Kohlbergian moral reasoning framework of Rest, Narvaez, Bebeau, and Thoma 1999. We document a significant effect of moral reasoning on auditor behavior. Specifically, we find that misreporting and premium fees are more likely with higher than with lower moral reasoning subjects, and the moral reasoning effect diminishes as economic penalties increase in the market. These findings provide valuable insights for specifying the determinants of auditor misreporting, the observable behaviors that signal its existence, and the institutions that can prevent its occurrence in the market. We conclude that the relation between moral reasoning and behavior is more complex than commonly assumed in the accounting literature, and identify directions for future research.

Examining the Role of Auditor Quality and Retained Ownership in IPO Markets: Experimental Evidence*

We use experimental markets to test the Datar, Feltham, and Hughes (DFH) 1991 model of entrepreneur choice of auditor and retained ownership in initial public offerings (IPOs). DFH predict that entrepreneurs use retained ownership to signal IPO value and substitute high-quality auditors for retained ownership to signal value as the risk of the IPO increases. Given the mixed support for DFH from archival research, we conduct experimental markets that directly operationalize the models decision variables, which permits a direct test of whether the model is descriptively valid. In addition, our market setting provides a strong test of this theory by including an alternative Nash equilibrium also present in field settings, one in which only auditor quality is used by entrepreneurs to signal IPO value. Our results suggest that DFH predict entrepreneur behavior in baseline markets where both computerized investors and auditors are programmed to price consistently with the DFH equilibrium. However, the DFH model does not describe behavior when “robot” investors are replaced with human investors in the market. The results suggest that entrepreneurs and investors strategically interact in a manner that leads them away from the DFH equilibrium and toward the alternative Nash equilibrium behavior of entrepreneurs with high-value assets hiring high-quality auditors irrespective of IPO risk. Our results imply that the DFH model has limited descriptive validity, document the importance of strategic behavior on market equilibrium formation, and suggest that the mixed results found in prior DFH-based field studies may reflect the models low descriptive validity.

The Effect of Accounting Uncertainty and Auditor Reputation on Auditor Independence

This paper reports the results of experimental economic markets designed to examine whether an auditors objectivity (independence) is impacted by uncertainty regarding the appropriate accounting treatment for a client. In particular, we are interested in whether the auditor exploits this uncertainty by agreeing with her clients preferred accounting treatment even when her evidence suggests an alternative treatment is more likely to be correct. We examine the effect of accounting uncertainty in a setting where the auditor not only wants to satisfy her client but also wants to maintain a reputation for audit objectivity in the market. The results provide strong evidence that the level of accounting uncertainty impacts auditor independence. Specifically, when accounting uncertainty did not exist, auditors maintained their independence by truthfully reporting the observed value. Auditors appeared to remain independent due to concerns about their reputations with managers and investors. However, when accounting uncertainty existed, auditors impaired their independence by misreporting the observed value in favor of the manager. Our results specify some initial boundary conditions for the impact of auditor reputation and investor pricing on auditor independence, and suggest that regulators should focus on enhancing auditor incentives to maintain independence when faced with accounting uncertainty. It appears that regulators do not need to be as concerned about independence violations when accounting pronouncements provide unambiguous guidance. An auditors concern about her reputation provides adequate incentive to prevent independence impairment when she is certain about the appropriate accounting treatment. Our results also suggest future research should assess the ability of other audit market forces to reduce the propensity of auditors to violate independence when faced with accounting uncertainty.

The Realism of Self-Interested Opportunism: An Experimental Investigation of Learning, Fairness, and Ethics

We examine the realism of the assumption of self-interested opportunism in agency theory. We place subjects into manager/producer pairs and set parameters so that the producer extracts the highest share of residual earnings from the manager by setting the budget at zero (100% slack) and providing low effort (shirking). Because the budget is public and effort is private, this setting allows us to examine two different forms of opportunism. To establish common knowledge of incentives, we give subjects extensive experience in both manager and producer roles. Finally, we manipulate pair rotation and the ability of the manager to reject the budget. Fully opportunistic levels of slack and shirking are not observed on average, and the two forms of opportunism differ systematically. With experience, subjects learn to build more slack into their budget but do not shirk more. Fairness concerns reduce both forms of opportunism but ethics concerns reduce shirking only. Subject rotation increases shirking but has no effect on slack. While rejection power reduces slack, it also increases shirking with all variables in the model. We discuss the implications of these results for theory and practice.

Entrepreneur Choice of Auditor and Retained Ownership in IPO Markets: Experimental Evidence

We use experimental economic markets to test the Datar, Feltham and Hughes (DFH) (1991) model of entrepreneur choice of auditor and retained ownership in initial public offering markets. The mixed evidence provided by prior research using archival data motivated our experimental approach. Experimental markets inherently exhibit considerably more control over the models decision variables than do archival studies. This enables us to test whether the model adequately describes human behavior and examine the effect of an important decision variable cited by prior research. Our results provide considerable support for the DFH model of entrepreneur behavior in treatments where investors are programmed to price consistent with the DFH equilibrium. We also found support in similar treatments for a modified DFH model that included the impact of client risk on auditor fees. However, the model was far less predictive of entrepreneur behavior in markets with human investors instead of programmed investors. The results suggest that human entrepreneurs and investors adapt to the choices each made within a particular market, such that less than half of the markets conformed to DFHs predictions while the rest followed an alternative equilibrium where only the entrepreneurs choice of auditor signaled firm value. Our results suggest that in signaling models like DFH, theorists should consider market environments and interactions that can lead to one equilibrium versus another.