Kristina M. Rennekamp

Impaired Judgment: The Effects of Asset Impairment Reversibility and Cognitive Dissonance on Future Investment

This paper examines how the reversibility of the accounting effect of asset impairments affects managers’ investment decisions. We conduct two experiments in which participants act as CEO of a multi-division electronics company that suffers a large asset impairment at one of the divisions. Drawing on prior psychology research involving cognitive dissonance and decision reversibility, we predict and find that managers who are responsible for the decision to record the asset impairment invest more in the impaired division when the accounting effect of the impairment is reversible than when it is irreversible. This is consistent with the idea that reversible accounting effects encourage behavioral attempts to alter the cash flow outcome, while irreversible accounting effects encourage belief revision to rationalize the cash flow outcome. Also in line with cognitive dissonance theory, we show that managers who are not responsible for the decision to impair the asset, or managers who are given the opportunity to deny responsibility for the asset impairment, do not differ in their investment in the impaired division, regardless of impairment reversibility.

Who Stands at the Top and Bottom of the Slippery Slope

Prior research argues that sequential decisions lead to a slippery slope toward unethical or fraudulent behavior, with little evidence to support such claims. We conduct two experiments which demonstrate the existence of the slippery slope in a controlled setting, and investigate how it leads “good people” (low-Machiavellians) to do “bad things.” The first experiment manipulates whether the potential to overstate personal performance in order to earn excess monetary compensation increases or decreases across two experimental tasks. We find that smaller initial incentives to misreport followed by larger subsequent incentives to misreport lead to greater subsequent misreporting by low-Machiavellians. High-Machiavellians do not exhibit this slippery slope pattern of behavior. Our second experiment manipulates the length of time between tasks to examine whether the effects of misreporting incentives on slippery slope behavior diminish as opportunities to misreport are separated. We again observe slippery slope behavior among low-Ms at the short horizon, but not at the long horizon. Our study confirms the existence of a slippery slope toward unethical behavior, highlights individual differences along an important personality trait, and suggests that slippery slope behavior is likely to be magnified when individuals are presented with frequent opportunities to misreport.

How Disclosure Features of Corporate Social Responsibility Reports Interact with Investor Numeracy to Influence Investor Judgments

Firms’ Corporate Social Responsibility (CSR) reports typically frame their strategies in terms of either community or global efforts (i.e., “strategy frame”). Further, the style used to depict CSR performance in reports often highlights either pictures or words (i.e., “presentation style”). These two prominent disclosure features of CSR reports promote a natural fit or misfit in the focus (relatively low-level or high-level focus) investors adopt when thinking about the firm and its CSR efforts. Further, these disclosure features likely have different effects on investors depending on their numeracy or, in other words, the way that they naturally process numerical information. In this study we predict and find that a fit between the strategy frame and the presentation style of a firm’s CSR report causes less numerate investors to be more willing to invest than when a fit is not present. Specifically, we find that a fit leads less numerate investors to experience subjective feelings of processing fluency and, in turn, positive affect that serves as a cue that the positive CSR performance information can be relied upon, which positively influences willingness to invest. Our results have implications for both CSR reports as well as other types of firm disclosures that increasingly vary along similar disclosure characteristics. Our results also contribute to both the growing literature on presentation effects in accounting, as well as the broader business literature on CSR reporting.

The Paradoxical Behavioral Effects of a Directional Goal on Investors' Risk Perceptions and Valuation Judgments

ABSTRACT Market participants who evaluate risk often have a preference or goal for positive company performance. The authors test how such a directional goal affects risk perceptions and the relation between risk perceptions and assessments of value in an investment context. Compared with investors without directional goals—who, consistent with prior behavioral research, focus on negative aspects of risk—the authors find that those with directional goals assess risk as being more symmetric (i.e., they are less focused on downside risk). However, investors with directional goals are also less likely to consider risk when assessing value. Taken together, these results suggest that a directional goal reduces one behavioral effect identified in prior literature (the tendency to focus on downside risk), but creates another behavioral effect (ignoring risk in assessing value). The authors discuss implications for standard setters and regulators seeking to communicate risk information to market participants.

Does Highlighting Concrete Language in Disclosures Mitigate Home Bias

In this study we use an experiment to examine whether home bias is caused, at least in part, by a psychological bias that can be reduced by highlighting concrete language in disclosures. Our results show that, when abstract language is highlighted in a prospectus, prospective investors are significantly more willing to invest in the stock of a domestic firm than a foreign firm, but that highlighting concrete language mitigates this bias. Drawing on psychology theory, we predict and find that the debiasing effect of highlighting concrete language operates via investors’ subjective feelings of comfort with evaluating a prospective investment. Further, using a controlled experiment allows us to manipulate highlighted language without changing differences in investors’ access to or ability to interpret information about the foreign and domestic firm, thus ruling out differences in information as a sufficient explanation for our findings. Our results demonstrate a simple, yet potentially powerful reporting tool of highlighting concrete language in disclosures for reducing sub-optimal decisions among investors, which may provide benefits at the individual, firm and societal level.