Steven J. Kachelmeier

Culture and competition: A laboratory market comparison between China and the West

Abstract Twenty laboratory markets (160 subjects) were conducted to measure the influences on competitive economic behavior of (1) political and ethnic culture, (2) information regarding the profits earned by others, and (3) interaction between (1) and (2) The market design maximized the distance between the competitive equilibrium prediction and the equitable division of profits between traders Isolated cultural differences were noted in price convergence trends However, these isolated trend differences are overshadowed by a close cultural similarity in price levels across market periods The data of this study therefore provide evidence that the competitiveness observed in several prior laboratory market studies persists even in a markedly different culture.

Do cosmetic reporting variations affect market behavior? A laboratory study of the accounting emphasis on unavoidable costs

Eight laboratory market sessions are conducted in which sellers have both opportunity costs (default redemption values from not trading) and unavoidable costs (fixed outlays that must be paid irrespective of trading). The treatment variation is whether sellers’ intermediate accounting reports compare sales revenues to unavoidable costs (four sessions) or default redemption values (four sessions). Findings indicate systematically higher seller asks and buyer bids in the condition where accounting emphasizes unavoidable costs. However, the price and efficiency implications of these higher asks and bids are offset by simultaneous shifts in the relative frequencies of seller-initiated and buyer-initiated trades.

Fairness in markets: A laboratory investigation

Abstract It is generally assumed in applications of economic theory that people are concerned only with their monetary wealth. However, bargaining and public choice research indicates that people respond not only to monetary incentives, but also to considerations of fairness. The purpose of this study is to consider the effect of fairness on market behavior. This issue was addressed in a series of eight laboratory markets. The results suggest that fairness can affect market prices, but that the effect may decline over time.

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.

Depreciation and capital investment decisions: Experimental evidence in a governmental setting

Abstract This study tested the premise that depreciation may serve as a cognitive reminder to decision-makers in governmental organizations of the need to replace long-lived assets as they physically deteriorate. This premise is grounded in recent work on melioration theory , which suggests that individuals tend to maximize current benefits at the cost of underweighting negetive long-run consequences of current decisions. In this framework, the present research addresses whether depreciation cues have a mitigating effect on melioration bias. Subjects ( n = 216) were randomly assigned to one of twelve cells in a computerized between-subjects laboratory experiment with monetary incentives. The experimental cells represent twelve possible combinations relating to two levels of depreciation, the presence or absence of historical data on past decisions, and three levels of initial expenditures. The task required subjects to allocate a governmental budget between current and capital expenditures over multiple periods. A governmental context was used because of its relevance to the current controversy over the role of depreciation in governments and other nonbusiness entities. The study found a significant interaction between depreciation and historical information, a relationship which is consistent with the contention that depreciation is a useful cognitive surrogate for explicit information on prior period capital expenditures.

When Do Ineffective Audit Committee Members Experience Turnover

We use information extracted from a major proxy advisory service to test predictions from institutional theory regarding when and why audit committee (AC) members experience turnover because of evidence of ineffective governance. First, we broadly categorize AC ineffectiveness concerns as either (i) financial reporting failures or (ii) characteristics of individual AC members. Institutional theory suggests that the visible nature of the first category is more likely to threaten perceptions of AC legitimacy and hence prompt turnover, which is what we find. We then enrich the analysis by interacting the AC-member ineffectiveness indicators with the extent of shareholder protest votes, finding that shareholder dissent elevates the turnover effects of both categories of ineffectiveness, as institutional theory would predict. Finally, we find that otherwise effective AC members face an increased likelihood of turnover if they serve on the AC when financial reporting failures are discovered, even if they were not on the AC when the events precipitating the failures occurred. Overall, our findings support the institutional theoretic premise that boards take remedial actions when necessary to restore perceived legitimacy.

Communicated Values as Informal Controls: Promoting Quality While Undermining Productivity?†

We find that the effectiveness of piece-rate compensation relative to fixed pay in a laboratory letter-search task hinges on the presence or absence of a nonbinding statement to participants that the experimenter values correct responses. In the absence of the value statement, participants with piece-rate rewards for correct responses generate more correct and incorrect responses than do their counterparts with fixed pay, correcting errors as they go along to maximize compensation. Essentially, piece-rate compensation acts as an output control, incentivizing participants to maximize correct responses through a “produce-and-improve” strategy. The value statement suppresses this strategy because participants appear to perceive it as an input constraint, prompting greater initial care at the expense of lower overall productivity. As a result, the value statement eliminates the gains in correct responses that piece-rate incentivized participants otherwise realize. Thus, in settings in which individuals can gain efficiency by working expeditiously and improving quality when necessary, our results suggest the possibility that organizations could be better off just letting incentive schemes operate, rather than emphasizing quality in ways that could overly constrain productivity.

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.

An Experimental Investigation of Forward-Looking Non-Financial Performance Disclosures

The AICPAs Special Committee on Financial Reporting has urged disclosure of relevant forward-looking and non-financial information to supplement conventional financial statements. We conduct an experiment consisting of 20 laboratory security markets with eight participants each to assess the effects of such disclosures on capital allocation decisions. We observe four markets in each of five accounting information conditions: a baseline condition with an income statement and balance sheet only and four conditions that combine this baseline with supplemental disclosures of proved reserves (a best estimate), total reserves (an upper bound), and minimum reserves (a lower bound). We find first that proved reserve disclosures improve capital allocation decisions, even though these disclosures are redundant with information in the primary financial statements. Second, disclosures of the upper bound (total reserves) in the absence of lower bound (minimum reserves) has the potential to bias security prices upwards, while disclosures of both total and minimum reserves remove this bias. Third, a comparison of individual price predictions to actual market prices reveals both a systematic prediction error and a differential effect of supplemental disclosures on security prices, suggesting that experimental investigations of capital allocation decisions should include market settings. The paper concludes with a discussion of implications for accounting standard setters.

Working Longer but Not Harder: The Effects of Rewarding Time When Workers Have Different Abilities

To address the empirical phenomenon that organizations often reward time on the job as an end in itself, we design an experiment in which participants solve anagram puzzles, manipulating whether a compensation pool generated from the output of paired workers is allocated based on the individual inputs of relative time spent or on the individual outputs of puzzles solved. Relative to an output-based allocation, we find that an input based allocation leads participants to spend more time on the task. However, when paired participants have widely different abilities, an input-based allocation also leads to less effort intensity, defined as puzzles solved per unit of time spent. We attribute these findings to fairness considerations, an interpretation we corroborate in a second experiment with purely individual incentives that finds the same effort duration advantage of input-based pay but no offsetting disadvantage in effort intensity.