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Kristy Lynne Towry
Gary Hecht
Kathryn Kadous

Professors at Emory’s Goizueta Business School are looking at accounting in an innovative way—going beyond debits and credits to consider how human psychology can, for better or worse, help to drive business decisions. The Emory scholars are considered to be at the head of the pack when it comes to applying behavioral analysis to accounting.

“We consider questions about the decision-making processes of both preparers and users of financial information. Some questions we consider focus on how analysts arrive at their buy-sell recommendations, and how company executives make their decisions,” explains Kristy Lynne Towry, an assistant professor of accounting at Goizueta. “For example, scholars in Emory’s behavioral accounting group are involved in research related to judgment and decision-making by auditors, tax professionals, company executives, financial analysts, and investors. Ultimately, we are interested in how psychological factors affect decisions in ways that aren’t necessarily predicted by economic analysis.”

Her own work focuses on the use of accounting to influence decision-making by firm managers. Towry is now considering how nonfinancial reporting metrics, such as quality or customer satisfaction, might be incorporated into managers’ compensation contracts.

In separate research, Molly Mercer, an assistant professor of accounting, at the Goizueta school, is exploring how firms develop reputations for credible disclosure. In one recent study, she shows that more forthcoming disclosure has a positive effect on reporting reputation in the short-term. However, she also finds that in the long-term, managers who report positive earnings news are rated as having a higher reporting reputation than managers who report negative earnings news—regardless of their previous disclosure decisions.

“Investors rate a ‘low-quality discloser’ who reports good news as higher in reporting quality than a ‘high-quality discloser’ who reports bad news,” she explains. “These results suggest that as time passes, investors ‘forget’ to reward managers for providing forthcoming disclosures. Instead, they base their assessments of management’s reporting quality solely on the firm’s financial performance.”

She notes that psychology studies show that people often latch onto the most salient attribute about someone or something and forget the rest.

“Such inferences can lead to problems down the road if investors inappropriately infer that management is credible and thus over-rely on subsequent management disclosures,” she cautions.

Meanwhile, Gary Hecht, an assistant professor of accounting at Goizueta, is focusing on the impact of a systems-related thought process and approach to audit, regulatory, and other issues.

“Consider the Sarbanes-Oxley Act, which was supposed to provide assurance about the integrity of financial reports issued by companies,” he says. “Under it, top executives like the CEO and CFO are required to sign off on internal controls, for example. But that may send an unintended signal to an auditor that greater reliance can be placed on those systems, at the expense of other efforts of the audit process.”

This is occurring at a time when Big Four CPA firms are moving away from substantial transaction testing-based audits, and are instead tying their level of confidence in a company’s internal system to the level of transactional testing.

“Current research, however, suggests that auditors may not be sufficiently trained to analyze and understand large, complex internal control and other systems,” says Hecht. “This appears to indicate that CPA firms’ training should place more emphasis on analytical systems skills. Further study in this area could influence the way that CPA firms structure the way they approach audits.”

Another Goizueta faculty member, Accounting Associate Professor Kathryn Kadous, studies the judgment and decision-making of auditors, tax professionals, financial analysts, and professional managers.

“This research includes an examination of how these professionals represent information in their individual memory, which, in turn, influences important professional judgments such as when to quit a failing project, and how to research whether a client’s position on a tax return or financial statements is acceptable,” she says. “The studies also address the issue of how the information processing will affect the reasonableness of earnings forecasts—whether they will be unduly optimistic or pessimistic.”

One of her papers addresses over-optimistic views that analysts appear to have regarding earnings-per-share forecasts that extend one or more years ahead. She says that analysts tend to “buy into” scenarios that management provides and become overly optimistic about a company’s prospects.

“We demonstrate that the optimism of analysts will be significantly reduced if they’re asked to list a few reasons why management’s plans might not work,” explains Kadous. “When analysts are asked to develop a large number of reasons, however, their optimism is not reduced.”

She believes that’s because analysts find it difficult to generate a long list of why a project might fail, and therefore appear to infer that management’s proposed outcome is likely to occur.
Behavioral decision research can help auditors learn how to more accurately measure risk and can potentially help capital market participants to learn how to better incorporate risk into their investment decisions. Ultimately, the research at Goizueta is likely to touch almost every point of the business and investor market.

—Marty Daks

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