The Psychological Attraction Approach to Accounting and Disclosure Policy*

Abstract

We offer here the psychological attraction approach to accounting and disclosure rules, regulation, and policy as a program for positive accounting research. We suggest that psychological forces have shaped and continue to shape rules and policies in two different ways. (1) Good Rules for Bad Users: rules and policies that provide information in a form that is useful for users who are subject to bias and cognitive processing constraints. (2) Bad Rules: superfluous or even pernicious rules and policies that result from psychological bias on the part of the 'designers' (managers, users, auditors, regulators, politicians, or voters). We offer some initial ideas about psychological sources of the use of historical costs, conservatism, aggregation, and a focus on downside outcomes in risk disclosures. We also suggest that psychological forces cause informal shifts in reporting and disclosure regulation and policy, which can exacerbate boom/bust patterns in financial markets.

The Allowance for Uncollectible Accounts, Conservatism, and Earnings Management

“…Nelson, Elliott, and Tarpley [2002] find that only 37% of attempts to increase future income by overstating current period expenses are adjusted by auditors. Hirshleifer and Teoh [2009] draw upon established theories from psychology to argue that managers prefer conservative accounting because it reduces the likelihood that they (and others) will be disappointed when the realization of significant accounting estimates become known in the future. Their insights suggest that managers may establish conservative allowances to protect against the possibility that future write-offs will exceed the allowance.…”

Managers’ Incorporation of the Value of Real Options into Their Long‐Term Investment Decisions: An Experimental Investigation*

“…This suggests that the way the planned path and real options components of value are reported could influence managers’ reliance on real options values in funding decisions. Firms that choose to use real options valuation and include the value of real options in subordinates’ standardized long‐term investment proposals have flexibility in how the planned path and real options components of project value can be displayed in those proposals (see, e.g., Hirshleifer and Teoh 2009). For example, Anheuser‐Busch and Merck combine the planned path and real options components of value in their analyses of investment projects (Arnold and Shockley 2001; Bowman and Moskowitz 2001), while Kimberly‐Clark and “Global Airlines” 9 use reports that display the planned path and real options components of value separately (Amram et al 2006; Jeffery 2006).…”

Revisiting conditional accounting conservatism in state-controlled firms

“…The investor attraction perspective is another dimension of the equity-market demand for conditional conservatism (Hirshleifer and Teoh, 2009). This view argues that individuals process gains and losses differently (Dickhaut et al, 2010), and the relative disappointment from losses exceeds the benefits of gains.…”