An economic theory which is not incorporating human behavior is not imaginable. For reasons of simplification economic models traditionally use the concept of a rational acting market participant. In order to face the inadequateness of this abstraction behavioral economic science reject the assumption of the homo economicus and adds various findings from supporting disciplines as psychology, sociology, and organizational theory. While the exploration of human behavior in finance theory has a long tradition, research in the area of psychological effects in accounting started not earlier than the mid of last century. The main intention of modern financial reporting is the supply of useful information for actual and potential investors within their decision-making process. As information processing of agents
on the market for equity is part of finance theory, this is the meeting point of the two disciplines. The intention of this paper is to identify overlapping contents of behavioral research in finance and accounting. For clarification selected studies from Behavioral Finance Research (BFR) and Behavioral Accounting Research (BAR) literature will be presented and comparatively analyzed. In addition varying fields of research of both schools which are not related with each other were outlined.
Table of Contents
1. BEHAVIORAL ACCOUNTING RESEARCH (BAR)
2. MEETING POINT OF BAR AND BFR - SIMILARITIES AND DIFFERENCES
3. "SOPHISTICATION" AND FUNCTIONAL FIXATION OF AGENTS IN THE CAPITAL MARKET
4. SUMMARY & CONCLUSION
Objectives and Core Topics
The primary objective of this paper is to explore the intersection between Behavioral Finance Research (BFR) and Behavioral Accounting Research (BAR). By comparatively analyzing selected literature, the work identifies overlapping research questions regarding how market participants process information and addresses the psychological biases that challenge the assumptions of the Efficient Market Theory.
- The divergence between the rational homo economicus and actual observed investor behavior.
- The impact of psychological biases on the valuation of equity and capital market efficiency.
- The role of financial accounting disclosures in the decision-making processes of investors and analysts.
- The influence of investor and analyst "sophistication" on information processing.
- The psychological concept of functional fixation and its application in financial and accounting research.
Excerpt from the Book
"SOPHISTICATION" AND FUNCTIONAL FIXATION OF AGENTS IN THE CAPITAL MARKET
According to the psychological concept of functional fixation prior use of an object for one function inhibits subjects’ ability to identify alternative functions for the same object when placed in a situation for which an alternative function would be appropriate. For example, prior use of a briefcase to perform the function of holding and transporting papers inhibits the ability to identify an alternative function for the briefcase, e.g. as a door stop.
IJIRI/JAEDICKE/KNIGHT (1966) were the first who introduced the psychological concept of functional fixation to the accounting research context. The basic research question addressed by this and the studies that have followed is whether or not accountants adapt changes in the meaning of accounting data. Where alternative accounting methodologies are available, the choice of methodology can often have a significant impact on the directly related financial statement account, which will flow through to net income and many other performance measures.
Early studies examine the ability of individual decision makers to adjust their decision processes to changes in accounting methodology. An experimental approach was used in this accounting literature. Efficient market researcher argued that the capital markets as a whole can "translate" between different methodologies. Sophisticated investors do not suffer from functional fixation and will trade against any naïve trading behavior by functionally fixated investors. In an efficient market this happens instantaneously and all investors become price-takers. Beginning with BALL (1972), WATTS (1982) and WATTS/ZIMMERMAN (1986) functional fixation research was then lifted to an upper level, from the observation of information processing by individuals or groups to the broad capital market studies. This was when functional fixated users of accounting information became a topic for BFR as well.
Summary of Chapters
BEHAVIORAL ACCOUNTING RESEARCH (BAR): This chapter outlines the development of BAR since the 1960s as an alternative to normative accounting research, focusing on judgment and decision-making by users of financial information.
MEETING POINT OF BAR AND BFR - SIMILARITIES AND DIFFERENCES: This section identifies the capital market as the central intersection of both disciplines and discusses how investors often exhibit irrational behavior when dealing with earnings and cash flow information.
"SOPHISTICATION" AND FUNCTIONAL FIXATION OF AGENTS IN THE CAPITAL MARKET: This chapter examines the psychological concept of functional fixation, testing whether investors are able to correctly decode financial statements or if they fall victim to biased assessments due to accounting choices.
SUMMARY & CONCLUSION: The final chapter synthesizes the findings, noting that while both fields share methodologies and interest in information processing, they differ in their intended audience and the specific implications drawn from their research.
Keywords
Behavioral Finance, Behavioral Accounting, Homo Economicus, Efficient Market Theory, Functional Fixation, Investor Sophistication, Capital Market, Earnings Forecast, Asset Pricing, Prospect Theory, Decision Usefulness, Information Processing, Financial Reporting, Market Anomalies, Behavioral Economics
Frequently Asked Questions
What is the core focus of this research paper?
The paper examines the intersection between Behavioral Finance Research (BFR) and Behavioral Accounting Research (BAR), specifically focusing on how human behavior and psychological biases influence information processing and decision-making in capital markets.
What are the primary fields of study analyzed?
The analysis covers behavioral aspects of stock valuation, asset allocation, portfolio construction, corporate finance, financial accounting, auditing, and tax accounting.
What is the main research question of this study?
The central question is to identify the overlapping contents of behavioral research in finance and accounting, and to evaluate how these findings challenge traditional assumptions of rational behavior in financial models.
Which scientific methods are employed in these research fields?
The research relies on a variety of methodologies including experimental approaches, field studies, and archival empirical works derived from psychology, sociology, and organizational theory.
What is the central theme of the main body?
The main body focuses on the "Functional Fixation Hypothesis," investigating whether investors and analysts can effectively interpret financial statements despite varying accounting methodologies, or if they exhibit systematic bias.
Which keywords best characterize this work?
Key terms include Behavioral Finance, Functional Fixation, Efficient Market Theory, Investor Sophistication, and Financial Accounting.
What does the Functional Fixation Hypothesis imply for investors?
It implies that investors may not properly decode information within financial statements, leading them to arrive at biased assessments of future cash flows and potentially being misled by firms' accounting method choices.
How does "sophistication" affect investor behavior?
The paper explores whether sophisticated investors—often measured by institutional ownership or level of education—are less susceptible to functional fixation and rational biases compared to "unsophisticated" market participants.
What do the experimental results in the paper suggest about price bubbles?
Experimental evidence suggests that speculative bubbles are more likely to occur when the ratio of inexperienced traders is high and when there is significant uncertainty regarding the fundamental value of an asset.
Why is the 1993 US tax rate increase used as a case study?
The 1993 tax increase serves as an empirical test for the Functional Fixation Hypothesis, as researchers could observe if investors and analysts correctly accounted for deferred tax adjustments in their earnings forecasts and price expectations.
- Quote paper
- Robert Breitkreuz (Author), 2008, Behavioral Accounting vs. Behavioral Finance, Munich, GRIN Verlag, https://www.grin.com/document/129284
