The Effect of Information Systems on Honesty in Managerial Reporting: A Behavioral Perspective

1. The Effect of Information Systems on Honesty in Managerial Reporting: A Behavioral Perspective • By: Hannan, Rankin, and Towry • Presenter: Sara Aliabadi • November 6, 2008

2. Two main questions: • Can information systems be useful in motivating mangers to more honestly reveal their private information? • Can a contractual use of the information system signal increase owner’s profit?

3. We examine the effect of information system on honesty in a three-stage process. • We compare managerial reporting under the presence and absence of an information system. • We investigate the effect of an information system’s precision on managerial reporting behavior. • We compare the owner’s profit when information system signal is used contractually, with when it is not.

4. Prior research • Prior research investigate whether reductions in information asymmetry affect budgetary slack when the additional information acquired by the owner is not contractible. • Mixed result from prior research: • Young(1985) finds that slack is lower when information asymmetry is low. • Stevens (2002) finds no effect across the two comparable levels of information asymmetry.

5. Prior research • Some of prior studies observed partial honesty. (e.g., Young 1985; Chow et al. 1988; Waller 1988; Chow, Cooper, and Haddad 1991) • Luft (1997) propose that the partial honesty observed in these studies may be explained by individuals having preferences for both being honest and wealth.

6. Hypotheses • Hypothesis 1: The information system signal is a focal point for managers reports. • Hypothesis 2 : Mangers’ reports are more honest when an information system exists than when no information system exists.

7. Hypotheses • Hypothesis 3: The information system signal is less of a focal point for managers’ reports when the information system is precise than when the information system is coarse. • Hypothesis 4: Managers’ reports are neither more nor less honest when an information system is precise than when it is coarse.

8. Experimental methods • Participants: 150 participated in the experiment. • Mostly accounting and finance major. • The experimental scenario describes a setting in which the manager has private information regarding the cost of production. • We vary (between subjects) the existence of an information system—present or absent.

9. Procedures • We use a contextually rich budgeting setting, • Managers submit budgets to the owner, • Managers know with certainty the actual unit cost before reporting the cost to the owner, • No budget is rejected, • Manager keeps the difference between resources received and actual cost.

10. Information system manipulation • Three levels of information system: • No information system: the owner did not receive any signal of the actual costs. • In the coarse and precise conditions, the owner has an information system that reported with 70 percent accuracy a range for the actual costs. • Between coarse and precise conditions, the precision of the range, but not the accuracy level varied.

11. Results

13. Test of hypotheses • To test hypothesis one we compare the portion of cost reports that are within the signal’s range in the coarse condition and no information condition. • Repeat the comparison between precise and no information condition.

14. Results • The result show that proportion of cost reports that are within the signal’s rang in the coarse condition is greater than the proportion in that same range when no information system was provided. • Similar finding when camper between precise and no information condition. • H1 is supported. • The signal provided by information system is a focal point.

16. Test of hypotheses • Table 2 shows that cost report is significantly lower when an information system exists. • Hypothesis 2 is supported • Hypothesis 3 is supported suggesting that as the marginal cost of appearing honest increases, more managers opt for the benefits of misrepresentation.

17. Comparisons with contractual solutions • Our results suggest that the owner’s profit-maximizing strategy for using an information system will depend on the information system’s precision. • Unless the available information system is sufficiently precise, the owner will obtain greater profits by not contracting on the information system signal.

19. conclusion • Since managers prefer to create a positive impression, they are willing to sacrifice the benefits of misrepresentation in order to appear honest. • As the precision of an information system increased, the marginal cost of appearing honest increases as well.