Judgment & Decision Making In Accounting (6314M0407Y)
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Universiteit Van Amsterdam (UvA)
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Judgment & Decision Making In Accounting (6314M0407Y)
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2021
2022
Judgment & Decision
Making
SUMMARY OF BOTH THE LECTURES AND SEMINARS
LOUIST
,Contents
Chapter 1. Introduction to the Course and probabilities ...................................................................... 5
1.1 Introduction ............................................................................................................................ 5
1.2 Models..................................................................................................................................... 5
1.2.1 Normative Decision Making ............................................................................................... 5
1.2.2 Descriptive models of decision making.............................................................................. 6
1.3 Tutorial .................................................................................................................................... 7
1.3.1 Normative versus descriptive models ................................................................................ 7
1.3.2 Probability and Bayes Theorem. ........................................................................................ 8
1.3.3 Bayes’s Theorem (exam material)...................................................................................... 9
Chapter 2. Risk and Uncertainty .......................................................................................................... 10
2.1 Introduction .......................................................................................................................... 10
2.2 Risk ........................................................................................................................................ 10
2.2.1 A risk-neutral utility function ........................................................................................... 10
2.2.2 Risk-Averse person ........................................................................................................... 10
2.2.3 Risk-seeking person .......................................................................................................... 11
2.3 Paper: Nelson and Kinney (1997) ......................................................................................... 11
2.3.1 Effect of ambiguity on subjective probabilities ............................................................... 12
2.3.2 The Charts ......................................................................................................................... 12
2.3.3 Results ............................................................................................................................... 12
2.4 Loss Aversion ........................................................................................................................ 13
2.5 Paper: Brink & Rankin (2013) ............................................................................................... 13
2.6 Mental Accounting ............................................................................................................... 14
Chapter 3. Bottom-Up processes ......................................................................................................... 15
3.1 Normative Models and Reality............................................................................................. 15
3.1.1 Normative Models ............................................................................................................ 15
3.1.2 Reality................................................................................................................................ 15
3.2 Bottom-up and Top-down processes ................................................................................... 16
3.2.1 Selective Attention ........................................................................................................... 16
3.2.2 Presentation formats ........................................................................................................ 16
3.2.3 Serial positioning .............................................................................................................. 16
3.2.4 Anchoring (+ Paper) .......................................................................................................... 17
3.2.5 Menu Effects ..................................................................................................................... 18
3.2.6 Choice architecture (+ Paper) ........................................................................................... 18
3.2.7 Language effects ............................................................................................................... 19
3.2.8 Availability heuristic ......................................................................................................... 19
A summary by LouisT for the course Judgment & Decision Making | University of Amsterdam | 2021-2022
,Chapter 4. Top-Down Processes........................................................................................................... 20
4.1 Representativeness .............................................................................................................. 20
4.2 Pattern Recognition .............................................................................................................. 21
4.3 Top-down processes ............................................................................................................. 21
4.3.1 Confirmation Bias ............................................................................................................. 21
4.3.2 Motivated Reasoning........................................................................................................ 21
4.3.3 Overconfidence ................................................................................................................. 22
4.3.4 Hindsight Bias.................................................................................................................... 23
4.3.5 Decision Myopia ............................................................................................................... 23
4.3.6 Status Quo Bias ................................................................................................................. 24
4.3.7 Sunk Cost Fallacy............................................................................................................... 24
4.3.8 Escalation of Commitment ............................................................................................... 24
Chapter 5. Social Norms ....................................................................................................................... 25
5.1 Social Norms ......................................................................................................................... 25
5.2 Paper: The effects of norms on investor reactions to derivative use ................................. 26
5.3 Social Preferences ................................................................................................................. 27
5.3.1 Fairness ............................................................................................................................. 27
5.3.2 Reciprocity ........................................................................................................................ 27
5.4 Trust and Cooperation .......................................................................................................... 27
5.5 Social Comparison and competition .................................................................................... 27
5.6 The effect of relative performance information on performance and effort allocation in a
multi-task environment.................................................................................................................... 28
5.7 Achievement and target setting ........................................................................................... 29
5.7.1 Gamification ...................................................................................................................... 29
5.7.2 In-group Favouritism ........................................................................................................ 29
Chapter 6. Ethics ................................................................................................................................... 30
6.1 Ethics ..................................................................................................................................... 30
6.1.1 Normative model .............................................................................................................. 30
6.1.2 Descriptive models ........................................................................................................... 30
6.2 Model of ethical decision making ........................................................................................ 30
6.3 Bounded ethicality (Most important) .................................................................................. 31
6.3.1 System 1 & 2 ..................................................................................................................... 31
6.3.2 Implicit attitudes ............................................................................................................... 31
6.3.3 Indirect unethical behavior .............................................................................................. 31
6.3.4 Sacred values .................................................................................................................... 31
6.3.5 Motivated blindness ......................................................................................................... 31
A summary by LouisT for the course Judgment & Decision Making | University of Amsterdam | 2021-2022
, 6.3.6 Social pressure .................................................................................................................. 32
6.3.7 Framing and motivated reasoning ................................................................................... 32
6.3.8 Moral cleansing and moral licensing ................................................................................ 33
6.4 Summary of how to make decisions .................................................................................... 34
A summary by LouisT for the course Judgment & Decision Making | University of Amsterdam | 2021-2022
,Chapter 1. Introduction to the Course and probabilities
This course exists because the production, certification, and use of accounting information still
require human judgment and decision-making. This means we need an understanding of the
psychology of judgment and decision-making.
1.1 Introduction
Changes in assets, liabilities, and equity, happen in the real world. This is the process of producing
accounting information by managers employees, and controllers. Then this accounting information is
provided by users and this accounting information is first certified by an external party, which is likely
to be the auditor. The users are owners, investors, creditors, analysts, etc.
Judgment is attaching a value to something, which doesn’t mean that it is quantitative, it can be
qualitative in this sense. Therefore, it could mean an estimate, an evaluation, or an opinion.
Compared to decisions, which are just about choosing between alternatives. These are closely
related to each other.
➔ Production of accounting information
This could be a decision about the depreciation method for a class of assets, residual value and
lifetime of an asset, valuation of intangibles, classification of an asset/liability, the reporting
requirement for organizational units, and layout of performance reports.
➔ Certification of accounting information
Materiality, risk of material misstatement, analytical procedures, complex estimates, and
going-concern.
➔ The use of accounting information
o Owners and investors: estimate future cash flows and decide to sell or buy shares
o Financial analysts: estimate future cash flows etc and make buy/hold/sell
recommendations
o Creditors: estimate default risk and describe loans, interest rates, etc.
o Managers and other employees: estimate the likely consequences of alternative
courses of action, make business decisions, and evaluate the performance of units,
teams, and individuals
o Government: tax, regulation, licenses, permission, integrity of financial reports,
macro-economic planning, etc.
o Suppliers and customers: judge liquidity, solvency, etc, and contracting decisions.
1.2 Models
Normative, descriptive, and prescriptive models.
➔ Normative: How people should be making judgments and decisions
➔ Descriptive: How people make judgments and decisions
➔ Prescriptive: Practical suggestions on designing judgment and decision-making processes
based on normative and descriptive models.
1.2.1 Normative Decision Making
Normative: a rational process. Use all available information and use this in the most optimal way to
maximize the expected net outcome. This is to make it as accurate as possible and make the best
decisions.
5
A summary by LouisT for the course Judgment & Decision Making | University of Amsterdam | 2021-2022
, According to the book:
1. Define the problem
2. Identify the criteria
3. Weigh the criteria
4. Generate alternatives
5. Rate each alternative on each criterion
6. Compute the optimal decision.
In reality, this of course doesn’t happen. However, we tend to be predictable and irrational. We
deviate from the normative framework in systematic, not just random, ways.
1.2.2 Descriptive models of decision making
As mentioned before, these models explain how people make decisions. These come from the
different psychological fields, neuroscience, biology, sociology, anthropology, and behavioral
economics.
Previously, human decision-making is easy because of its simplicity in the past. We are not well
prepared to make complex economic decisions, in a dynamic, unpredictable environment with many
heterogeneous actors. When we face such decisions, we cannot simply ignore our human nature and
follow a rational process. However, we can try.
Dual Process Theory.
We have two systems, which are:
➔ System 1: Intuitive, fast, automatic, emotional, effortless, a system of decision making. It is
employed when we interpret verbal language, process visual information, walk, talk, etc.
➔ System 2: Slow, effortful, conscious, and explicit. You are aware of your thinking, you are
deliberately making a decision.
Both systems are always on, System 2 is typically in a comfortable low-effort mode. System 1
continuously provides system 2 with impressions, intuitions, feelings, etc. System 2 is only mobilized
when system 1 runs into difficulties. The division of labor is highly efficient.
Therefore, even if we try to be rational, we are unlikely to succeed. Our judgments and decisions will
deviate from normative benchmarks.
Central Notion: Accessibility
When faced with a difficult question, it substitutes it for something easier. It could be easier from the
memory or see how we perceive the world. Things that come to mind easily play a too large role in
our decision-making.
Our brain is easily satisfied, it tends to “jump to conclusions”. The easily accessible perceptions,
impressions, intuitions, etc. from system 1 have a disproportionate weight on our judgments and
decisions. The cognitive easy feel good and doubt/uncertainty are difficult and often feel bad. This
means your brain tends to take immediate action to avoid “cognitive dissonance” and to restore your
familiar and coherent notion of the world. You might not even become of information that, from a
normative perspective, requires you to change your mind.
Determinants: perpetual salience, surprisingness, familiarity, and when things are associated with
emotion, potential losses, and are in line with our current ‘mindset’
Heuristic: instead of answering a difficult question, our first impulse is to find an easier accessible
answer to a related question using our system 1. We substitute a difficult question for an easier
6
A summary by LouisT for the course Judgment & Decision Making | University of Amsterdam | 2021-2022
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