Judgment and Decision-Making

Judgment and Decision-MakingOpening ActivityI have a rule in mind that applies to the sequencing of three numbers. You have to try to guess the rule using the following table. I will give you one sequence that fits my rule. Also, as you generate sequences of your own to try to figure out my rule, I will tell you whether your guess is consistent with my rule or inconsistent with my rule . When you get to 100% sure, you are done.

Sequence Or Your guess about the ruleHow sure are you?2, 4, 6 Why Study Judgment?Principles based standardsMovement toward fair-value accountingAccounting for leasesConvergence toward a single set of high quality standardsgreater judgment, fewer prescriptive rules.Greater emphasis on inspectionsgreater scrutinyAuditors subject to PCAOB inspections have to justify decisions made in the conduct of the audit. In order to provide such justification, auditors need to have clarity on how to reach important decisions.

Consultation

The KPMG Professional Judgment Framework44Doug: Briefly introduce KPMG framework, note that frameworks may be simple but they accomplish at least three important things: 1) establish a simple but effective process for making good judgments/decisions; 2) provide a consistent, shared conceptual framework to enhance understanding and communication in firms; and 3) provide a context in which to understand where judgments tend to go wrong so we can be aware of and on guard for traps and biases that can derail an effective judgment process!McGladrey Professional Judgment Framework

John: This slide depicts McGladreys judgment framework in a useful diagram. You may notice that we have numbered certain elements of the framework. While I will begin by discussing these number steps, it is important to point out that the judgment process is iterative, and so the sequence of the steps is non-linear.Center for Audit Quality: Judgment Tools

Embrace EthicsBeware of BiasesC o n s i d e r C o n s t r a i n t s M o n i t o r y o u r M i n d s e tFactors affecting judgmentBounded RationalityIncomplete informationTime and cost constraintsCognitive constraintsMemoryIntelligencePerceptionAttentionEnvironmental Constraints (considered later in this presentation)

Dealing with Bounded RationalitySatisficing

Heuristics

Kennedy (1993) describes Heuristics and biases as follows:Heuristics: Biases:

Heuristics and BiasesAvailabilityHeuristic:

Resulting bias

RepresentativenessHeuristic:

Resulting biases:

AnchoringUsually numericHeuristic: Resulting bias The Problem with Biases--OverconfidenceExamples:They couldnt hit an elephant at this dist (last words of Union General John B. Sedgwick)Two phrases that signal overconfidence bias: Watch this and Hold my beerhttps://www.youtube.com/watch?v=fPlQHYkHEzc Overconfidence can lead to:

What to do about it:

The Problem with Biases--ConfirmationExamples

Confirmation bias can lead to

What to do about it:https://www.youtube.com/watch?v=W_A5j3RuWHM

The Problem with Biases--AnchoringExamples:

Anchoring biases can lead to

What to do about it:

The Problem with Biases: AvailabilityExamples:

Availability bias can lead to:

What to do about it:Other TendenciesDistorted or motivated reasoninginterpreting information the way you want it to come outHindsightWe tend to attribute greater ability to have predicted uncertain outcomes in the past. So, we think we can predict the future better than we actually can.Rush to solveWith limited resources and tight deadlines, every accountant has to face this. https://www.youtube.com/watch?v=H4SpQqP2zuU Self-serving biasIt is almost impossible to discount how the expected outcome would affect us. As a result, we tend to favor the alternative that works out best for us (especially in the short-run).

Environmental Constraints on Decision-MakingIntuition and Decision-MakingIntuitionFast, effortless, automatic, implicit, emotional, evolutionarily priorDecision-makingSlow, effortful, conscious, explicit, rational, evolutionarily recent Reasons Why Auditors Are Susceptible to BiasFrom Bazerman et Al.AmbiguityAttachmentApprovalFamiliarity DiscountingEscalation