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«Forthcoming, American Economic Review Abstract We conduct an experiment assessing the extent to which people trade off the economic costs of ...»

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By contrast, in the model based on heterogeneous preferences for truthfulness, where Ci varies continuously throughout the population, varying economic costs would lead some individuals with intermediate total lying costs to change their behavior. Higher economic costs of truthfulness would then make it less likely that an individual would tell the truth.

Thus, we have the alternative hypothesis reflecting Gneezy’s conjecture:

Hypothesis HET (Model based on heterogeneous preferences for truthfulness):

The fraction of the population telling the truth varies with economic costs of truthfulness.

In Section III, we test these two hypotheses using aggregate behavioral data. We also specify an empirical model for individual choice to test the corresponding underlying predictions regarding the marginal effect of economic costs of truthfulness on individual choice.

Experimental method6 II.

We are interested in situations requiring a choice between telling the truth and telling a lie, in which the former decision involves an economic sacrifice. As our context, we chose accounting earnings management (henceforth called “earnings management”).7 This situation illuminates a real-life conflict: management’s variable compensation is frequently tied to stock price performance, which in turn often hinges on earnings announcements.

We envisioned a framework in which earnings management would be understood to be legal (for example, within GAAP rules) although explicitly self-interested and dishonest--a decision-making problem focused exclusively on the managerial choice. We required the recipient (the market, played by the computer) to accept passively all financial statements.

The advantage of this approach is that, due to the absence of strategic interactions, we have been able to isolate, at least better than in the real world, factors influencing individuals’ choices, without monitoring the participants’ thoughts regarding the behavior of other players.8

A. Participants and procedure

A total of 261 participants (median age: 23 years) took part in this online experiment. We recruited participants from undergraduate classes at the University of Zurich (Switzerland).

50% of the participants were economics and finance students, 40% psychology students, and 10% students from other fields. 42% were women and 58% were men (distributed across the fields). All participants were told at the outset that anonymity was ensured.9 The full set of instructions is available in a Supplementary Appendix. The experiment included tasks whose content and results are not described here for space reasons.

Accounting earnings management occurs “when managers use judgment in financial reporting and in structuring transactions to alter financial reports to either mislead some stakeholders about the underlying economic performance of the company or to influence contractual outcomes that depend on reported accounting numbers” (Healy and Wahlen 1999). Accounting earnings management can be viewed as a form of lying, which is defined as “a statement that one knows to be false” (Grover 2005). Nelson, Elliott, and Tarpley (2003) provide many examples collected from auditors.

In particular, despite the intuitive appeal and real-world relevance of the strategic games employed in Gneezy (2005) and in Hurkens and Kartik (2009), these games come with some interpretational challenges.

For instance, in sender-receiver games, even telling the truth can be deceptive, because the sender may hope that the receiver will not believe the true message that is sent (Sutter 2009). Additionally, Rode (2010) found that decision makers were significantly less trusting in a competitive context than in a cooperative context.

At the time of the experiment, the exchange rate was about US $1 = CHF 1.15. Most participants received payment one week after the experiment. For this purpose, each participant received, before the experiment, a They were first asked to respond to a few demographic questions and to read some basic instructions. They were informed that they would individually receive a payment, CHF 8, for their completed participation in the study, and an additional payment that depended on their decisions. After having demonstrated their understanding of the (unlabelled) tasks and of the rules of the experiment, the participants completed, in randomized orders, the three main parts of the experiment: 1) the truthtelling task, 2) the effort task, and 3) the measurement of various controls and potential proxies for intrinsic costs of lying. Finally, all the participants were paid. For simplicity, we describe the procedure for one of the randomized orders of tasks.

1) In the truthtelling task, each participant was placed in the situation of a CEO who had to announce earnings per share for the previous quarter. The participants were told that the variable component of their salaries would depend on the earnings they announced. They were also told that the market currently anticipated the announcement of 35 cents per share as earnings, but that the true earnings were 31 cents per share. The participants were told that they could announce earnings of 35 cents per share while remaining within legal accounting limits,10 and that the decision would be solely theirs. They were also informed that they would be paid an amount based on the CEO compensation (according to their decisions). This additional experimental payoff would be converted into real money at the rate of CHF 100,000 = CHF 0.5. Importantly, participants earned less when choosing to tell the truth.

The participants were then told they would have to announce their financial statements

that day. The truthtelling task questionnaire follows:

Which earnings will you announce?

__ 31 cents per share -- In this case, your compensation will be CHF 60,000 (CHF 0.30).

__ 35 cents per share -- In this case, your compensation will be CHF 300,000 (CHF 1.50).

code, based on which the experimenter prepared an envelope containing the earnings. Participants received the sealed envelopes by indicating their personal codes. It is, therefore, unlikely that a desire to appear honest affected the participants’ behavior systematically. Ariely, Bracha, and Meier (2009) document how publicly displayed monetary incentives can be less effective in promoting pro-social behavior than privately displayed incentives.

Therefore, risk preferences of individuals did not matter, as their choices were not based on the trade-off between the expected benefits and costs of committing a crime.

__ 31 cents per share -- In this case, your compensation will be CHF 120,000 (CHF 0.60).

__ 35 cents per share -- In this case, your compensation will be CHF 300,000 (CHF 1.50).

__ 31 cents per share -- In this case, your compensation will be CHF 180,000 (CHF 0.90).

__ 35 cents per share -- In this case, your compensation will be CHF 300,000 (CHF 1.50).

__ 31 cents per share -- In this case, your compensation will be CHF 240,000 (CHF 1.20).

__ 35 cents per share -- In this case, your compensation will be CHF 300,000 (CHF 1.50).

__ 31 cents per share -- In this case, your compensation will be CHF 300,000 (CHF 1.50).

__ 35 cents per share -- In this case, your compensation will be CHF 300,000 (CHF 1.50).

A few questions served as a manipulation check to verify that participants distinguished between the 31 and 35 cent options. The participants were asked, using a 5-point scale ranging from –2 to +2, the extent to which they judged announcing 31 cents as dishonest vs. honest, manipulative vs. not manipulative, short-term-oriented vs. long-term-oriented, and associated with personal benefits vs. associated with personal costs. The same was also done for the 35-cent announcement option.

2) Participants engaged in a simple calculation (effort) task.

3) We then measured, as potential sources of intrinsic costs of lying (a term we introduce formally in Section IV), their tendencies towards impression management and selfdeception, and their levels of protected values. Moreover, we also measured their altruistic concerns.

After the experiment, the participants anonymously received their payments of CHF 8 plus their earnings. The average total payment was slightly less than CHF 30.5.11 B. Variables of interest TRUTHFUL CHOICE. This represented the dependent variable in the truthtelling task, coded as a binary variable that took on the value of 1 if a participant chose to announce This amount includes payment for other tasks in the full experiment, as described in the Supplementary Appendix.

earnings of 31 cents (the honest option), and the value of 0 if a participant announced 35 cents (the dishonest option).

ECOST. This was a within-participants variation. Economic costs of truthfulness derived from the amount of money a participant forfeited by announcing 31 cents. The ECOST variable took on values from CHF 0 to CHF 1.20 (= 1.50 – 0.30), in increments of 30 cents.

IMPRESSION MANAGEMENT and SELF DECEPTION. Using the standard Deception Scales (PDS) of Paulhus (1984) in the German version of Musch, Brockhaus, and Bröder (2002), we measured individuals’ tendencies to give socially desirable responses. These tendencies come in two distinct forms: a tendency to deceive others (impression management) and a tendency to deceive oneself (self-deception). Both are expected to be positively related to intrinsic costs of lying. Accordingly, we coded two variables, EXTDECEIT and SELFDECEIT. We scaled the measures to be between 0 and 1.

Participants who exhibited more socially acceptable responses scored higher on both scales.

PROTECTED VALUES (PV). The extent to which participants held truthfulness as a protected value and, therefore, felt committed to truthtelling was another source of intrinsic costs of lying. To measure this source, we used an index developed by Tanner, Ryf, and Hanselmann (2009), the details of which are available in the Supplementary Appendix.

This index took on a value between 0 (for an individual with no protected values) and 6 (for an individual with maximum protected values). The internal consistency of this scale, as assessed by Cronbach’s , was very satisfactory ( = 0.86).12 ALTRUISTIC CONCERNS. We asked participants the extent to which they believed that announcing 31 cents (or 35 cents) had consequences for other stakeholders (-2 = hurting other stakeholders to +2 = not hurting other stakeholders). Of course, within the strict confines of the experiment, there were no such consequences. Nonetheless, this variable was a relevant control for any altruistic preferences or fairness concerns of the participants which might confound our inferences. Answers to this question were coded as the variable 35HURTS.

Cronbach’s Alpha is a measure of the reliability and the internal consistency of an instrument. The measure ranges from 0 to 1 and will generally increase when the correlations between the items increase.

DEMOGRAPHIC CONTROL VARIABLES. SEX was equal to 1 for female participants and to 0 for male participants. AGE was equal to each participant’s age in completed years. PSYCHOLOGY was equal to 1 for psychology students (“psychologists”) and to 0 otherwise. OTHER was equal to 1 for participants from fields other than psychology and economics and to 0 otherwise. ECONOMICS was the omitted category.

–  –  –

A. Descriptive evidence We first confirm, through a manipulation check, that the participants generally understood the announcement of 31 cents to be the honest, non-manipulative action that would lead to a personal loss, while the opposite was true of the announcement of 35 cents. (See Table I.)


Table II allows a first look at the choices the participants made in the experiment. In approximately 42% of cases (32% when omitting the free-truth situation), participants chose to announce low earnings, that is, chose not to engage in earnings management. By telling the truth, those participants opted to suffer, on average, effective monetary losses of 11% of the maximum total amount they could have earned in the truthtelling task or 27% of the variable amount they could have earned above the guaranteed payout.


The fact that a large proportion of the participants reported the truth, even when the conditions opposed it, is consistent with the notion that many individuals have positive total costs of lying. By contrast, this finding is inconsistent with the standard economic model.

B. Reactions to economic costs of truthfulness In this section, our primary goal is to test the implications of the type-based model, which posits that the (participant) population consisted only of “economic types” and “ethical types,” against the implications of the model based on heterogeneous preferences for truthfulness.

Table II, showing aggregate data, reveals substantial variation in the participants’ responses as the economic costs of truthfulness changed: with higher economic costs, the percentage of participants telling the truth was lower. This is inconsistent with the typebased model’s prediction in Hypothesis TYP, according to which the fraction of participants who told the truth would have remained constant. Formally, a  2 -test strongly rejects the hypothesis that there is a fixed fraction of “ethical” types who always tell the truth and a fixed fraction of “economic types” who always lie, with nobody differing from these two types. (This is true not only of the specific version postulated by Hurkens and Kartik (2009), where exactly half of the population always tell the truth and the other half always lie, but also for any other fraction between 0 and 1.) When there was no economic cost of truthfulness, 18% of the participants still chose the earnings-management solution.

This can be explained by recognizing that the model based on heterogeneous preferences for truthfulness allows agents to have a negative total cost of lying. (The manipulation check confirms that this group of people perceived 35 cents as the less honest option.) To investigate statistically the influence of the economic costs of truthfulness on individual behavior, we estimate a discrete choice / random utility model (e.g., King 1998;

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