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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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1) TRUTHTELLING TASK. 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 depended on the earnings they announced. They were also told that the market currently anticipated the announcement of 35 cents per share as earnings,3 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,4 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 choices). This additional experimental payoff was 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 to submit their financial statements that day. Specifically, they

were provided, in a randomized manner, with one of two orders of the following choice tasks:

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).

__ 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).

Manipulation check: As our manipulation check, the participants were provided with four items and 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, and short-termoriented vs. long-term-oriented. The same was also done for the 35-cent option. To verify that The actual term for the equivalent of cents in the Swiss currency is “Rappen,” and the experiment used the precise Swiss terminology, that is, a choice between 31 Rappen and 35 Rappen, where 100 Rappen = CHF 1. For simplicity, we refer to “cents” within the text.

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.

participants correctly perceived their options, we also asked participants the extent to which they associated announcing 31 cents (or 35 cents) with personal costs or personal benefits (-2 = associated with personal costs to +2 = associated with personal benefits).

2) EFFORT TASK. Participants engaged in a simple calculation task, testing the prediction that protected values of truthfulness would play no role in tasks without an honesty/dishonesty dimension. This also allowed us to examine somewhat the possibility that participants’ choices were affected by concerns regarding the experimenter’s wealth or by aspects of the experiment’s design (for example, the order of choices). In this task, all participants were given the role of a manager who could affect the firm’s value and their own remuneration by the amount and the

accuracy of the work that they did. Participants were then provided with the following slide:

In this task, you can increase earnings per share and, therefore, your compensation, by working. You will work on five sets of calculations. In each set, you can decide whether to do 1 or 5 simple calculations.

Doing 5 calculations takes approximately five times as long as doing 1 calculation, and you will be paid more for this. The compensation you receive for 1 and for 5 calculations will vary over the five sets of calculations. Moreover, you will receive CHF 0.2 for each correct calculation.

Participants were shown an example of a calculation, such as 3 + 4 – 5 + 8 + 3 – 9 = ? The

participants then read the following screen, one set of choices at a time:

How many calculations do you wish to do?

__ 1 calculation -- In this case, your compensation will be CHF 60,000 (CHF 0.30).

__ 5 calculations -- In this case, your compensation will be CHF 300,000 (CHF 1.50).

…. [Three analogous choice situations offering, for 1 calculation, CHF 120,000 (CHF 0.60), CHF 180,000 (CHF 0.90), and CHF 240,000 (CHF 1.20), respectively, are omitted for space reasons.] __ 1 calculation -- In this case, your compensation will be CHF 300,000 (CHF 1.50).

__ 5 calculations -- In this case, your compensation will be CHF 300,000 (CHF 1.50).

On this task, participants could earn between CHF 4.50 (for always choosing one calculation, done incorrectly) and CHF 12.50 (for always choosing five calculations, done correctly).

3) MEASUREMENT OF PROTECTED VALUES. According to the correspondence (or compatibility) principle established by Ajzen and Fishbein (1980), values and behavior need to be assessed at a similar level of specificity in order to be able to uncover a link between the two. This principle underlies the measure developed by Tanner, Ryf, and Hanselmann (2009), which we used to assess the extent to which participants held truthfulness as a protected value and, therefore, felt committed to truthtelling. Since we are studying earnings management behaviors, we adapted the introduction of their questionnaire to the present context. The questionnaire (see Section II of the Appendix) contains two highly correlated subscales designed to approach protected values from different angles. Five items assessed the participants’ reactions to violations of honesty by a hypothetical CEO reporting company information. This represents an indirect approach because the decisions of others were being evaluated. Four additional items assessed the participants’ own protected values more directly by examining how much importance they attributed to specific features of protected values (such as trade-off reluctance, unwillingness to sacrifice a value, or incommensurability), again referring to the specific context of a hypothetical CEO’s decisions regarding the reporting of information.





The participants also had to answer another set of questions, which served as control variables.

After the experiment, the participants anonymously received their payments of CHF 8 plus their earnings.5

DEPENDENT VARIABLES

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

EFFORT CHOICE. This represented the dependent variable in the effort task. It took on the value of 1 if a participant chose to do five calculations (high effort), and the value of 0 if a participant chose to do one calculation (low effort).

EXPLANATORY VARIABLES

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

As explained earlier, by using codes to distribute earnings, we took as much care as possible to ensure anonymity.

That is, we tried to remove any possible grounds for expecting reciprocity. It is, therefore, unlikely that a desire to appear honest affected the participants’ behavior systematically. See Ariely, Bracha, and Meier (2009) for a study of how publicly displayed monetary incentives can be less effective in promoting pro-social behavior than privately displayed incentives.

PROTECTED VALUES (PV). After appropriate recoding of some items, an index of the degree of protected values (PV) was constructed, based on the means across the four direct and the five indirect items. 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).6

CONTROL VARIABLES

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 potentially relevant control for altruistic preferences or fairness concerns that participants might have and that might confound our inferences regarding protected values of truthfulness. Answers to this question were coded as the variable 35HURTS.

SOCIALLY ACCEPTABLE RESPONDING. We used the standard Deception Scales (PDS) of Delroy Paulhus (1984); see Musch, Brockhaus, and Bröder (2002) for the German version. This questionnaire measured individuals’ tendencies to give socially desirable responses (SDR), in two distinct forms: self-deception and impression management. Accordingly, we coded two variables SELFDECEIT and EXTDECEIT. Participants who exhibited more socially acceptable responses scored higher on both scales.

DEMOGRAPHIC CONTROL VARIABLES. SEX, AGE, and STUDIES served as 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.

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. We also did the analysis using the direct and indirect subscales separately, with similar results.

II. Protected Values survey According to the correspondence (or compatibility) principle established by Ajzen and Fishbein (1980), values and behavior need to be assessed at a similar level of specificity in order to be able to uncover a link between the two. This principle underlies the measure developed by Tanner, Ryf, and Hanselmann (2009). Since we are studying earnings management behaviors, we adapted the introduction of their questionnaire to the present context. The questionnaire, contains two highly correlated subscales designed to approach protected values from different angles. Five items assessed the participants’ reactions to violations of honesty by a hypothetical CEO reporting company information. This represents an indirect approach because the decisions of others were being evaluated. Four additional items assessed the participants’ own protected values more directly by examining how much importance they attributed to specific features of protected values (such as trade-off reluctance, unwillingness to sacrifice a value, or incommensurability), again referring to the specific context of a hypothetical CEO’s decisions regarding the reporting of information. After appropriate recoding of some items, an index of the degree of protected values (PV) was constructed, based on the means across the four direct and the five indirect items.

Note: The original Protected Values survey was conducted in German. In the paper, for ease of interpretation of the empirical results, we changed the scale to range from 0 to 6.

Because CEOs’ compensation levels depend on the earnings they report to their shareholders, CEOs have an incentive to modify reports to shareholders. What is your opinion on CEOs modifying company information in reports?

Please choose the appropriate category. This is:

–  –  –

CEOs have an opportunity to modify information in the reports they provide to their shareholders.

Some view such modification as a violation of truthfulness, others regard it as acceptable protection of personal interests. What do you think about the value of truthfulness in such a situation?

Truthfulness is something

–  –  –

Figure S-1: This figure plots the kernel density (using an Epanechnikov kernel) of the strength of protected values of the participants who chose to manage earnings (broken line) and for those participants who willingly bore economic costs for not managing earnings (solid line). The figure is plotted for the median cost level in Phase 1. Protected Values (PV) is the average of all nine items of the survey described in the text. Higher numbers correspond to stronger protected values.

B. Quantitative implications for preference parameters



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