Even when lying, people are unselfish Monday, 23 June 2014
When and how much managers lie in company performance reports depends on how their colleagues would be affected by the results. New research by Associate Professor Marcel van Rinsum of Rotterdam School of Management, Erasmus University (RSM) reveals managers are more likely to overstate numbers if it means colleagues get some kind of benefit. But they are less likely to lie if it means colleagues get less. So, even when lying, we are unselfish.
Companies with shareholders are required to report earnings, and these performance reports are an important indicator of the company’s financial health. Good figures can invite investors to jump in – and poor results warn them to stay away, so accurate and honest information is crucial.
But it’s said that managers often lie in these performance reports, both internally and externally. Van Rinsum did an experiment that showed there’s a lot of lying going on with 47 per cent of participants always being honest, but the other 53 per cent choosing to lie. And what’s more, of this huge proportion that chose to lie, 37 per cent of the liars lied to get the maximum bonus.
Van Rinsum’s research (co-authored by V.S. Maas) reveals that the timing and extent of managers’ deceits in their performance reports depend on how their colleagues are affected by the results. Managers are more likely to overstate their numbers if it means colleagues get some kind of benefit. But they are less likely to lie if it means colleagues get less.
“People are afraid to be exposed as a liar, because it is a sin against the social norms.”
Group bonuses can turn people into ‘unselfish liars’. If a group bonus increases when people lie, resulting in higher bonuses for all, people lie more. This can happen when companies use ‘profit sharing’ plans. But if the team bonus is set at a fixed total amount and is divided between employees based on how well they performed, then people are less likely to lie because this can take away from the bonus earnings of someone else, which is seen as unfair. This is the case when companies use ‘relative performance evaluation’.
But when making the results public there are fewer overstatements, especially when managers have to make their performance reports known to others. People are afraid to be exposed as a liar – it’s a sin against social norms. When internal reports are not anonymous, lies occur less frequently.
These factors potentially affect how companies could stop accounting scandals where managers are ‘cooking the books’. Therefore, Van Rinsum suggests to use a pre-set amount for group bonus pools, since managers are reluctant to gain by lying at another person’s expense. And he also suggests making individual performance reports transparent within the company.
Rotterdam School of Management, Erasmus University (RSM) is ranked among Europe’s top 10 business schools for education and among the top three for research. RSM provides ground-breaking research and education furthering excellence in all aspects of management and is based in the international port city of Rotterdam - a vital nexus of business, logistics and trade. RSM’s primary focus is on developing business leaders with international careers who carry their innovative mindset into a sustainable future thanks to a first-class range of bachelor, master, MBA, PhD and executive programmes. RSM also has offices in the Amsterdam Zuidas business district and in Taipei, Taiwan. www.rsm.nl
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Read the entire RSM Discovery article on the research below.
Honesty presents a challenge in performance reporting
By Marcel van Rinsum
New research into the honesty of business unit managers when reporting performance shows that they have a tendency to overstate results when financial rewards are at stake.
Honesty in the presentation of financial performance figures by bonus-driven executives presents a continuing challenge to modern business. The bad news is that its requirements can easily be sidestepped by unscrupulous individuals or groups of individuals determined to maximise their own financial return at the expense of colleagues.
The good news is that there exist effective potential remedies for the condition. This has clear implications for all stakeholders in any commercial operation. Greater transparency can deliver positive results, as demonstrated in the paper How Control System Design Influences Performance Misreporting I co-wrote with Victor S. Maas and which was published in the Journal of Accounting Research.
The inspiration for the paper was the belief that managers who benefit from an information advantage will tend to exaggerate the results they have achieved in order to be awarded larger bonuses than would otherwise be the case. The recent news that UK supermarket chain Tesco had overstated profits by £250m provides a timely example of managers exaggerating results (see box).
Those who know and understand the underlying numbers better than anyone else in the organisation are well placed to overstate income or understate costs for their own short-term financial benefit. Putting it simply and bluntly, people have a tendency to lie in their own self-interest, a recurring theme throughout our experiment and the subsequent ongoing analysis.
Different questions arise with different forms of bonus payment. In the case of group bonus systems, for example, the incentive exists for a broader number of people to lie in order to boost evenly distributed group bonus payments. Even a partly trained moral philosopher could probably argue that this particular tendency towards what some might label as social lying is acceptable; a full-blooded utilitarian might even go further and argue that it is in fact right to lie in order to generate the best result for the greatest number of people. In the reverse situation, where a group bonus is divided proportionally based on individual performance, one manager might lie in order to increase his/her own stake at the expense of others. This might be labelled anti-social lying.
Reporting profits can at times appear to be as much an art as a science. The existence of a range of variables such as product and maintenance costs that can be changed almost arbitrarily creates opportunities and temptations to be economical with the truth. Ambiguity in accounting standards can further complicate the issue, presenting opportunities for non-fraudulent dishonesty.
Spending less on the maintenance of plant and machinery, for example, will boost short-term profits at the expense of longer-term issues. But by the time those issues force themselves to the top of the agenda, the managers involved will likely have moved elsewhere (and might well have repeated the trick elsewhere, boosting their own managerial reputation without delivering true added value).
Our experiment confirms that a considerable proportion of participants will report dishonestly to increase their payoff, although not to the maximum possible extent (they might be dishonest but they are not all greedy). The problem to solve, then, is to reduce the propensity to lie and therefore to reduce the number of liars and the volume of lies they tell.
Increasing honesty
Organisations seeking to increase honesty in reporting should not only pay greater attention to monetary incentives and selection policies in order to help them to hire ‘more ethical’ managers, but also to the social setting in which performance-reporting decisions are made. Organisations can use the two control system design variables from our study, related to transparency and group bonus type, to influence this setting and the social norms that govern the reporting decisions of managers.
In summary, our results suggest that performance misreporting by managers is influenced by the design of the management control system itself. First, overstatements can be seen to be lower in a group bonus system in which managers reduce the monetary payoff of their peers if they report a higher performance figure. In practice, this can be the case when a fixed bonus pool amount is distributed to managers based on their individual relative performance.
In contrast, when a group bonus grows with group performance, and is distributed evenly among managers, performance is much more often overstated. This dishonesty constitutes a ‘social lie’: it helps the individual manager, but also the group, by increasing the available group reward. This can happen under certain profit sharing arrangements.
Second, overstatements are reduced if companies adopt an open information policy with regard to individual performance reports, such that everyone knows exactly what everyone else has reported. Thus, deciding to be transparent in internal reporting systems seems a viable path for companies wishing to reduce dishonesty in managerial reporting.
The topic lends itself well to future study. Further research is needed to investigate, for example, how robust our results are in settings that differ from our own. In general, we believe that future accounting research should continue to incorporate insights and models from behavioural economics.
As our study shows, design variables of accounting and control systems - which are trivial within the traditional agency framework - can be very relevant from this broader perspective. Therefore, our understanding of the antecedents and consequences of such systems in real-world organisations is likely to be enhanced if researchers start out from a more comprehensive model of man than the homo economicus.
This article draws its inspiration from the paper How Control System Design Influences Performance Misreporting, written by Victor S. Maas and Marcel van Rinsum and published in the Journal of Accounting Research, Vol. 51 No. 5, p1159-1186, December 2013. http://onlinelibrary.wiley.com/doi/10.1111/1475-679X.12025/abstract
Marcel van Rinsum is Associate Professor, Department of Accounting & Control, Rotterdam School of Management, Erasmus University. Email: mrinsum@rsm.nl
