Chapter 4 Homework

University of Alabama in Huntsville ACC 607 Advanced Accounting Information Systems

Submitted by: Tina Newell, Holly Wade, Yajie Xu, and Elise Yarnell 3/14/2012

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Impression Management with Graphs: A Critique

University of Alabama in Huntsville ACC 607 Advanced Accounting Information Systems
Submitted by: Tina Newell, Holly Wade, Yajie Xu, and Elise Yarnell

The work by Vairam Arunachalam, Buck Pei, and Paul Steinbart titled Impression Management with Graphs: Effects on Choices explores the impact that improperly designed graphs have on decision making as it relates to corporate financial reports and information used by decision makers. The authors explore the idea that some corporations manipulate the use of an impression management tool, the graph, to present a more favorable view of their financial performance and the impact this has on investors.

Arunachalam et al summarize six rules of graphical representation that support the goal of leading users of graphs to reach the same conclusions about performance as would an analysis of the financial data. The first task was to establish that corporations manipulate financial data by using improperly designed graphs in financial reports to present a more favorable view to investors. They established this by citing five previous research papers with statistically significant numbers of prejudiced graphs. These studies indicate the instances of graph manipulation are increasing. The next goal was to ascertain if these graphs influence decisions makers.

The authors research centered on manipulating financial graphs in one of four ways. Proportionality distortions give the appearance that growth rates are higher than they actually are. Masking is a technique used to distort underperforming or declining performance by graphing that variable with another using one vertical scale even though the data range for the two variables are relatively broad. The designers of the graph choose a scale so that the underperforming/declining variable appears to change only slightly there by masking the true performance. Year reversal is presenting the data in reverse chronological order; this technique starts with the most recent year on the left and graphs each previous year to the right. Companies use this technique to create the sense that declining sales are actually increasing. The final improperly designed graph omits negative values. Preparers of corporate reports use a scale from zero to some positive value and do not graphically represent any performance result less than zero thought the numerical figure appears on the graph. This smoothing technique gives the impression that performance is much less erratic.

The authors chose college students as test subjects. They presented the case that the average investor has no greater understanding of corporate finance than that of a business student. This point while correct fails to take into account the stakes are far greater for the Page | 1

investor. One may make the argument that the monetary incentive is strong and encourages the investor to be more critical in his/her choices when purchasing stock. The study provided incentives for the top performing student portfolios which could only benefit the student, not cause a financial loss. The data related to was faithful to the available financial reports of the various firms. The researchers altered the graphical presentations to create the sense that firms were experiencing greater positive financial performance or a lesser degree of negative performance. The rational is that where performance management is occurring, it is to produce a favorable image of performance. This approach is supported by the research of Muino and Trombetta (2009, p.83) in their work Does graph disclosure bias reduce the cost of equity capital? in which the researchers conclude that graphical treatments relate improvements in management execution and that where distortion in graph depiction occurs, it tends to portray a more favorable view of corporate performance than the financial data actually represents; these conclusions are consistent with the authors contention that corporations are using graphs as tools of impression management. The experiment was in two phases. During the first phase, researchers asked the students to choose one of three companies that they would invest in based on the financial information provided in the graphs. The scientist used one of the previously mentioned distortion techniques modified two of the three graphs in each selection. The modified data sets were from the middle or lowest performer for the given category of financial information. The study design did not allow for the modification to the top performers graphs. This seems to be a flaw in the study. Although corporations appear to choose incorrect graphing techniques to boost the perceived performance, the experimenters were looking to see if these modifications influenced the choices made. The decision to not include the top performer by under representing the performance, we are left to conclude that only positive misperceptions can influence decision-making. The researchers missed an opportunity to test the other side of their hypothesis. In addition, this might have reflected on the validity of the data collected. The students may have made a bad choice when presented with the highest financial performer in the worst light. In the second phase, the researches worked exclusively with graph distortion on growth rates and the impact that a twofold misrepresentation would have on the choices a new set of students Page | 2

would make. A third experiment conducted with a control group to look at growth rates and the lowest ranked firms supported the conclusions of the first two. The results supported Vairam Arunachalam, Buck Pei, and Paul Steinbart assertion that graph distortions in financial reports do influence decision makers.

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References Arunachalam, V., Pei, B.K.W., and Steinbart, P.J. (2002), Impression management with graphs: theory and experiment, Journal of Information Systems, Vol. 16 No. 2, pp. 183-202. Muino, F. and Trombetta M. (2009), Does graph disclosure bias reduce the cost of equity capital?, Accounting and Business Research, Vol. 39 No. 2, pp. 83-102.

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