Academic journal article Auditing: A Journal of Practice & Theory

The Effects of Immediate Context on Auditors' Judgments of Loan Quality

Academic journal article Auditing: A Journal of Practice & Theory

The Effects of Immediate Context on Auditors' Judgments of Loan Quality

Article excerpt

INTRODUCTION

Auditors make many judgments regarding company attributes during the audit process. Systematic biases in judgments can lead auditors to different conclusions regarding accounting and auditing issues. We examine whether auditors, when making a series of judgments, have their later judgments non-normatively influenced by earlier judgments (referred to as the "immediate context"). The immediate context can lead to both contrast and assimilation effects in auditors' judgments and task-specific experience may moderate these effects. The study of auditors' susceptibility to these effects is important because they can significantly alter auditors' judgments. In addition, we attempt to better understand auditors' underlying cognitive processes when making a series of judgments using Parducci's (1965) range-frequency theory.

We report the results of an experiment in which participants made a series of judgments about the collectibility of commercial loans where the majority of the loans they evaluated were either high quality or low quality. The primary research question is what effect these "contextual" loans have on auditors' subsequent ratings of medium-quality loans. (1) We are interested in whether judgments made early in the series influence judgments made later in the series. This is related to, but different than, studies that examined Hogarth and Einhorn's (1992) belief-adjustment model. The belief-adjustment model is an "update" model where the decision maker is making a single judgment but revising his or her judgment based on new information. We examine the situation where the decision maker makes a series of independent judgments.

It is possible that the immediate context of evaluating loans of one quality level can lead to a contrast effect in judgments of loans of other quality levels. Parducci's (1965) range-frequency theory has been proposed as an explanation of how the distribution of recently experienced stimuli can affect judgment and lead to contrast effects. A contrast effect is a shift in judgment away from an anchor point on a scale in a direction opposite of that of the preceding stimuli. In the present study, a contrast effect would be reflected in a tendency for auditors to judge a loan as risky after examining a series of high-quality loans, but judge the same loan as sound after examining a series of low-quality loans.

Other theories, however, suggest that immediate context can lead to an assimilation effect in later judgments. Assimilation refers to a shift in judgment toward an anchor point on a scale, in the direction of the majority of the preceding stimuli. Several theories suggest that assimilation effects are produced as the result of biases in attention to and encoding of information. For example, the use of cognitive categories that reflect positive loan qualities in analyzing loans early in the series may prime those categories (Srull and Wyer 1980) increasing the probability that those same categories will be used in organizing one's perceptions of loans later in the series. Assimilation might also result from a categorization process, as is often observed in the literature on the use of group stereotypes in judgment (Biernat et al. 1991). In a loan analysis task, evaluating a preponderance of low-quality loans may build the perception that the loaning agency takes on risky loans. This characterization of the loaning agency may be used in evaluating subsequent loans, producing assimilation.

The determination of how context affects auditor judgment is important because auditors spend a large portion of their time making judgments about various attributes of individual companies, such as the correctness of account balances, adequacy of disclosures, effectiveness and reliability of internal controls, and collectibility of receivables. If context effects lead to systematic biases in auditor judgments, then one auditor's judgment about an item may differ from that of another auditor if each views the same item in different immediate contexts. …

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