This is the second of a three-part series from Jim Peterson on bias in the accounting profession. You can read part one here.
Why do we make so many bad decisions? In life generally, or specifically in the accounting profession, how is it that people with high skills and apparent good faith so often lapse into seriously poor behaviors? All with the best intentions, the strenuous efforts of leaders, training and methodologies and guidance, rules and regulations?
The first installment in this series posed questions that–no less than in the human population as a whole–have bedeviled the accounting profession forever.
There are no “silver bullet” answers or solutions but we can recognize that the achievable goal is improvement rather than perfection. That is, there is a way forward, thanks to the practical applications of research done over the last fifty years, going to the very nature of our basic decision-making, and the sources of bias and error that are apparent in our human DNA.
A brief recap
Evolution has not relieved us of our prehistoric ancestors’ “fight or flight” instincts. Although never perfect or free of individually fatal mistakes, those instincts served often and well enough against ancient threats–-predators and enemies–to preserve the tribe and the safety of the species. But carried forward to complex modern life, these are ill-suited to situations where modern humans often default to easy and instinctive habits that are detrimental to good outcomes.
A future post will map these challenges to the accountants’ practice operations and management. This selection highlights how the shortcomings of our ancestral heritage show up in modern form in engagement performance and what some alternative approaches might be.
To start, the themes of ethics and skepticism are everywhere. The attention is pervasive: in every university course in accounting and audit and ethics and management, in the profession’s own standards, in leadership speeches and training seminars and CPE courses. Why then is it so hard to be ethical in behavior and skeptical in judgment? Or in the context where failures have consequences–-if the basic precepts are so easy most of the time, why do they so often break under pressure, when a choice made under stress can go so catastrophically wrong?
The answer from the scholars in human behavior is terse: it is easier to adopt simple stories that we want to believe, and to conform our choices to the pressures of the moment.
Why? Because that’s the way all humans are wired, going back to our pre-history. And accountants are not specially equipped or given a bypass around their human synapses.
The examples are everywhere, in life and practice:
- On a losing streak in the casino, we want to believe in the “gambler’s fallacy” because it feels better to convince ourselves that after a streak of reds, the wheel is somehow due for black.
- The business world wants to believe in the “success bias” of entrepreneurs. That’s the American spirit, after all, whether it’s the fictions of Theranos or FTX, as told by an enthusiast in cargo shorts or a Steve Jobs turtleneck. Or the messianic fantasy of Adam Neumann pitching the lifestyle gospel of WeWork, or a client CFO with starry visions in a newly-hatched business plan.
- A first cousin to “success bias” is the readily observed “herd behavior,” by which the enthusiasm of a crowd can overcome an individual’s capacity for analysis and discernment. While fads in a broad population can be as fleeting and harmless as hula hoops or pickleball, the energy of an irrational herd will feed its dangerous frenzies. Simply consider the investors in Bernie Madoff’s Ponzi scheme or the FOMO underpinning cryptocurrencies and non-fungible tokens.
- As a professional engagement wraps up: 1) “confirmation bias” motivates belief in the CFO’s confident projections-–to accept the client’s estimate as “good enough” based on last year’s results; 2) buying into its numbers under the “induction fallacy” that the CFO has never before fudged numbers for the audit committee; 3) also keeping the client relationship smooth and cheery and renewable for next year.
- “Readiness to believe” has a flip side: the difficulty of being the voice of bad news. Nobody likes a party pooper, and a dissenting view or a non-conforming opinion is a nail to be pounded down.
- Even more, the case brought forward by a message of dissent, when a response requires time and energy to wrestle with its numbers. Just as the ancient hunter had neither time nor energy to waste before his choice to take flight, the bias of the modern decision-maker is to “get on with it.”
- An over-optimistic CEO may have little patience with the reminder that: 1) most new ventures will fail; 2) very few money managers actually outperform the market; 3) optimistic projections are subject to the disruption of unanticipated events; 4) very few Stanford alumni will found a successful unicorn venture, black turtleneck or not.
Challenges to engagement judgments
Difficult areas of engagement judgment are particularly vulnerable:
- The bias of continuity and the easy default to inertia (i.e., if it ain’t broke don’t fix it). This would suggest staying this year with what worked last time, when the provision for doubtful accounts receivable had smoothly tracked the growth in client turn-over for several years. Failure to appreciate changes in a client’s customer profile, or expansion into new or untried markets, however, could leave the simpler approach exposed.
- While goodwill impairment judgments are difficult enough in the best of times, a swashbuckling CEO on a gallop of acquisitions will project overconfidence that is hard to resist. Track records may be short and ambiguous; a fast-growing enterprise may have outgrown its systems; limits on senior management experience may expose the entire process to “not knowing what they don’t know.”
- Client projections and estimates are candidates for failures under the “planning fallacy”–-the bias that underestimates the likelihood of unanticipated disruptions and delays. Long-term contract completion timetables, revenue growth targets for new products or markets, or the speed of recovery from a pandemic set-back–-all fit the same pattern and risk the prospect for a nasty burst of bad news.
Behavioral research provides an approach
While no span of the available examples can be comprehensive, there is a general recommendation from the scholars. It lies in the decision-makers finding a way to pause the process before making fast and instinctive gut-based commitments, and before overly enthusiastic leadership muscles forward with a hasty and flawed strategy.
It takes energy to break the old pattern that assumes smoothness and continuity. Straightforward examples include asking:
- “What’s new this year?” to set up fresh thinking.
- “What’s here that I might not understand?”to embrace and recognize that the world is both complex and fluid.
- “Have we reviewed this strategy for ways it could go wrong, our competitors’ responses, or alternatives that might actually be better?” Fresh perspectives can inject a pause into an otherwise headlong plunge.
Practical examples that cover a long span of history:
- A Roman emperor riding in the glory of his gilded chariot tasked a nearby slave to remind him of his limits: “Remember, sire, you too are mortal.”
- The retinue of rulers of old included the jester or the court fool–-not simply for royal entertainment, but with license to speak to power the truth of the king’s fallibility.
- The best business leaders will have in place a trusted source of second opinion and counsel to avoid “confirmation bias.” The legendary Warren Buffett has openly relied for decades on the input of lawyer/advisor Charlie Munger.
- Alfred P. Sloan, long-time leader of General Motors, pungently set out his distaste for yes-man conference table consensus:
Gentlemen, I take it we are all in complete agreement on the decision here…. Then, I propose we postpone further discussion … to give ourselves time to develop disagreement and perhaps gain some understanding of what this decision is about.
These themes map in various ways into engagement manuals and checklists. The next installment will focus on some areas of firm leadership, personnel interactions, and practice management.
