In assessing the probable and actual effects of measurement information: Measurement information avoid perverse effects
- it is its impact on behaviour that counts; and
- how people use information and respond to it are therefore critical issues.
It cannot be assumed that those who use financial reporting information are perfectly rational in how they respond to it. Certain biases in the way that people typically process information are well attested; some of these are intellectual short-cuts that people use to make it easier to handle information, others are emotional biases. These biases may well affect how people deal with financial reporting information. For example, there is some evidence that investors tend to disregard the effects of changes in the value of money. As much financial reporting information includes data that covers long periods of time, this could have a distorting effect on how people interpret it.
How, if at all, financial reporting should respond to such biases is far from clear. The point being made here is simply that they are relevant to how information is used, and are therefore at least potentially relevant to deciding measurement questions in financial reporting.
Much information is relevant because it measures performance on which organisations and individuals are judged. But if people are judged on the basis of a particular measure, this can have perverse effects: ‘when a measure becomes a target, it ceases to be a good measure.’ There are three key problems here:
- Desirable activities whose results are not reflected in the measurement will tend to be neglected. For example, some argue that concentration on annual profit measurement leads to the long-term and non-financial effects of actions being disregarded by managers.
- There will be a tendency to redefine what is or is not included in the measurement, so as to achieve a favourable result.
- Those whose performance is being judged in the light of the measurement have a motive to bias it.
All of these are behavioural issues with which financial reporting (and business reporting in general) constantly has to grapple. Other things being equal, information that does not have perverse effects is obviously preferable to information that does. Measurement information avoid perverse effects
The implications of such behavioural issues for financial reporting are profound, as they suggest a need for it to be constantly evolving to keep ahead of the behavioural techniques that will inevitably develop to ensure that reported measures are as favourable as possible, regardless of whether they
reflect underlying reality. Measurement information avoid perverse effects
There are also behavioural issues affecting the links between management reporting and financial reporting, and whether particular measurement practices lend themselves to fraud. Measurement information avoid perverse effects