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Cognitive Processes and Ethical Decision Making in Accounting

Chapter 02

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Learning Objectives

L O 2-1: Analyze the thought processes involved in, and the impact cognitive biases have on, making decisions and taking ethical action.

L O 2-2: Describe Kohlberg’s stages of moral development.

L O 2-3: Explain Rest’s Model and how its components influence ethical decision making.

L O 2-4: Describe the link between organizational culture, ethical climate, ethical leadership, and ethical decision making.

L O 2-5: Distinguish between Equity, Diversity, and Inclusion.

L O 2-6: Apply both the Integrated Ethical Decision-Making Model and the Giving Voices to Values Methodology to a case study.

Chapter Organization

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Learning Objective 1

Analyze the thought processes involved in, and the impact cognitive biases have on, making decisions and taking ethical action.

Behavioral Ethics

Behavioral ethics emphasizes how individuals actually make decisions and the impact our cognitive biases have on those decisions.

Kahneman’s suggests two distinct modes of decision making:

System 1 thinking is an intuitive system of processing information.

Fast, automatic, effortless, and emotional.

System 2 thinking is a reasoned decision process.

Slower, conscious, effortful, and explicitly.

Cognitive Biases

Understanding unconscious biases that people may have is an important first step to preventing unethical behavior.

Where these bias’s come from.

Types of Biases.

Incrementalism.

Situational Factors.

Cognitive Dissonance.

Bystander Effect.

Theories About the World

Deterministic Bias.

Hindsight Bias.

Attribution Bias.

Framing Bias.

All of the above biases contribute to underestimating the risk associated with the decisions being made.

Theories About Other People

Ethnocentrism

Thinking of ourselves and those most similar to us as better than others.

US versus Them Mentality.

Our nation is better than any other nation.

Our Baseball team is better than any other team.

People who think and act like me are better than those that don’t.

Stereotypes

Derived from ethnocentrism.

People often attribute negative attributes to those not similar to themselves.

Theories About Ourselves

Overconfidence/Superiority Bias.

Oversimplification Bias.

Loss Aversion Bias.

Authoritative Bias.

Conformity Bias/ Group Think.

Incrementalism

The Slippery Slope.

Once you agree to do something unethical and or illegal once it is more likely you will do it again.

Your past actions can be used against you in the future.

Often times presented as a ‘one time’ request or as being ‘immaterial’.

There is no concept of materiality when it comes to fraud.

Situational Factors

Time Pressure

People tend to cut corners when under a deadline.

Transparency

The importance of Internal Controls – People do not respect what you do not inspect.

Leon Festinger

Recognized the limitation of philosophical reasoning approaches integrated into decision making models.

How we think we should behave is different from how we decide to behave.

Coined term of Cognitive Dissonance in 19 56.

Cognitive Dissonance

Inconsistency between our thoughts, beliefs, or attitudes and behavior creates the need to resolve contradictory or conflicting beliefs, values, and perceptions.

Only occurs when we are “attached” to our attitudes and beliefs.

How we think we should behave is different from how we decide to behave.

Bystander Effect

Tendency not to report wrongdoing or try and help someone in need thinking others will.

The New York City Subway Incident.

The Harvey Weinstein Case.

Countless other incidents of Sexual Harassment in the workplace.

Learning Objective 2

Describe Kohlberg’s stages of moral development.

Kohlberg and Cognitive Development

Psychologist.

20 years of research.

Moral reasoning processes becomes more complex and sophisticated with development.

Higher stages are consistent with philosophical theories of rights and justice.

Heinz and the Drug

Heinz’s wife has a rare cancer.

A radium drug could help.

Druggist charged 10 times what drug cost ($200 cost; $2,000 for small dose of drug).

Heinz could only get together $1,000.

Druggist would make no exceptions to price of drug.

What should Heinz do?

Sample Responses to the Heinz Dilemma

Egoism: Steal the drug, depending on how much Heinz likes his wife and how much risk to stealing.

Ends justify the means: Steal the drug, due to loving the wife so much and cannot watch her die.

Act Utilitarianism: Weigh the costs and benefits of alternative actions.

Rule Utilitarianism; justice: Do not steal the drug, since stealing is against the law.

Rights: Right to life above all else (Constitutionally: life, liberty, and the pursuit of happiness).

Kohlberg’s Stages of Moral Development

Lawrence Kohlberg’s six stages of moral development are divided into three levels of moral reasoning.

Level 1 – Preconventional.

Level 2 – Conventional.

Level 3 – Postconventional.

Level 1 - Preconventional

Rules are seen as something external imposed on one’s self.

Individual is very self-centered.

Stage 1 – Obedience to rules; avoidance of punishment.

Stage 2 – Satisfying one’s own needs (egoism); follow rules only if they satisfy one’s needs.

Level 2 - Conventional

Individual becomes aware of the interests of others and one’s duty to society.

Personal responsibility is an important consideration in decision making.

Stage 3 – Fairness to others; commitment to loyalty in the relationship.

Stage 4 – Law and order; one’s duty to society, respect for authority, maintaining social order.

Level 3 - Postconventional

Individual recognizes there must be a society wide basis for cooperation.

Orientation to principles that shape whatever laws and role systems a society may have.

Stage 5 – Social contracts; upholding the basic rights, values, and legal contracts of society.

Stage 6 – Universal ethical principles that everyone should follow, Kohlberg believed this stage rarely existed; Kant’s categorical imperative.

Characteristics of Kohlberg’s Model

Kohlberg maintains that his stage sequence is universal.

Same in all cultures.

Stages refer not to specific beliefs, but underlying modes of reasoning.

Suggests that people continue to change their decision priorities over time and with additional education and experience.

Individual’s moral development can be influenced by corporate culture, especially ethics training.

Learning Objective 3

Explain Rest’s Model and how its components influence ethical decision making.

Moral Reasoning and Moral Behavior

Moral judgment is the single most influential factor of a person’s moral behavior.

Morality requires.

Person’s actions be rational.

Motivated by purpose or intent.

Carried out with autonomous free will.

Rest’s Model of Morality

James Rest’s model of ethical action is based upon the presumption that an individual’s behavior is related to her/his level of moral development. He breaks down the ethical decision-making process into four major components.

Components of Rest’s Model

Moral Sensitivity – ability to identify what is moral and amoral.

Moral Judgment – ability to reason through several courses of actions and making the right decision when faced with an ethical dilemma.

Moral Motivation – influences that affect an individual’s willingness to place ethical values ahead of non-ethical values.

Moral Character – having one’s ethical intentions match actions taken.

Moral Intent

Critical component of ethical decision making.

Internalization of virtues.

Acting in accordance with principles.

One must want to make the ethical decision.

Components Interact

All processes must take place for moral behavior to occur.

This framework is not a linear decision-making model, the processes instead work through sequence of “feed-back” and “feed-forward” loops.

Moral failure can occur when there is a deficiency in any one component.

Libby and Thorne: Virtues Important for Auditing

Intellectual virtues: indirectly influence individual’s intentions to exercise professional judgment.

Most important: integrity, truthful, independent, objective, dependable, principled, and healthily skeptical.

Instrumental virtues: directly influence individual’s actions.

Most important: diligent, alert, careful, resourceful, consultative, persistent, and courageous.

Linda Thorne’s Integrated Model of Ethical Decision Making

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Learning Objective 4

Describe the link between organizational culture, ethical climate, ethical leadership, and ethical decision making.

Organizational Ethics, Ethical Culture, and Ethical Climate

Organizational Ethics

Generally accepted principles and standards that guide behavior in organizational contexts.

Ethical Culture

Explicit statement of values, beliefs and customs from top management. It is typically found in the Company’s Code of Ethics.

Organizational ethical climate

Moral atmosphere and level of ethics practiced within a company.

Importance placed on E D I.

Determined by leaders.

Shared values, beliefs, goals, and problem-solving.

Focuses on issues of right and wrong.

Establishing an Ethical Culture

Corporate culture is the shared beliefs of top managers in a company about how they should manage themselves and other employees, and how they should conduct business.

Tone at the top refers to the ethical environment that is created in the workplace by the organization’s leadership.

Corporate culture starts with an explicit statement of values, beliefs, and customs from top management.

Creating a culture which actively promotes an inclusive work environment that values diversity is essential.

A code of ethics serves as a guide to support ethical decision making.

It clarifies an organization’s mission, values, and principles, linking them with standards of professional conduct.

Ethical Leadership: Tone at the Top

Leaders of Good Character

Possess integrity, courage, and compassion.

Careful and prudent.

Decisions and actions inspire employees to act in an enhancing way.

Virtues

Courage, temperance, wisdom, justice, optimism, integrity, humility, reverence and compassion.

Role Models

Employees follow the actions of their leaders over written codes of conduct.

Key Markers of Highly Ethical Organizations

Humility.

Zero tolerance for individual and collective destructive behaviors.

Justice.

Integrity.

Focus on Equity, Diversity and Inclusion.

Trust.

A focus on process.

Structural reinforcement.

Social responsibility.

Values-driven organization that encourages openness, transparency, and provides supportive environment to voice values without fear of retribution or retaliation.

Learning Objective 5

Distinguish between Equity, Diversity, and Inclusion.

Equity, Diversion, and Inclusion (E D I)

E D I means to give each person the same opportunity, accepting people from different races, genders, religions, and nationalities.

E D I policies should promote ethical behavior and tear down biases.

Promote justice and fairness.

Virtues of caring, kindness and empathy.

Deloitte Survey: How to Create a Culture of Belonging

25% identified fostering an environment where workers feel they are treated fairly and can bring their authentic selves to work (feeling comfortable) as the biggest driver of belonging.

31% identified having a sense of community and identifying with a defined team (feeling connected) was the biggest driver.

44% identified feeling aligned to the organization’s purpose, mission, and values and being valued for their individual contributions (feeling their contributions matter) was the biggest driver of belonging at work.

Deloitte Survey: Value of E D I efforts in the Workplace

72 % indicated that fostering a sense of belonging at work is important.

93% indicated that a strong sense of belonging drives organizational performance.

Unfortunately, only 13% indicated that they were ready to address / make the changes necessary to foster belonging in their organizations.

Better Up Survey: Importance of E D I Efforts

Workplace belonging can lead to:

a 56% increase in job performance;

a 50% reduction in the risk of turnover;

And, a 75% decrease in the number of employees calling in sick.

One single incidence of a micro-exclusion can result in a 25% reduction in productivity.

Factors that Influence Ethical Decision Making

Individual Factors

Values of individuals.

Organizational and social forces shape behavioral intentions and decision making.

Organizational Factors

Organization’s values have a greater influence than a person’s own values.

Ethical Dissonance

The Organizational to Individual Fit.

Opportunity

Conditions that limit or permit ethical or unethical behavior.

Business Ethics Intentions, Behavior, and Evaluations.

Organizational ethical culture is shaped by effective leadership.

Organizational Influence on Ethical Decision Making

The Jones-Hiltebeitel model looks at the role of one’s personal code of conduct in ethical behavior within an organization.

When one’s personal code is insufficient to make the necessary moral decision, the individual will look at professional and organizational influences to resolve the conflict.

Ethical Dissonance Model

Interaction between the individual and the organization, based upon person-organization ethical fit at various stages of the contractual relationship in each potential ethical fit scenario.

Four potential fit options:

High-High (high organization & high individual ethics).

Low-Low (low organization & low individual ethics).

High-Low (high organization & low individual ethics).

Low-High (low organization & high individual ethics).

Ethical Dissonance Model 2

High Organization Ethics & Low Individual Ethics	High Organizational Ethics & High Individual Ethics
Low Organizational Ethics & Low Individual Ethics	Low Organizational Ethics & High Individual Ethics

Learning Objective 6

Apply both the Integrated Ethical Decision-Making Model and the Giving Voices to Values Methodology to a case study.

Accountants Ethical Behavior

Accounting profession has professional standards to encourage ethical behavior.

These standards, an individual’s attitudes and beliefs, and ethical reasoning capacity influence professional judgment and ethical decision making.

Post conventional reasoning is the ethical position to take even though it may go against corporate culture of, “go along to get along”.

Ethical Domain in Accounting and Auditing

Four key constituent groups of accountants and auditors’ domain are the:

Client organization that hires and pays for accounting services.

Accounting firm that employs the practitioner.

Accounting profession including various regulatory bodies.

General public who rely on the attestation and representation of the accounting firm.

Empirical Studies

Studies have shown that:

Ethical reasoning may be an important determinant of professional judgment.

Unethical and dysfunctional audit behavior may be systematically related to the auditor’s level of ethical reasoning.

Ethical reasoning may be an important cognitive characteristic that may affect individual judgment and behavior.

Ethical Decision-Making Models

Consciously thinking about and analyzing what one has done (or is doing).

A systematic process to organize the various elements of ethical reasoning and professional judgment.

Evaluate stakeholder interests.

Analyze the relevant operational and accounting issues.

Identify alternative courses of action.

Integrated Ethical Decision-Making Process

Identify the ethical and professional issues (ethical sensitivity).

Identify and evaluate alternative courses of action (ethical judgment).

Reflect on the moral intensity of the situation and virtues that enable ethical action to occur (ethical intent).

Take action (ethical behavior).

Ace Manufacturing

Three stockholders: Smith, Williams, & Jones.

Jones hires son Paul to manage the office.

Paul is given complete control over payroll, approves disbursements, signs checks, reconciles G/L cash to bank statement.

Paul hires Larry Davis to help with accounting.

While Paul is on medical leave, Davis finds $10,000 total in payments over payroll amount to Paul in January and February.

What should Davis do?

Application of Decision-Making Model to Ace Manufacturing 1

Identify the ethical and professional issues (ethical sensitivity).

G A A P – Potential fraud, misstated F/S, incorrect taxable income.

Stakeholders – owners, Paul, Davis, I R S, banks.

Ethical/professional standards – objectivity, integrity, due care.

Identify and evaluate alternative courses of action (ethical judgment).

Legal issues – G A A P, fraudulent F/S, tax understatement.

Alternatives/ethical analysis – do nothing, confront Paul, report to Jones or all the owners. Rule utilitarianism and rights argue for informing other partners who have a right to know, although Paul can be approached first under the theory he has a right to correct the matter.

Application of Decision-Making Model to Ace Manufacturing 2

Use Ethical Reasoning to evaluate the alternative courses of action.

Will Davis be responsible for getting Paul in trouble?

What is the right thing to do?

Can Davis trust Paul again?

Davis needs to maintain Integrity and avoid cognitive dissonance.

Take action (ethical behavior).

Have courage, insist on correction to accounting, give Paul an opportunity to explain.

Giving Voice to Values

Behavioral ethics approach with an emphasis on developing the capacity to effectively express one’s values in a way that positively influences others.

Finding levers to effectively voice and enact one’s values.

Ask to think about the arguments others might make that create barriers to expressing one’s values in workplace.

Ask to think how best to counteract these “reasons and rationalizations”.

Used post-decision making (already decided what to do).

G V V Questions

How you get it done effectively and efficiently?

What do you need to say, to whom, and in what sequence?

What will the objectives or pushback be, and, then.

What will you say next?

What data and examples do you need to support your point of view?

G V V relies on developing arguments, action plans, and rehearsing how to voice/enact moral values.

Reasons and Rationalizations

Expected or Standard Practice – “Everyone does this”.

Materiality – “The impact is not material. It doesn’t really hurt anyone”.

Locus of Responsibility – “This is not my responsibility; I’m just following orders”.

Locus of Loyalty – “This is not fair to the client, but I don’t want to hurt my reports/team/boss/company”.

Isolated Incident – “This is a one-time request”.

4 – Step G V V Process

What are the main arguments you are trying to counter? That is, what are the reasons and rationalization you need to address?

What’s at stake for the key parties, including those with whom you disagree?

What levers can you use to influences those with whom you disagree?

What is your most powerful and persuasive response to the reasons and rationalizations you need to address?

Ace Manufacturing Analysis with G V V 1

What are the main arguments to counter or reasons and rationalizations to address?

No one hurt, private company, sympathy card, materiality, not being compensated properly, isolated incidents, Jones has approved, will pay back.

What’s at stake for the key parties?

Reputations, embarrassment, right to know, loss of job, ability to obtain loan.

Ace Manufacturing Analysis with G V V 2

What levers can you use to influence those with whom you disagree?

Ask for supporting documents for coding of expenses, harm to company and embarrassment to dad, long-term effects, telling all the owners.

What is your most powerful and persuasive response to the reasons and rationalizations?

Verifying that vendor is not paid twice, using money for personal use is stealing and no materiality test, challenges Jones about knowing, owners need (have a right) to know.

Concluding Thoughts/Key Issues

“The road to success is littered with failures, but the lessons learned are crucial in plotting your course to success.” Kristi Loucks.

Kohlberg’s model of moral development.

Rest’s model of ethical decision-making.

Cognitive development.

Issues of moral intensity and virtue in Integrated Decision-Making mode.

Behavioral ethics.

Moral reasoning skills.

Giving Voice to Values.

Video Links

Ethics Relationships.

Baby Lab.