Environmental Complexity and Financial Reports

Environmental Complexity and Financial ReportsAuthor(s): Henry MillerSource: The Accounting Review, Vol. 47, No. 1 (Jan., 1972), pp. 31-37Published by: American Accounting AssociationStable URL: http://www.jstor.org/stable/244564 .

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Environmental Complexity and Financial Reports

Henry Miller

IN A thought-provoking October, 1970 Accounting Review article, Lawrence Revsine described a relationship be-

tween the complexity of the financial reporting environment and the conceptual structure of financial statement users.' By borrowing from psychologists' literature, he pointed out that information processors' conceptual level is at a point of maximum abstractness at some intermediate point of environmental complexity. He concluded that although this relationship has been empirically tested by psychologists, it was "not yet demonstrably relevant to" financial reporting, and should therefore be empirically tested in accounting.2

Upon further examination of Revsine's hypothesis and the body of literature that supports it, it appears that the relationship is more complex than indicated and ought to be studied in greater depth before empirical tests are applied. It is the purpose of this article to further develop Revsine's arguments, to examine their implications, and to demonstrate that accountants may have some notion of the complexity of the external reporting environment before they conduct rigorous empirical tests. The author thus hopes to provide further insight into the purpose of such tests and contribute to the debate over whether the expansion of existing financial reports is useful at this time.

ENVIRONMENTAL COMPLEXITY AND CONCEPTUAL STRUCTURE3

Revsine applied behavioral scientists' findings that decision-makers have limited capacities for processing information to external accounting reports. He noted that Schroder, Driver and Streufert have demonstrated empirically that increases in the complexity of the information processor's environment beyond an optimal point results in a lowering of the processor's ability to make judgments.4

Schroder, Driver and Streufert, in examining the relationship between environmental complexity and conceptual structure, concluded that an environment is complex if it provides "excessively diverse and/or numerous dimensional units of information," i.e., information which requires substantial integration of thought can be described as multi-dimensional and

1 Lawrence Revsine, "Data Expansion and Concep- tual Structure," THE ACCOUNTING REVIEW (October 1970), pp. 704-11.

2 Ibid., p. 711. 3 Much of this section is a restatement of that portion

of Revsine's hypothesis which is essential for further development.

4 Revsine, p. 709, and Harold M. Schroder, Michael J. Driver and Siegfried Streufert, Human Information Processing (Holt, Rinehart and Winston, Inc., 1967), p. 33.

Henry Miller is Assistant Professor of Accounting at the State University of New York at Binghamton.

31



3T The Accounting Review, January 1972

therefore complex.5 The financial reporting environment appears to be complex since the financial decision-maker must con- sider the many dimensions of a single bit of information.6

Conceptual structure refers to an individual's potential to generate new attri- butes of information and discriminate between stimuli as the number of dimensions he perceives increases. An individual who can make fine discriminations within a complex, flexible schemata is considered to have an abstract conceptual structure whereas one who processes information according to a fixed set of rules and who resolves conflict or ambiguity by eliminat- ing information from consideration is considered to have a concrete conceptual structure.7 Other characteristics which differentiate abstract structures from more concrete ones include the individual's ability to shift reflectively from one aspect of a situation to another, his ability to hold in mind various aspects of a situation simultaneously, and his ability to grasp the essential of a given whole, breaking it up into parts and isolating and synthesiz- ing the parts.8 Conceptual level varies for processors in their roles as financial statement users e.g., the financial analyst who can integrate many of the diverse dimensions of financial information demon- strates an abstract conceptual structure while the investor who makes decisions by evaluating only price-earnings ratios dem- onstrates a relatively concrete conceptual structure.

Revsine presents the Schroder, Driver and Streufert conclusion that prior to the attainment of maximum abstractness, an increase in environmental complexity (in the case of financial reporting, information load may be substituted for environmental complexity) will increase abstractness. Beyond the maximum point, abstractness is decreased as the environment grows more complex.9 No matter how relevant

the information that is added to the environment may be, if it is presented after maximum abstractness is reached, it will reduce conceptual structure and cause the decision-maker's model to grow more concrete. The general relationship between environmental complexity and conceptual structure is given by Revsine and Schro- der, Driver and Streufert as in Figure 1.

Abstract

Conceptual Level

Concrete

Low X High

Environmental Complexity

FIGURE 1

ENVIRONMENTAL COMPLEXITY AND CONCEPTUAL STRUCTURE

The findings of the behavioral scientists appear, then, to have implications for accountants. The facilitation of financial decisions, an assumed objective of financial reporting, appears to be accomplished by the attainment and maintenance of optimal abstractness of conceptual structure. Revsine indicates difficulties in im- plementing an optimal environment since accountants do not know how complex the current environment is and because of the potential variation of users' conceptual

Schroder, Driver and Streufert, p. 31. 6 Revsine, pp. 705-706. 7 Peter Suedfeld, "Attitude Manipulation in Re-

stricted Environments: I. Conceptual Structure and Response to Propaganda," The Journal of Abnormal and Social Psychology (March 1964), p. 243.

8 0. J. Harvey, David E. Hunt and Harold M. Schroder, Conceptual Systems and Personality Organiza- tion (John Wiley and Sons, Inc., 1961), pp. 31-33. The reader is referred to this work for a more comprehensive description of conceptual structure.

9 Schroder, Driver and Streufert, p. 38.



Miller: Environmental Complexity 33

structures.10 He calls for empirical tests to determine the applicability of the described model for financial reporting and the uncovering of "more precise knowledge concerning user decision models and im- plicit data needs," a task he describes as "easily the most formidable ever faced by accounting researchers.""

APPLICABILITY OF THE APPROACH TO THE FINANCIAL REPORTING ENVIRONMENT

Jensen cautions accountants on the potential lack of applicability of some behavioral science findings to accounting.'2 He emphasizes such findings are usually limited to the specific instance examined and should not be generalized to describe other situations to which they have not been empirically tied.

The warning seems appropriate for the application of the Schroder, Driver, Streu- fert model to financial reports. The environment in which the psychologists tested their hypothesis differs from the financial reporting environment in that it was held constant for all participants. The conceptual levels of the participating groups varied as they sought to interpret the dimensions of information they re- ceived in a tactical war game and a simulation of international politics. These two environments, although complex, provide a relatively limited universe of operations in which all participants face essentially the same set of alternatives and receive the same set of information, i.e., despite the complexity of their tasks, the participants operate in a restricted environment which is constant for each group. An analogous financial environment would require every financial statement user's information environment to be potentially the same. In fact, the investor's financial reporting environment provides several levels of information from which he can choose none or all of the information made available by accountants, financial analysts,

newspapers, stockbrokers and other investment advisory services. It is unlikely that a significant number of investors would choose the same set of information and thus place themselves in an environment of similar complexity. In fact, Tuck- man has shown that there is a relationship between information search and the abstractness of the individual. He concluded, on the basis of the results of a stock mar- ket simulation, that abstract processors seek more information than those with more concrete structure.'3 Thus, it appears likely that the processor's level of abstractness will be a determinant of the complexity of his environment. Despite this environmental difference, Schroder, Driver and Streufert do provide some insight into the environment-decision making capability relationship in financial reporting.

The basic relationship described by Revsine (Figure 1) is, in fact, an aggrega- tion of one of two possible groups of individual relationships. These are shown in Figures 2 and 3. Figure 2 shows the relationship that Schroder, Driver and Streu- fert found in their experiments. It indicates that the point of maximum abstractness is constant for all conceptual structures, including the most abstract and the most concrete processors, within the same environment.'4 If this relationship exists for financial reporting as well, the problem of finding the optimal information load, i.e., environmental complexity, appears possible. There is, according to this hypothesis, only one optimal environment for a decision task (e.g., the shareholder's

10 Revsine, p- 709. I' bid., p. 711. 12 Robert E. Jensen, "Empirical Evidence from the

Behavioral Sciences: Fish Out of Water," THE Ac- COUNTING REvrEw (July 1970), pp. 502-3.

13 Bruce W. Tuckman, "Personality Structure, Group Composition, and Group Functioning," Socionietry (December 1964), p. 484.

14 Schroder, Driver and Streufert, p. 153.



34 The Accounting Review, January 1972

Abstract

Conceptual Level

Concrete '_ _ Low X High


FIGURE 2

MAXIMUM ABSTRACTNESS IN A

CONSTANT ENVIRONMENT

investment decision), regardless of the variation in users' structures.

Figure 3 shows an alternative group of curves which correspond to Schroder, Driver and Streufert's Theory I.15 These researchers have compiled preliminary evidence which supports this series of relationships in a chosen environment, i.e., the evidence indicates abstract and concrete processors differ in their requests for in-

Abstract

Conceptual Level

Concrete I I Low Xi X2 X3' X4 High


FIGURE 3

MAXIMUM ABSTRACTNESS IN A CHOSEN ENVIRONMENT

formation.'8 It is likely, then, that if their requests are met, i.e., they choose their own environment, they will reach maximum abstractness at varying points because of their varying environments. If this relationship exists for financial reports, there is no common point of maximum abstractness and the accountant's goal of the facilitation of financial decisions is more difficult to achieve. As indicated above, this possibility is more likely for the financial reporting environment. Some shareholders make investment decisions according to the advice of a broker, seek- ing little other information, whereas others seek far more information. If, indeed, empirical tests reveal that the relationship between the financial reporting environment and users' decision-making capability is as shown in Figure 3, there are significant implications for accounting theor- ists.

IMPLICATIONS

The most obvious implication of the preceding discussion is the probability that unlimited data expansion similar to the recommendations of Sorter"7 and John- son18 will eventually lower the conceptual levels of financial statement users. If the Schroder, Driver and Streufert approach has any applicability to the external reporting environment, users' conceptual levels will decrease in a superoptimal environment, regardless of whether the environment is considered constant or cho-

15 Ibid., p. 158. In addition, Harvey, Hunt and Schroder, pp. 204-43, theorize that maximum abstractness is attained at different levels of environmental complexity for different processors. They describe four general conceptual systems, i.e., they classify conceptual level on a concrete-abstract scale by distinguishing four types of processors, and conclude that there can be further individual variations within these systems.

16 Schroder, Driver and Streufert, pp. 155-57. 17 George H. Sorter, "An 'Events' Approach to Basic

Accounting Theory," THE ACCOUNTING REVIEW (Jan- uary 1969), pp. 12-19.

18 Orace Johnson, "Toward an 'Events' Theory of Accounting," THE ACCOUNTING REVIEW (October 1970), pp. 641-54.




sen. This limitation of the events approach to accounting theory stresses the need for information selection criteria.

The information selection criterion most often encountered in recent accounting literature is the relevance of information to users' decision models."9 The implemen- tation of this criterion and the decision model approach, however, is exceedingly difficult when it is tied to the description of the relationship of environmental complexity and conceptual structure in chosen environments. If the theorist is to design an optimal environment for financial reports and optimal levels vary for different processors, which optimal level is he to choose as his goal? The choices range from the most concrete to the most abstract processor with perhaps some average level as an inviting possibility. The theorist could, of course, attempt to design special purpose reports to meet the needs of users' varying conceptual structures although such an approach is beyond prior definitions of the need for special purpose reports,20 and would probably be fruitless since it would require users to know their conceptual structures.

One solution, the choice of the financial analyst's (probably a highly abstract processor) optimal environment, appears

sound. Financial analysts filter the inf or- mation they receive with the results of filtering becoming part or all of many other processors' environments. An examination of the analyst's role as an intermediary in the external reporting process clarifies the need for this choice. An intermediary may, in fact, be an investment service publica- tion or a "customers' man" in a brokerage firm, but these, too, depend upon the analyst for information. The financial reporting process (for the investor) is dia- grammed in Figure 4.21

The analyst, like the accountant, perceives economic activities and selects some of these activities, though not necessarily the same ones as the accountant, for trans- mission to the investor. He also receives

19 See especially, Committee to Prepare a Statement of Basic Accounting Theory, A Statement of Basic Ac- counting Theory (American Accounting Association, 1966), and 1966-68 Committee on External Reporting, "An Evaluation of External Reporting Practices-A Report of the 1966-68 Committee on External Report- ing," THE AccOUNTING REVIEW Supplement to Vol. XLIV (1969), pp. 79-122.

20 A complete discussion of this need appears in Lawrence Revsine, "General Purpose Reports and Users' Data Needs," Financial Analysts Journal (Sep- tember-October 1969), pp. 37-46.

21 For a more complete analysis of this presentation of the financial reporting process, see Henry Carl Miller, "The Use of Revelance as an Information Criterion for Reporting to Shareholders," (unpublished Ph.D. dis- sertation, University of Illinois at Urbana-Champaign, 1971), pp. 14-37.

Economy c' Accountant Financial Investor Activities Statements n

IntermediaryI ~ Fnancial Interme iar Advice

economic ct on

Economic Activities

I]

FIGURE 4

THE FINANCIAL REPORTING PROCESS



36 The Accounting Review, January 1972

the results of the accountant's efforts and incorporates his interpretation of financial statements in his financial advice to the investor. The widespread use of the analyst's advice is described by Backer:

Various types of investment information services have arisen and these services are widely used by investors of all types.... The ubiquity of investment advisory service is such that there are probably few investors who do not utilize the results of investment analysts' work to some ex- tent at least. At a minimum, this takes the form of reading analytical reports supplied by brokers, consulting customer representatives, or looking up security ratings in published services. Many per- sons who own no securities nevertheless have a stake in pension and endowment funds whose in- vestments are guided by the work of security analysts.22

It thus appears likely that the creation of an information environment that is optimal for the analyst will serve others as well if the Schroder, Driver and Streufert approach is empirically tied to the reporting environment.23 It also seems intuitively wise to select the most abstract investor's decision model for financial reports. The selection of a more concrete processor in a chosen environment would deprive the sophisticated investor of information which might be crucial to his decision. Finally, selection of an average or concrete processor's optimal level eliminates the opportunity to educate users so they may develop more abstract processing ability.24

A second implication of the preceding discussion is an indication that the external environment is currently suboptimal. Revsine called for empirical tests of his hypothesis to determine whether we are approaching or have surpassed optimality,21 but Schroder, Driver and Streu- fert do provide some insight into this problem, even before empirical tests are undertaken. These researchers found that information processors with abstract conceptual structures prefer more information until they reach their optimal level, after

which this desire diminishes rapidly.26 This situation is contrasted with that of the concrete processor who fails to quickly recognize his superoptimality and con- tinues to request more information as his conceptual level is lowered.

Recently, surveys of financial analysts, who are among more sophisticated users of financial statements and probably have the most abstract conceptual structures, have been made. These surveys reveal re- peated requests for more information.2Y Recent treatises by analysts also called for more data28 as did analysts at a recent symposium.29 Because these abstract processors continually request more information, it appears likely that increases in information load will bring them closer to optimality rather than farther from it, if the Schroder, Driver and Streufert approach can be demonstrated to be at all relevant to financial reporting.

Another implication of the earlier analysis of the relationship between environmental complexity and conceptual structure is the emergent format for conducting empirical tests. Revsine's suggestion that we must determine whether external re-

22 Morton Backer, Financial Reporting for Security Investment and Credit Decisions (National Association of Accountants, 1970), pp. 11-12.

23 This is true whether the environment is constant or chosen. In a constant environment, the preliminary evidence indicates there is only one optimal level, and in a chosen environment, the analyst, serving as a filter, creates more concrete processors' environment.

24 This point is stressed in Revsine, p. 708; Robert R. Sterling, "A Statement of Basic Accounting Theory: A Review Article," The Journal of Accounting Research (Spring 1967), p. 106; and Schroder, Driver and Streufert, p. 159.

5 Revsine, p. 711. 26 Schroder, Driver and Streufert, p. 157. 27 See Backer; Robert K. Mautz, Financial Reporting

by Diversified Companies (Financial Executives Insti- tute, 1968); and Allan R. Cerf, Corporate Reporting and Investment Decisions (University of California, 1968).

28 Corliss D. Anderson, Corporate Reporting for the Professional Investor (Financial Analysts Federation, 1962) is most prominent.

29 See John Burton (ed.), Financial Reporting: Con- flicts and Challenges (American Institute of Certified Public Accountants, 1969).




ports provide a suboptimal or superoptimal environment before we proceed with data expansion seems less urgent in light of the probability that we have yet to ex- ceed analysts' optimal conceptual levels. In addition, a replication of the Schroder, Driver and Streufert experiments in a financial reporting context, i.e., empirical tests within a contrived, constant environment, might not yield as meaningful results as a test of actual financial statement users in the environment in which they act. The difficulties inherent in such a test, e.g., the difficulty in introducing new information formats within the traditional reporting context, are significant obstacles to overcome, but this type of systematic determination of the goals of accounting is essential if we are to improve the useful- ness of our product.

The author therefore suggests the fol- lowing approach to empirical verification of the discussed hypotheses. The initial task of the researcher should be the determination of whether financial statement users do exhibit information processing characteristics similar to those described by Schroder, Driver and Streufert and whether they can be characterized as operating in a constant or chosen environment. If the chosen environment is found to be operative, financial analysts should be tested, to determine whether they do, indeed, exhibit abstract conceptual structures and to determine how varying information formats affect their movement toward maximum abstractness. Such research must be conducted in conjunction with research on the measurement of relevance to insure that optimal environmen-

tal complexity is reached through the presentation of the most relevant information.

CONCLUSION

The purpose of this paper has been to develop the hypothesis presented in an earlier paper by Revsine so that it might be better applied to financial reporting. The preceding pages have indicated the probability that the reporting environment is chosen by participants who therefore reach maximum abstractness at varying points of environmental complexity. It was shown that in such a situation the choice of the financial analyst's environment for the design of financial reports will probably insure the greatest use of financial information by investors. It was further shown that accountants do have some insight into the complexity of users' environments and that optimality has yet to be reached. A structure for testing the hypotheses was proposed because of their currently tenuous nature since they have not yet been empirically related to financial reports.

It was shown that we can probably fol- low a data expansion policy now although we will eventually be limited. Continual haphazard expansion will inevitably cause superoptimality and a reduction in the use- fulness of financial reports for decision making. Our efforts, then, to define relevant information, to determine the appropriate methodology for defining decision models, to decide upon the degree of special purpose in our reports and to determine the optimal reporting environment become even more significant.



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