Evaluations of Outcome Sequences

Organizational Behavior and Human Decision Processes Vol. 83, No. 2, November, pp. 331–352, 2000 doi:10.1006/obhd.2000.2913, available online at http://www.idealibrary.com on

Evaluations of Outcome Sequences Dawn Matsumoto Harvard University

Mark E. Peecher University of Illinois at Urbana–Champaign

and Jay S. Rich University of Connecticut

We extend the literature on intertemporal choice by investigating how possession of knowledge related to the present value of future outcomes (PV knowledge) affects the extent to which individuals weight certain attributes when evaluating outcome sequences. While PV-knowledgeable individuals can ascribe value to attributes according to their PV relevance (or irrelevance), unknowledgeable individuals cannot do so. Such knowledge, therefore, likely interacts with outcome-sequence attributes to affect the extent to which individuals exhibit impatience when evaluating outcome sequences. The main experimental findings indicate that higher PV knowledge increases the extent to which individuals value impatience (as opposed to improvement). However, these findings also reinforce a need to distinguish among impatience, improvement, and PV because some higher PV knowledge participants willingly sacrifice PV while exhibiting impatience (while others do so in order to gain improvement). Overall, PV considerations appear central, but not determinative, in higher PV-knowledgeable individuals’ evaluations of outcome sequences. q 2000 Academic Press

We thank S. Biggs, M. Shelley, R. Tubbs, as well as workshop participants at the University of Iowa’s Judgment and Decision-Making Colloquium, the University of Utah, the University of Connecticut, and Rutgers University for their helpful comments. Address correspondence and reprint requests to Mark E. Peecher, Department of Accountancy, College of Commerce and Business Administration, University of Illinois at Urbana–Champaign, 284 Commerce West Building, 1206 South Sixth Street, Champaign, IL 61820. E-mail: [email protected]. 331 0749-5978/00 $35.00 Copyright q 2000 by Academic Press All rights of reproduction in any form reserved.

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Key Words: intertemporal choice; impatience; improvement; time value of money; present value; outcome sequences.

Many decisions have intertemporal effects. By consuming all today, one leaves nothing for tomorrow. By saving all for tomorrow, one goes without today. Between these extremes an infinite number of possible sequences exist. If individuals had complete control over the timing of receipt, what sequence would they choose? One can decompose this descriptive research question into at least two related questions. The first question concerns the attributes that individuals generally consider when evaluating sequences. The second question concerns more primitive factors that affect the extent to which certain individuals weight these various attributes. The experiments reported in this article address both questions. Three goals motivated the research. First, as business researchers, we are especially interested in how people evaluate certain types of sequences (e.g., earnings, stock returns, and so on). A popular assumption in business research is that managers and other stakeholders are impatient at least in the sense that they homogeneously maximize present value (PV). While impatience as a construct need not require PV maximization (i.e., impatience can manifest when persons choose among alternatives of equal PV), many common behaviors and experimental findings contradict even broad conceptualizations of impatience, including PV maximization. Why do academics frequently opt to be paid over 12 instead of 9 months (Loewenstein & Thaler, 1981)? Why do participants in experiments frequently choose improving outcome sequences (Loewenstein & Sicherman, 1991)? Why do over 70% of individual taxpayers make interest-free loans to the IRS (Omer & Shelley, 1998)? Why does the market reward firms who report patterns of increasing earnings after controlling for growth and risk (Barth, Elliott, & Finn, 1999)? These behaviors raise questions about the relative importance of PV maximization in the outcomesequence evaluation process (Shefrin & Thaler, 1992). Second, with the exception Benzion, Rapoport, and Yagil (1989), much of the experimental support for the aforementioned “anomalous behaviors” stems from participants who are relatively unknowledgeable about PV concepts. Arbitrage theory suggests that relatively unknowledgeable but capable individuals seek to acquire knowledge to avoid being driven from markets (Loewenstein & Thaler, 1981), and expert performance research suggests that knowledge likely moderates how individuals mentally represent and evaluate outcome sequences (Chi, Feltovich, & Glaser, 1981). While Loewenstein and Sicherman (1991) provide hints of the moderating role of knowledge in that PV maximization increases for college graduates and high-wage-earners, no research of which we are aware directly investigates the influence of PV knowledge on individuals’ outcome-sequence evaluations. Third, we conjecture that an interaction between sequence-evaluator’s PV knowledge and attributes of sequences shape the extent to which evaluations reflect impatience as opposed to improvement. Knowledgeable individuals can choose to weight or ignore attributes of sequences because of their PV relevance

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(or irrelevance). Unknowledgeable individuals are constrained to the use of alternative grounds in determining which attributes to weight or ignore. To illustrate, consider how evaluators react to the attribute of outcome sequence liquidity. Liquid sequences feature goods that are themselves cash or readily convertible to cash (e.g., commodities) or are thought of by evaluators as such (e.g., tickets to major sporting events routinely are scalped, whereas tickets to high school musicals typically are not). Holding all else constant, relatively liquid sequences likely instigate greater impatience in higher, as opposed to lower, PV-knowledge individuals. HYPOTHESIS DEVELOPMENT

Background Literature Most theoretical discussions of the evaluation of outcome sequences assume individuals should use a positive discount rate (i.e., delayed outcomes have less value today). The quantitative expression of this process for a given event sequence, X 5 (x1, x2, . . . , xn), is: V(X ) 5

n

o wtu(xt), t51

(1)

where u(x) is the undiscounted utility for event x and wt is a discount factor applied to period t, such that 0 , wt # 1, wt21 . wt , and wt11/wt 5 k, where k is a constant marginal utility of substitution between discount factors for adjacent periods. Normative considerations aside, psychology research on intertemporal choice provides evidence that individuals often want to delay desired outcomes (e.g., Loewenstein, 1987), especially when they evaluate outcome sequences (e.g., Chapman, 1996; Hsee & Abelson, 1991, Loewenstein & Sicherman, 1991; Loewenstein & Prelec, 1993). Loewenstein and Prelec (1993), for example, ask 95 Harvard University students, “Which would you prefer if both were free? ‘‘dinner at a fancy French restaurant’’ or ‘‘dinner at a local Greek restaurant.” ” Eighty-two students (86%) choose the French restaurant. Those preferring the French restaurant answer a second and a third question. The second question asks students to choose between “dinner at the French restaurant on Friday in 1 month” or “dinner at the French restaurant on Friday in 2 months.” Consistent with PV, 78% prefer the French dinner earlier. The third question asks students to choose between “dinner at the French restaurant on Friday in 1 month and dinner at the Greek restaurant on Friday in 2 months” or “dinner at the Greek restaurant on Friday in 1 month and dinner at the French restaurant on Friday in 2 months.” Surprisingly, 57% defer consumption of the French dinner when it is part of an outcome sequence, whereas only 22% of students do so when it is framed as an isolated event. In terms of Eq. (1), these data violate the assumption that wt21 . wt for all t and imply nonstationary discount factors. To see the latter, note that most question two responses suggest w1 . w2, whereas a majority of question three responses suggest w1 , w2

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(as long as French dinners are preferred to Greek dinners, which is established by question one). One could argue that the above data reveal little about how individuals evaluate business-related sequences comprised of items such as dividends, operating cash flows, and accounting earnings. For such sequences, one can argue that “time is money.” There is, however, similar anomalous evidence for liquid, monetary sequences. Loewenstein and Sicherman (1991) report that visitors to Chicago’s Museum of Science and Industry overwhelmingly choose increasing over decreasing cash flows, even when the total cash over 6 years is fixed. This finding holds across two sequence domains, wages and rent, and despite an explanation of some PV concepts. In particular, the percentage of subjects choosing PV-maximizing sequences ranges from 7 to 28%, with lower percentages associated with the wage context (roughly 15%) than with the rent context (roughly 26%). Drawing on these data and a number of other studies’ findings, Loewenstein and Prelec (1993) develop a descriptive model that expresses the value of intertemporal event sequences as a weighted average of three attributes. Two of these attributes run counter to positive time discounting/PV assumptions. The LP model can be expressed as: V(X ) 5

n

n

n

o ut 1 b t51 o dt 1 s t51 o .dt., t51

(2)

where ut is the undiscounted utility received from an event at time t; b and s are parameters indicating that an individual prefers improving (b . 0) or declining (b , 0) sequences and uniform (s , 0) or nonuniform (s . 0) set t n quences; and where dt 5 o ui 2 o ui, or the difference between the cumulan i51 i51 tive utility that would have been received if the outcomes were uniformly allocated across the n periods and the cumulative utility actually received up to period t.1 Our concern primarily is with factors that influence the sign of the model’s b parameter, which reflects an impatience-to-improvement continuum. 1

Another way of expressing dt is in terms of anticipation utility (AU) and recollection utility (RU). In the LP model, anticipation utility is a linear function of the undiscounted utility of a given future event and the number of periods that precede realization of the future event (t 2 1): AU 5 o (t 2 1)ut. t

Recollection utility (RU) similarly is the sum of given utility levels multiplied by the number of subsequent event periods (n 2 t): RU 5 o (n 2 t)ut. t

As an example, suppose that one frames two vacations—one on March 1st and one on July 1st—as a calendar year’s worth of vacations. The first vacation would have 3 months of anticipation and 9 months of recollection and the second vacation would have 6 months of anticipation and 6 months of recollection.

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Loewenstein and Prelec find that, consistent with much prior research, b is positive for the majority of their experiments’ participants. Specifically, they ask 52 visitors at Chicago’s Museum of Science and Industry to evaluate sequences of five consecutive weekends. Of the five weekends, one is very enjoyable, two are moderately enjoyable, and one is boring. Bar graphs reflect the relative enjoyability of the five different weekends. Subjects’ rank orderings imply a positive b estimate for 77% of the subjects. Further, a second reported experiment also provides evidence that b . 0, as participants prefer increasing sequences roughly 80% of the time (cf. Ross & Simonson, 1991). In fact, the finding of b . 0 is empirically supported in a number of other studies. The preference for improvement holds for aversive sequences (e.g., Fredrickson & Kahneman 1993), and it intensifies for sequences that improve faster than others, especially near the end of the sequence (Hsee, Salovey, & Abelson, 1994). Finally, Schmitt and Kemper (1996) show that although differences between anticipated and experienced utilities exist for outcome sequences, improvement itself is valued in both measures of utility. Relatively few studies investigate evaluator-specific determinants of the sign of b. Chapman (1996), however, does so by examining how evaluator-specific expectations influence outcome-sequence evaluations. She initially observes a domain effect (i.e., health versus wages) in that, on average, undergraduates more frequently prefer decreasing sequences in a health, as opposed to a wage, domain. Regardless of domain, undergraduates who expect their wages or health to increase (or decrease) also tend to prefer increasing (decreasing) sequences. Overall, expectations partially mediate the effects of domain on the undergraduates’ preferences. Hypotheses We predict the sign of b to be a function of individuals’ PV knowledge and outcome-sequence attributes. We also predict that knowledge and outcomesequence attributes interactively affect the sign of b. We examine both nonmonetary and monetary outcome sequences. Because PV concepts are rooted in the time value of money (e.g., interest), we predict that the extent to which PV knowledge induces impatience will be greater in liquid, monetary sequences than in less liquid, nonmonetary sequences. Within the monetary sequences, we examine evaluators’ sensitivity to domain (wage vs rent) and to interchangeability (cash flows held constant vs PV held constant). With respect to interchangeability, we expect PV knowledge to increase the extent to which impatience is exhibited so long as total cash flow, not total PV, is held constant across alternative sequences. When cash flows are held constant, higher PV knowledge participants will recognize that impatience maximizes PV. When PV is held constant, the time value of money becomes less relevant, so that higher and lower PV knowledge participants likely will exhibit similar degrees of impatience. With respect to domain, we expect PV knowledge to mitigate the prior research finding in which greater impatience was exhibited in cash flow sequences involving rent as opposed to wages

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(Loewenstein & Sicherman, 1991). From a PV perspective, the key point is that both wages and rents are cash flows. Finally, while we anticipate that domain, interchangeability, and liquidity may themselves interactively affect evaluators’ assessments of outcomes, our investigation is somewhat exploratory with respect to higher order interactions. Exploration is necessary in this regard because no descriptive theory currently exists which is sufficiently precise to pinpoint predictions concerning how all these factors simultaneously interact. To summarize, we investigate the following hypotheses: H1: Ceteris paribus, greater knowledge of PV concepts produces more impatience in outcomesequence evaluations. H2: Ceteris paribus, greater PV knowledge increases (decreases) the weight ascribed to outcome-sequence attributes that are PV relevant (PV irrelevant).

EXPERIMENT 1

The purpose of the first experiment is to provide an initial test of the generalizability of b . 0. Consequently, we recruited relatively high-knowledge participants and employed liquid, monetary outcome sequences. Our thinking was that if b . 0 given these participants and sequences, there would be no compelling reason to conduct additional experimentation to test whether ­b/­K is negative. Method Participants. Fifty-four undergraduate seniors majoring in accounting at the University of Washington participated in exchange for a free cafe´ latte. We construed these participants to be knowledgeable relative to subjects typically tested in psychology. Unlike most psychology-study participants, by the time accounting undergraduates are seniors, they have taken several courses that explicitly focus on and test PV concepts. For example, several accounting courses test students’ knowledge of specific financial accounting standards that require application of such PV concepts. Materials and procedure. The instrument was a pencil-and-paper task with a format quite similar to that used by Loewenstein and Sicherman (1991). It was composed of three parts (i.e., Parts 1, 2, and 3), followed by four short postexperimental questions. The administrator read aloud cover-page directions that emphasized that participation was voluntary, that preferences were being solicited, and that no single “right” or “wrong” answers existed. Participants started the materials in unison. They were allowed to look through the three-page instrument before completing individual parts. Part 1 asked participants to rank order six outcome sequences, and Part 2 asked them to estimate and briefly justify the amount they would pay for their preferred sequence. Part 3 asked participants to choose between two outcome sequences after providing some reasons in support of each sequence. Stated

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reasons in support of the “present-value maximizing” alternative were that front-ended cash can be put into a bank and earn interest so that one can have more money every year. For the “non-present-value maximizing” sequence, stated reasons were that it can be satisfying to get bigger payments each year, that it is often difficult to save money, and that selecting it would give more spending later without worrying about putting money away in the earlier years. Appendix A contains excerpts of the Experiment 1 instrument. Although we concentrated on highly liquid, monetary sequences, we manipulated sequence domain, between subjects, to enhance generalizability. There were two such manipulations, each at two levels; one was for Part 1 sequences, and the other was for Part 3 sequences. In Part 1, one domain was dividends from a common stock investment. Six 6-year investment alternatives were presented, with total dividends received held constant. Instructions emphasized that the alternatives differed only in sequencing and that both the purchase and future selling prices were identical. The other Part 1 domain was rental income, with the rent hypothetically being the participants’ only source of income for 6 years. Both the rental and stock dividend scenarios asked participants to ignore tax effects. The Part 3 manipulation also varied domains, but they also altered the duration and outcome amounts of the sequences. One domain pitted two 6year, context-free sequences of $150,000 in total cash flows against each other. These alternative cash-flow sequences mirrored each other, with periodic cash flows increasing in one and decreasing in the other. The other Part 3 domain was lifetime wages. Participants were asked to imagine that they knew their wages until retirement (i.e., 30 to 40 years) and to choose between an immediate, lump-sum payout and any other self-specified allocation. Last, participants briefly justified their choices in Part 3. Results We categorized participant responses according to whether they strictly were consistent with impatience (i.e., b , 0) or improvement (i.e., b . 0). Because the sequences in Part 1 decreased in present value going from option 1 to option 6, strict impatience requires a rank ordering of 1st, 2nd, 3rd, 4th, 5th, and 6th. At the other extreme, strict improvement requires a rank ordering of 6th, 5th, 4th, 3rd, 2nd, and 1st. For Part 3, the categorization process was simpler: the participants’ dichotomous choice reflected either impatience or improvement. Panel A of Table 1 presents pooled data for all 324 Part 1 rankings (54 subjects 3 6 rankings), while Panel B presents data partitioned by participants for both Parts 1 and 3. The pooled data show that roughly 3 of every 4 Part 1 rankings strictly fit impatience (72.5% in Panel A). Similarly, the participantspecific data show that roughly two of every three participants strictly fit impatience (63% in Panel B). Further, evidence for improvement is minimal in both the pooled and participant-specific data (12.3% in Panel A and 6% in Panel B). In Part 3, impatience also dominates improvement (70 versus 30%

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TABLE 1 Implied Signs of b for the High-Knowledge Participants in Experiment 1 Panel A: Part 1 data pooled across all participants Ranking according to strict-PV heuristic Participants’ rankings

1

2

3

4

5

6

1 2 3 4 5 6

44 2 1 1 2 4

0 42 1 5 4 2

0 1 37 5 5 6

0 2 10 38 3 1

0 7 3 3 37 4

10 0 2 2 3 37

Panel B: Participant-level data from Parts 1 and 3 Implications for b Part of instrument Part 1 Part 2

Strict impatience (b , 0)

Strict improvement (b . 0)

34 63% 38 70%

3 6% 16 30%

Other 17 31% n/a

Note. In Panel A, data in each of the six columns and rows total n 5 54, for a population of observations totaling n 5 324. Numbers in bold denote impatience (235/324 5 72.5%); impatience implies b , 0. Numbers underlined denote improvement (40/324 5 12.3%); improvement implies b . 0. In Panel B, data are aggregated at the participant level so that each row totals N 5 54.

of responses; see Panel B). The extent to which the Panel B participant-specific data suggest that impatience dominates improvement is significantly greater than one would expect by chance for both Part 1 [X2(2) 5 26.78, p , .001] and Part 3 [X2(1) 5 8.96, p 5 .006]. And, interestingly, impatience prevails more frequently here than in Loewenstein and Sicherman (1991), where impatience accounted for less than 30% of responses. Thus, at a minimum, our data allow us to reject the proposition that b . 0 for relatively high-PV-knowledge individuals when they evaluate liquid outcome sequences.

EXPERIMENT 2

While Experiment 1 demonstrates that b , 0 for individuals who are relatively knowledgeable of PV concepts, it does not directly test whether the sign of b differs with PV knowledge. Experiment 1 also does not explicitly test whether differential PV knowledge is associated with differential weighting of certain attributes of outcome sequences. We designed Experiment 2 to address these issues.

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Method Participants. We recruited 85 higher PV-knowledge participants and 291 lower PV-knowledge participants, or 376 participants in total, from two undergraduate accounting courses at the University of Illinois at Urbana– Champaign. Participants received nominal course credit for participating. Our “higher knowledge” participants were students in an advanced managerial accounting course. These students were juniors and seniors, and they had taken between four and five other accounting classes, on average. In contrast, our “lower knowledge” participants were students in a second-semester introductory accounting course. These students were almost exclusively sophomores, and they had taken one other accounting class. Due to course sequencing, about half of our “lower knowledge” participants were concurrent enrollees in an introductory finance course that focuses heavily on PV concepts. In ancillary analysis, we single out these participants, whom we would expect to behave more like our higher PV-knowledge participants than the rest of our lower knowledge participants. Materials. The instrument featured two main parts followed by a questionnaire devoted to demographic information (Appendix B contains excerpts from the Experiment 2 instrument). We used these two main parts to manipulate sequence liquidity within subjects at two levels (i.e., monetary versus nonmonetary). We counterbalanced the presentation order. The liquid, monetary domain consisted of cash-flow sequences that were similar to those used in Experiment 1 [i.e., consistent with Loewenstein & Sicherman (1991)]. The illiquid, nonmonetary domain consisted of restaurant sequences like those adopted by Loewenstein & Prelec (1993).2 Design. We manipulated two additional factors, between subjects, that vary in PV relevance. These factors were manipulated only within the monetary sequences. First, we manipulated domain at two levels (i.e., wages versus rent). We expect lower PV-knowledge individuals to assign greater importance to this attribute. Specifically, wage levels often reflect mastery with a profession (cf. Loewenstein & Sicherman, 1991), and individuals seldom have the option to front-end lifetime wages. In contrast, rental domains offer no synonym for mastery and front-ending rent over a multiyear contract is common (e.g., automobile leases). Consequently, in the absence of PV knowledge, individuals are expected to value improvement more in the wage domain than in the rent domain. Second, we manipulated interchangeability at two levels. We operationalized 2 Holding all else constant, more impatience is invoked by monetary than by nonmonetary sequences. Relative to our monetary sequences, however, our nonmonetary sequences feature shorter durations and smaller amounts. Since shorter durations and smaller amounts both invoke impatience, we cannot here predict a main effect for liquidity (i.e., the monetary versus nonmonetary manipulation). We made this design choice because it simultaneously facilitates direct comparisons with our Experiment 1 and allows testing of our hypotheses, which concern a PV knowledge 3 liquidity interaction but not a liquidity main effect.

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higher and lower interchangeability by holding constant either total cash flow or total PV, respectively, across the six alternative sequences. According to PV theory, cash flows in different periods should be weighted by different discount factors and, thus, are not interchangeable. We effected the interchangeability manipulation by including, at the bottom of graphs depicting each sequence, either “Total Cashflows 5 $150,000” or “Total Present Value 5 $106,800.” We expected this manipulation to seem more important to higher knowledge participants and that they would be more impatient when total cash flow was held constant. Viewed slightly differently, by holding total present-value constant, we provided an opportunity for higher PV-knowledge participants to demonstrate that they ascribe at least some value to improvement.3 To summarize, the design of Experiment 2 consists of four two-level independent variables, one of which we measured and three of which we manipulated. The measured variable is PV knowledge. The three manipulated variables are liquidity, domain, and interchangeability. Liquidity is manipulated within subjects with sequences being either monetary or nonmonetary. Between subjects, domain is manipulated by using either wages or rent, and interchangeability is manipulated by holding constant either total cash flow or present value. Results Primary results As before, we coded the participants’ responses according to whether they suggested impatience (i.e., b , 0) or improvement (i.e., b . 0). A coding scheme categorized each participant’s monetary ranking as being predominantly consistent with either impatience or improvement. Specifically, we multiplied each participant’s row matrix of rankings of options 1 through 6, R 5 (r1, r2, . . . , r6) by a column matrix ranking the options strictly according to PV 5 (pv1, pv2, . . . , pv6) 5 (1,2,3,4,5,6). The cross product (i.e., R ∗ PV T) for strict adherence to PV (improvement) is 91 (56). The midpoint of these rankings [i.e., (1,4,6,5,3,2) and (2,3,5,6,4,1)] produces products of 74 and 73, respectively. We chose 73.5 as a partition and code higher products as “impatience” and lower products as “improvement.” Use of other reasonable cutoffs such as .78 [i.e., (5,3,1,2,4,6)] for impatient and ,69 [i.e., 6,4,2,1,3,5)] for improvement do not affect our inferences because our data are bimodal, manifesting heavily on the end points of the 56-to-91 distribution (only 26 of the 376 participants’ responses fall between 67.5 and 79.5). Each participant provided a response for the monetary sequence and for the nonmonetary sequence, with the order of presentation counterbalanced. Each of these responses could comply with either impatience or improvement. So, each participant could respond in one of four ways: (1) value impatience for both the monetary and nonmonetary sequences (i.e., always impatient); (2) 3 We note that if one holds PV constant across increasing and decreasing sequences, the first term of the Loewenstein and Prelec model (i.e., undiscounted utility of the individual outcomes) likely would differ across the alternative sequences as the total cash flow varies.

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value impatience for the monetary sequence but improvement for the nonmonetary sequence (i.e., impatient only for monetary); (3) value improvement for the monetary sequence but impatience for the nonmonetary sequence (i.e., impatient only for nonmonetary); and (4) value improvement for the monetary and nonmonetary sequences (i.e., never impatient). Panels A and B of Table 2 provide frequency and percentage data that summarize the responses of lower and higher knowledge participants across these four profiles. To test our hypotheses, we ran a repeated-measures Categorical Model (CATMOD) ANOVA (see Table 3A). Because the order of monetary and nonmonetary sequences does not interact with any of our independent variables and affects none of our inferences, we simplify presentation of our analyses by excluding

TABLE 2 Response Profile Frequencies and Percentages in Experiment 2 Experimental condition Rent domain Cash flow constant

PV constant

Column averages

Panel A: Response profile frequencies Lower knowledge participants (1) Always impatient 23 21 18 (2) Impatient only for monetary 14 9 17 (3) Impatient only for nonmonetary 24 25 22 (4) Never impatient 18 17 16 Row totals 79 72 73

13 7 25 22 67

75 47 96 73 291

Higher knowledge participants (1) Always impatient (2) Impatient only for monetary (3) Impatient only for nonmonetary (4) Never impatient Row totals

10 4 5 3 22

3 2 13 3 21

32 17 25 11 85

Panel B: Response profile percentages Lower knowledge participants (1) Always impatient 29 29 25 (2) Impatient only for monetary 18 13 23 (3) Impatient only for nonmonetary 30 35 30 (4) Never impatient 23 24 22

19 10 37 33

26 16 33 25

Higher knowledge participants (1) Always impatient (2) Impatient only for monetary (3) Impatient only for nonmonetary (4) Never impatient

14 10 62 14

38 20 29 13

8 6 4 2 20

40 30 20 10

PV constant

Wage domain

11 5 3 3 22

50 23 14 14

Cash flow constant

45 18 23 14

Note. In Panel B, percentage columns sum to 100% for lower and higher knowledge participants.

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TABLE 3A Repeated-Measures Analysis of Variance for Experiment 2 Source Intercept Knowledge (Lower vs Higher) Domain (Rent vs Wages) Interchangeability (Total cash vs Present value) Liquidity (Monetary vs Nonmonetary) Knowledge 3 Domain Knowledge 3 Interchangeability Domain 3 Interchangeability Knowledge 3 Liquidity Domain 3 Liquidity Interchangeability 3 Liquidity Knowledge 3 Domain 3 Liquidity Knowledge 3 Interchangeability 3 Liquidity Knowledge 3 Domain 3 Interchangeability Domain 3 Interchangeability 3 Liquidity Knowledge 3 Domain 3 Interchangeability 3 Liquidity

Chi-squarea 458.84** 8.79** 3.05 1.68 10.77** 0.13 0.07 2.68 0.90 5.33* 5.83* 5.66* 0.35 0.49 3.13 1.26

a For each chi-square test df 5 1. * p , .05. ** p , .005.

the order-related explanatory variables.4 Five effects are significant at conventional levels. Four of these five effects stem from a three-way (Knowledge 3 Domain 3 Liquidity) interaction, which subsumes the Domain 3 Liquidity interaction as well as the Knowledge and Liquidity main effects. The remaining effect is a two-way (Interchangeability 3 Liquidity) interaction. We first discuss the Knowledge 3 Domain 3 Liquidity interaction and then comment on the less complex Interchangeability 3 Liquidity interaction. To investigate the Knowledge 3 Domain 3 Liquidity three-way interaction, we collapse the data across Interchangeability and again present response profiles (1) through (4) (see Table 3B). Table 3B also presents the percentage of participants who exhibited impatience for monetary sequences (5) by summing the percentages in response profiles (1) and (2). Similarly, it sums the percentages in response profiles (1) and (3) to yield the percentage of participants who were impatient for nonmonetary sequences (6). Lines (5) and (6) provide the summary data for the Knowledge 3 Domain 3 Liquidity interaction. We next discuss the Knowledge 3 Domain 3 Liquidity interaction in terms of the Domain and Liquidity main effects and the interaction thereof, as applicable, separately for lower and higher knowledge participants. For lower knowledge participants, a significant Liquidity main effect obtains 4

While intuition might suggest that responding to monetary sequences would increase the degree of impatience exhibited on nonmonetary sequences, whether monetary sequences were completed before or after nonmonetary sequences did not significantly affect the degree of impatience exhibited on nonmonetary sequences [X2(1) 5 3.24, p 5 .174].

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TABLE 3B Response Profiles Collapsed across Interchangeability for Experiment 2 Domain (percentages)

Lower knowledge participants (1) Always impatient (2) Impatient only for monetary (3) Impatient only for nonmonetary (4) Never impatient Totals (5) Impatient on monetary 5 (1) 1 (2) (6) Impatient on nonmonetary 5 (1) 1 (3) Higher knowledge participants (1) Always impatient (2) Impatient only for monetary (3) Impatient only for nonmonetary (4) Never impatient Totals (5) Impatient on monetary 5 (1) 1 (2) (6) Impatient on nonmonetary 5 (1) 1 (3)

Rent

Wage

Both

29 15 33 23 100

22 17 34 27 100

26 16 33 25 100

44 62

39 56

42 58

45 26 17 12 100

30 14 42 14 100

38 20 29 13 100

71 62

44 72

57 66

[X2(1) 5 18.77, p , .001]. These participants were more impatient for nonmonetary (58%) than for monetary sequences (42%). Neither the Domain main effect nor the Domain 3 Liquidity interaction affected their responses (lowest p 5 .175). Thus, as reported in Table 3B, their most popular response was “impatient only for nonmonetary” (about 33% of their responses), followed by “always impatient” (26%), “never impatient” (25%), and “impatient only for monetary” (16%). For higher knowledge participants, a significant Domain 3 Liquidity interaction obtains [X2(1) 5 7.21, p 5 .007]. This interaction is illustrated in Fig. 1. Higher knowledge participants exhibited more impatience in monetary (71%) than in nonmonetary (62%) sequences in the rent domain. But, their impatience was greater in nonmonetary (72%) as opposed to monetary (44%) sequences in the wage domain (Table 3B). Specifically, for the rent domain, higher knowledge participants modal response was “always impatient” (45%), followed by “impatient only for monetary” (26%), “impatient only for nonmonetary” (17%), and “never impatient” (12%). In contrast, for the wage domain, the modal response was “impatient only for nonmonetary” sequences (42%), and a substantial percentage of participants were “always impatient” (30%). Finally, smaller percentages of participants opted for “impatient only for monetary” (14%) or “never impatient” (14%). As also shown, higher knowledge participants exhibited greater impatience than did lower knowledge participants for both monetary (57%higher vs. 42%lower) and nonmonetary sequences (66%higher vs 58%lower). Post hoc examination shows that the knowledge effect in monetary sequences obtains in three conditions

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FIG. 1. Higher knowledge participants’ (Domain 3 Liquidity) interaction in Experiment 2. ( ) never impatient; (m) impatient only for nonmonetary; (□) impatient only for monetary; ( ) always impatient.

(69%higher versus 46%lower; p , .001 in the conditions of Rent/Cash flow, Rent/PV, and Wages/Cash flow). In these same conditions, knowledge does not influence participants’ impatience in nonmonetary sequences ( p 5 .451). In the remaining Wages/PV condition, however, the knowledge effect is essentially the opposite. Knowledge does not influence participants’ impatience for monetary sequences ( p 5 .545), but higher knowledge produces marginally greater impatience for nonmonetary sequences (75% vs 56%; p 5 .072). We now discuss the remaining two-way (Interchangeability 3 Liquidity) interaction ( p 5 .016) without reference to any table. Whether Interchangeability was high (i.e., cash flow constant) or low (i.e., PV constant) did not influence the extent to which participants exhibited impatience for nonmonetary sequences (61%cash flow vs 65%PV ). The Interchangeability distinction mattered, though, for monetary sequences. Specifically, when PV was held constant, fewer participants exhibited impatience in the monetary sequences (57%cash flow vs 42%PV ) without regard to their PV knowledge. We expected some of these results, but not others. One, we expected higher knowledge to increase impatience for monetary sequences because the time value of money underlies PV concepts. We found higher PV knowledge to result in greater impatience across the board, for both monetary and nonmonetary sequences. Similarly, we expected PV knowledge to moderate the difference in impatience observed in monetary sequences when cash flow, as opposed to PV, was held constant. While our findings show higher knowledge participants were more impatient in monetary sequences when total cash flow (67%) instead

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of PV (49%) was held constant; the same was true for lower knowledge participants (cash flow 60%; PV 36%). Finally, we had expected a significant domain effect to obtain for lower knowledge participants, but we found domain to matter more for our higher knowledge participants. From a different perspective, it is notable that we observe significant knowledge effects even though our lower knowledge participants exhibit more impatience than has been exhibited by participants in previous research (see Table 4). Specifically, for monetary sequences, our lower knowledge participants exhibit greater impatience than did participants in Loewenstein and Sicherman (1991). And, for nonmonetary sequences, they exhibit greater impatience than did participants in Loewenstein and Prelec (1993). It is possible that these interstudy differences in impatience stem from both impatient persons selfselecting into business courses and to instruction about PV altering preferences. Ancillary findings. Because it would be presumptuous to label any of the Experiment 2 participants as being nai¨ve with respect to PV concepts, one should limit how broadly they interpret the knowledge main effect and related interactions. Persons may react differently to PV concepts depending on their predisposition to seek PV knowledge in the first place. That is, knowledge of PV might reinforce preexisting tendencies to be impatient that exist in our participants but not in the general population. While we leave direct investigation of this possibility to future research, we examine here whether instruction influences the preferences of our lower PV-knowledge participants. We partitioned these participants into two groups based on whether they currently were enrolled in or had finished an introductory finance course that presents PV concepts. We ran a categorical model, using the finance class as a partitioning variable to proxy for PV knowledge. Suggestive that initial instruction in PV concepts alters preferences, instruction in PV increases impatience in our lower knowledge participants [55% versus 45%, X2(1) 5 6.13, p 5 .013].

TABLE 4 Comparison of Experiment 2 Results to Previous Psychology Research Wages

Rent

Panel A: Monetary sequences Experiment 2 Higher knowledge 43% Lower knowledge 38% Loewenstein and Sicherman (1991) 15%

72% 44% 26%

Panel B: Nonmonetary sequences Experiment 2 Higher knowledge Lower knowledge Loewenstein and Prelec (1993)

67% 59% 43%

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EXPERIMENT 3

Experiment 2 suggests that individuals who possess relatively high PV knowledge value impatience more than do those with relatively low PV knowledge. In Experiment 2, individuals who value improvement when cash flows were held constant act as if they willingly sacrifice PV in order to gain improvement. In Experiment 3, we make PV trade-offs more salient by informing participants whether the PV of outcome sequences increase or decrease across options 1 through 6. Consequently, in Experiment 3, we explicitly (1) distinguish impatience from PV and (2) investigate whether PV-knowledgeable people consciously sacrifice PV because of impatience or desires for improvement. Method Participants. Fifty undergraduate accounting majors at the University of Connecticut participated in exchange for nominal course credit. Over 90% of the students were within 1 month of graduating. They had earned an average (range) of 25 (15 to 34) h of accounting credit at a time when 24 h of accounting credit was required in order to take the Uniform CPA Examination in Connecticut. Materials. The instrument employed three primary parts followed by collection of demographic information. Each of the three parts asked participants to rank order six outcome sequences in the wage domain. All three parts included bar graphs of the different wage sequences, just as in Experiments 1 and 2. We manipulated one independent variable, PV, within subjects at three levels by varying the discount rate. In a control condition, the outcomes have identical PV. In a second condition, we disentangle PV from impatience by having PV increase when going from option 1 ($112,400) to option 6 ($113,940). For example, participants who prefer option 1 the most are impatient, but they sacrifice PV. Finally, in a third condition, we disentangle PV from improvement by having PV decrease from option 1 ($103,660) to option 6 ($102,660). In this case, participants who prefer, for example, option 6 value improvement but sacrifice PV. Panel A of Table 5 summarizes the PV amounts used in all three conditions of Experiment 3. Results. As in Experiment 2, we multiplied each participant’s row matrix of rankings of options 1 through 6, R 5 (r1, r2, . . . , r6) by a column matrix ranking the options strictly according to impatience, I 5 (1,2,3,4,5,6). All individuals whose product was above 73.5 in the control condition were coded as “impatient,” while individuals whose product was below 73.5 were coded as “improvement.” As before, the results are not sensitive to changes in the cutoff. Panel B of Table 5 shows that in the PV-constant (control) condition, 14 participants valued impatience (m 5 88.50; maximum possible of 91) and 36 valued improvement (m 5 59.67; minimum possible of 56). Of the 36 participants who valued improvement in the control condition, only six switched to impatience in order to avoid sacrificing PV in condition 3. Conversely, 30 of

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TABLE 5 Present Values in and Results of Experiment 3 Panel A: Present values presented to participants Condition

Option 1

Option 2

Option 3

Option 4

Option 5

Option 6

PV Constant (Control) PV Improving PV Declining

$108,400 $112,940 $103,660

$108,400 $113,370 $103,240

$108,400 $113,550 $103,060

$108,400 $113,620 $102,990

$108,400 $113,880 $102,740

$108,400 $113,940 $102,660

Panel B: Results Preference

PV Constant (Control) Sacrifice PV and maintain preference Revealed in control condition Avoid sacrificing PV and switch from Preference revealed in control condition

Impatience

Improvement

Total

14

36

50

11

30

41

3

6

9

the 36 participants who valued improvement in the control condition willingly sacrificed PV to secure improvement. The number of participants who willingly sacrificed PV is greater than one would expect by chance ( p , .001). Because knowledgeable participants forgo at least some PV to obtain improvement, PV unlikely is determinative in their evaluations of outcome sequences. Last, of the 14 individuals who valued impatience in the control condition, 11 continued to be impatient in condition 2. In this condition impatience resulted in a salient PV loss ( p , .001). Revealed preferences that imply impatience is sought at the cost of forgone PV suggests a need to distinguish between impatience and PV—even for people knowledgeable of the time value of money. CONCLUSIONS

Our experimental evidence suggests that evaluators who are relatively knowledgeable about present value (PV) tend to favor being impatient over seeking improvement when evaluating monetary and nonmonetary sequences. Evidence also suggests that the acquisition of PV knowledge significantly increases participants’ tendency to exhibit impatience on such sequences. The increased tendency to exhibit impatience due to PV knowledge does appear to have some bounds, however. For some types of monetary sequences, PV knowledge does not increase impatience (e.g., sequences of wages where PV is held constant). Finally, the experimental evidence indicates that impatience does not necessarily coincide with a desire to maximize PV in that some knowledgeable participants exhibited impatience while willingly sacrificing PV. Our findings relate back to our three motives for conducting the study. Business researchers will be comforted by our findings because PV considerations

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appear central (but not determinative) when knowledgeable individuals evaluate outcome sequences. Our findings nevertheless add credence to psychology models and findings that emphasize that people value impatience and improvement (as opposed to PV, per se). As one example, over 40% of our knowledgeable participants valued improvement for monetary sequences in Experiment 2. And a significant number of knowledgeable participants even sacrificed a modest amount of PV in order to obtain improvement in Experiment 3. Future research can investigate the conditions under which knowledgeable individuals sacrifice even greater magnitudes of PV to secure improvement. Future research also can investigate how knowledge and expectations interact in the outcome-sequence evaluation process (e.g., Chapman, 1996). Knowledge of PV concepts may affect individuals’ normative beliefs about what sequences are appropriate to choose. Normative beliefs may significantly influence individuals’ stated objectives (e.g., if one believes they ought to calculate the amount of salary that they should withhold for federal income tax purposes, they may state that as their objective). Descriptive beliefs, or expectations about “real-world” behaviors, may significantly influence actual decisions. In other words, descriptive beliefs might overcome normative beliefs, causing people to act inconsistently with their stated preferences (e.g., if one believes that others do not calculate withholding correctly so as to receive larger income tax refunds, they copy others’ expected behavior). APPENDIX A Excerpts from the Experiment 1 Instrument

Excerpts from Part 1 Stock Domain. Imagine that you have to rank six investments of 10,000 shares of common stock. Assume the investments differ only in terms of the sequence of cash dividends they will pay—the total dollar amount of dividends received will be the same for each investment. Assume further that the dividend sequences shown below have no uncertainty—they will definitely occur as illustrated. Finally, assume that both the purchase price today and the selling price at the end of year six will be the same for each investment option. Ignoring any possible tax effects, please rank investment options below from 1 (i.e., the investment you most prefer) to 6 (i.e., the investment you least prefer). Rent domain. Imagine that you are not employed now and your only source of income is a small apartment building that you recently inherited. You have agreed to lease the building to a real estate broker for the next six years. The broker has offered you six different payment options. Assume that the income from the apartment, which totals the same in each case, will be your only source of income during the next six years. Ignoring any tax effects, please rank the following options from 1 (i.e., the option you most prefer) to 6 (i.e., the option you least prefer).

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Excerpts from Part 3 Context-free cash flows. Examine the two payment options below. Some researchers believe people should prefer option A. Their argument is that you can put part of the extra money you get at the beginning in the bank and withdraw it with interest later on. In fact, by choosing option A you could have more money every year. Other researchers believe people should prefer option B. Their argument is that, first, it is satisfying to get a bigger payment each year. Second, even though you could save money in the first years, it is often difficult to save money. Option B gives more spending later without worrying about putting money away in the first few years.

Which of the two options would you prefer and why? (Please justify your preference.) Option A: Option B:

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Wages until retirement. Assume it were possible to perfectly forecast your total “wages until retirement” and that you had the following choice. You could receive all your “wages until retirement” in a lump sum today, or you could allocate whatever portions of your “wages until retirement” to your various working years. Some researchers think that given such a hypothetical circumstance you should prefer the lump sum. Their argument is that you can put the lump sum into a bank and/or other investments and withdraw it with interest later on. In fact, by choosing the lump sum option, you could have more money every year. Other researchers think that given such a hypothetical circumstance you should allocate your wages over the working years of your life, so that your wages are greater in later years than in early years. Their argument is that, first, it is satisfying to get bigger wages each year. Second, even though you could save and/or the money from a lump sum, it is often difficult to save and/ or invest money. Allocating some of your wages to your later years gives more spending later without worrying about saving and/or investing an initial lump sum. Which of these two options would you prefer and why? (Please justify your preference below). Lump Sum: Some Other Allocation: APPENDIX B Excerpts From the Experiment 2 Instrument

Monetary Context—Wage Domain Imagine that you are not working now, but have been offered a six year job, and are presented with a choice between different payment options. You are certain that you will work at this job for the next six years. The wages, which total $150,000 in each option, will be your only source of income over the next six years. Finally, the payment option you select will not affect your future jobs or income from those jobs in any way. Ignoring any possible tax effects, please rank the payment options below from 1 (i.e., the option you most prefer) to 6 (i.e., the option you least prefer). Nonmonetary Context Ignore personal scheduling considerations (e.g., your preexisting plans) when responding to the following questions. Which would you prefer if both were free? (mark only one). A. Dinner for two at a fancy French restaurant. B. Dinner for two at a local Greek restaurant. If you prefer the French restaurant, which of the following would you prefer? (mark only one). C. Dinner for two at a fancy French restaurant on a Friday in 1 month. D. Dinner for two at a fancy French restaurant on a Friday in 2 months.

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Which would you prefer? (mark only one). E. Dinner for two the fancy French restaurant on Friday in 1 month and dinner for two at the local Greek restaurant on Friday in 2 months. F. Dinner for two at the local Greek restaurant on Friday in 1 month and dinner for two at the fancy French restaurant on Friday in 2 months.

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