Management Accounting Section Midyear Meeting

Do Tax Differences Benefit or Hurt Internal Decision Making? The Effects of Controller Compensation on Costing System Design

• In Event: Costing Systems and Cost Behavior (Mixed Methods)

Abstract

Controllers often face difficult decisions that can affect both internal and external stakeholders. This study reports results of an experiment in which controller participants decide about the implementation of a more advanced costing system, which has the potential to improve long term internal decision making of other decision makers, but at the same time also increases the firm’s external tax liabilities. Contrary to common wisdom, we find that compensating controllers based on after-tax profits together with rewarding them for long-term profits more heavily increases the controller’s propensity to choose the advanced costing system as compared with compensating controllers based on before-tax profits and/or rewarding them for profits realized in each period equally. This result is consistent with cognitive psychology theory which predicts instigating individuals to detect that their decision has conflicting consequences triggers more analytical thinking. Results with a manager participant pool show that choosing for the advanced costing system is more profitable as the benefits of improved decision making dominate the tax savings. Consistent with our theory, results materialize more strongly for more experienced controllers. Our results offer important new insights for practice. Companies should explicitly incorporate conflict considerations into executive compensation to instigate executives to examine their decisions more thoroughly.

Authors

• Eddy Cardinaels, Tilburg University

• Qinwei Chi, Jinan University

• Wenjing Li, Jinan University

• Huaxiang Yin, Nanyang Technological University