A Longitudinal Investigation of Reference Points: The Impact of Expectations on Risk-Taking Behavior

• In Event: Management Accounting 2

Abstract

This study examines whether individuals’ reference points change over time based on expectations derived from prior economic outcomes. I apply expectations-based reference-dependent preferences theory to analyze if and how individuals’ reference points change over time in an economic setting. Specifically, the theory suggests that individuals develop reference points based on expectations of future outcomes (Koszegi and Rabin 2006). Moreover, these expectations are based upon prior economic outcomes. Therefore, this study examines whether individuals’ expectations affect the formulation of their reference point and how possible changes in reference points affect subsequent risk-taking behavior.
A 1 x 2 between-subjects experiment was conducted over five periods to examine the research questions. Since expectations are likely to differ based on the budget level, budget target difficulty is manipulated at two levels: easy and moderate. The results of the experiment provide evidence that individuals’ reference points change over time. Moreover, the magnitude of the change in reference point was related to the number of times the budget target was attained. This implies that individuals who continually attained the budget target develop greater expectations of future economic outcomes, which lead to an increase in the reference point, consistent with expectations-based reference-dependent preferences theory. The results related to decision making, however, were inconclusive and thus did not provide evidence relating to the impact of changing reference points on risk-taking behavior.

Author

• Lee Kersting, Northern Kentucky University