Client Risk Factors and Audit Resource Allocation Decisions

While contemporary auditing standards such as ISA 315 provide broad categories of client risks, prior research regarding audit resource allocation decisions has been based on individual client risks. This study contributes to the literature by using factor analysis to examine how individual client risks are categorized into broad risk factors and by examining the extent to which such broad risk factors are associated with audit engagement planning decisions. These issues are important because auditing standards direct auditors to consider risk patterns and interrelationships in addition to individual risks. Finally, we consider additional individual client risks that reflect those relevant to contemporaneous audit approaches and have not been examined in prior studies. Based on archival data extracted from the working papers of 228 clients of a Japanese audit firm, we find that individual client risks empirically group together in a way that is similar to categories discussed in recent auditing standards. We also find significant relationships between audit resource allocation decisions and broad risk factors that have not been found in prior studies which use individual risk assessments in their models. Finally, we find that client risks that are emphasized in holistic audit approaches such as aggressiveness of forecasts and industry decline also have a significant impact on audit resource allocations.     

Credibilistic risk aversion

In the probabilistic risk aversion approach, risks are presumed as random variables with known probability distributions. However, in some practical cases, for example, due to the absence of historical data, the inherent uncertain characteristic of risks or different subject judgements from the decision-makers, risks may be hard or not appropriate to be estimated with probability distributions. Therefore, the traditional probabilistic risk aversion theory is ineffective. Thus, in order to deal with these cases, we suggest measuring these kinds of risks as fuzzy variables, and accordingly to present an alternative risk aversion approach by employing credibility theory. In the present paper, first, the definition of credibilistic risk premium proposed by Georgescu and Kinnunen [Fuzzy Inf. Eng., 2013, 5, 399–416] is revised by taking the initial wealth into consideration, and then a general method to compute the credibilistic risk premium is provided. Secondly, regarding the risks represented with the commonly used LR fuzzy intervals, a simple calculation formula of the local credibilistic risk premium is put forward. Finally, in a global sense, several equivalent propositions for comparative risk aversion under the credibility measurement are provided. Illustrated examples are presented to show the applicability of the theoretical findings.     

The effects of risk‐taking tendency on risk choice and pre‐ and post‐decisional information selection

Ideally, people seek and select information about unfamiliar risks with which they are confronted, before they make a risk choice. This study investigated what happens when people do not have this opportunity. The main question was how risk‐taking tendency influences intuitive risk decisions and how this impacts subsequent information search and subsequent choices. In the present study, participants had to make a choice about an unfamiliar risk, either before or after they had had the opportunity to search for (risk‐promoting or risk‐averse) information. In the condition where they could only seek for information after they had made a choice, they had to reconsider their first choice and make a second risk choice. We expected that (1) risk‐taking tendency would impact people's risk choices, but only in the situation where they have little information. On the basis of cognitive dissonance theory, it was furthermore predicted that (2) risk‐taking tendency and (3) initial risk choice would affect risk information selection. Furthermore, we predicted that (4) the first risk choice and (5) the risk information selected would influence the subsequent risk choice. The results suggest that if people make a first, intuitive decision about an unknown risk, risk‐taking tendency has an effect on the choice, but that this does not happen when people can first select information. Risk‐taking tendency did not influence information selection, but initial choice did (although in another way than we expected). Furthermore, both the first risk choice and the risk information selected affected subsequent risk choices. These findings suggest that people often make initial intuitive decisions that are influenced by personality characteristics, and that are subsequently difficult to change.     

Consequences,morality, and time in environmental risk evaluation

Environmental risks pose a serious problem to individual and societal decision‐making, and the public debate is often characterized by a conflict between morally‐principled and technically oriented points of view. Drawing on previous work of Böhm and Pfister (), we propose a model on how environmental risks are cognitively represented and how risks are evaluated. The model suggests two evaluative pathways, evaluations of consequences and evaluation of moral considerations, each leading to a distinct set of emotions and action tendencies. Either one of these pathways may become dominant depending on the evaluative focus of the person, which, in turn, depends on the causal structure of the risk. An experimental study yields confirming evidence for this model. Furthermore, the influence of time perspective, that is, the delay of negative consequences caused by an environmental risk, is investigated. Contrary to the common assumption, only weak evidence for temporal discounting effects is found. It is concluded that environmental risks, due to their strong moral component, are partly immune to time perspective.     

Risk aversion vs. individualism: what drives risk taking in household finance?

Despite a considerable premium on equity with respect to risk-free assets, many households do not own stocks. We ask why the prevalence of stockholding is so limited. We focus on individuals’ attitudes toward risk and identify relevant factors that affect the willingness to take financial risks. Our empirical evidence contradicts standard portfolio theory, as it does not indicate a significant relationship between risk aversion and financial risk taking. However, our analysis supports the behavioral view that psychological factors rooted in national culture affect portfolio choice. Individualism, which is linked to overconfidence and overoptimism, has a significantly positive effect on financial risk taking. In microdata from Germany and Singapore, as well as in cross-country data, we find evidence consistent with low levels of individualism being an important factor in explaining the limited participation puzzle.     

The Spillover effect of compulsory insurance

The assumption usually made in the insurance literature that risks are always insurable at the desired level does not hold in the real world: some risks are not—or are only partially—insurable, while others, such as civil liability or health and workers' injuries, must be fully insured or at least covered for a specific amount. We examine in this paper conditions under which a reduction in the constrained level of insurance for one risk increases the demand of insurance for another independent risk. We show that it is necessary to sign the fourth derivative of the utility function to obtain an unambiguous spillover effect. Three different sufficient conditions are derived if the expected value of the exogenous risk is zero. The first condition is that risk aversion be standard—that is, that absolute risk aversion and absolute prudence be decreasing. The second condition is that absolute risk aversion be decreasing and convex. The third condition is that both the third and the fourth derivatives of the utility function be negative. If the expected value of the exogenous risk is positive, a wealth effect is added to the picture, which goes in the opposite direction if absolute risk aversion is decreasing.     

The effect of temporal risk aversion on liquidity preference

In most instances, investors are not indifferent to risk. Their attitudes toward it influence their decisions. Temporal risk aversion, the dynamic analogue of the usual concept of risk aversion, has a marked effect on investors' decisions but is usually ignored in the literature. This paper investigates the liquidity preference of temporally risk-averse investors. The analysis shows that, all other things being equal, temporal risk aversion reduces the liquidity premium investors must receive to hold an asset that is not perfectly reversible. Thus, the optimal investment policy is closer to what one would expect had a frictionless exchange market existed for the irreversible asset. As far as an individual's investment behavior is concerned, temporal risk aversion counters the effects of an asset's irreversibility and tends to compensate for the absence of frictionless exchange.     

Bad reputation: stigma as an inhibitor of risk behaviors

In recent years, it has been suggested that technological and scientific advancements have made the world a safer place, yet the fear of risk and threats to safety is higher than ever. This theory suggests that people are increasingly basing decisions about risk behaviors on the potential impact on their reputation. Specifically, the stigma of taking risks has been alleged to be a primary factor inhibiting risk-taking behavior. This claim, however, has remained theoretical and without empirical tests to determine its validity. The present study uses data collected from a random sample of college students, including data from open-ended responses to vignette-style questions, to assess the presence and impact of the fear of stigma as a factor in making decisions regarding risk behaviors. Results indicate that stigma is considered by individuals, but is not as meaningful an inhibitor as other factors, such as fear of harm and fear of harming others.     

The ‘Plateau‐ing’ of the European Better Regulation Agenda: An Analysis of Activities Carried out by the Barroso Commission

In this paper we examine cases commonly characterised as risk‐risk tradeoffs (i.e., creating new risks while solving existing ones), in an attempt to learn lessons that can be valuable for future regulatory decision‐making. A broad range of environmental and health literature was reviewed and numerous cases of proclaimed risk‐risk tradeoffs were analysed in order to determine: 1) why regulatory measures were initially taken, 2) why these measures caused a countervailing risk to emerge, 3) how tradeoffs could have been avoided, and 4) whether the case is a good example of a risk‐risk tradeoff. The analysis reveals that only a small number of these cases can actually be considered risk‐risk tradeoffs. In a large number of cases safer alternatives are and were available at the time decisions were made. In some cases the proclaimed risk‐risk tradeoff simply did not exist or occur, and in some cases countervailing risks were ignored for reasons unknown. In many cases, the countervailing risks could have been anticipated and avoided by proactively seeking safer alternatives, completing a tradeoff and impact assessment, or increasing stakeholder input in the decision‐making process. We conclude that concerns about risk‐risk tradeoffs are not a reasonable argument against future application of the precautionary principle. Indeed, sound decision‐making processes in the face of uncertainty should always consider and attempt to mitigate reasonable risk‐risk tradeoffs.     

Risk communication in dementia care: family perspectives

Family carers are often involved in decisions concerning the health and social care needs of people with dementia. These decisions frequently involve considering risks inherent in daily living situations and discussing these with care recipients and professionals. The purpose of this study is to understand the risks that present most concern to family carers; explore attitudes and approaches of this group towards risk; and examine how information about risks is shared between familial carers, care recipients and professionals working in dementia care. Five focus groups were held across Northern Ireland between April and July 2015 involving 22 carers. Risks of most concern were driving, falls, financial risks, getting lost and using electrical appliances. Concepts of ‘risk’ related to terms such as danger, harm and vulnerability with emphasis on consequences rather than likelihoods. The psychosocial benefits of taking risk were recognised by some participants. Discussion of risks with family members with dementia primarily involved bringing risk matters to the attention of the individual. Family carers talked with a wide range of professionals about risks. Divergences in perspectives were noted, particularly in relation to matters of health and safety. A model of risk communication is developed illustrating how this can play a key role in informed, shared decision-making where a family member has dementia, serving an important role in risk management processes in informal community dementia care.     

Differences in the strengths of evidence matters in risk–risk trade-offs

Making decisions between alternatives are challenging when there is weak or unreliable knowledge about the risks and benefits of the alternatives. This requires a trade-off between risks (and benefits). Here, we comment on a recent paper on risk–risk trade-offs and highlight the difficulties of making such trade-offs when the available evidence is of different strength. One current example of a risk–risk trade-off under weak evidence is the restriction and reevaluation of the risks of neonicotinoid insecticides to bees conducted by the European Food Safety Authority (EFSA). We argue that a risk–risk trade-off is essential in this context. Although considerable research efforts have been focused at determining the risks of neonicotinoids to bees, the evidence base is still limited. However, focus on strengthening evidence on impacts of one substance may lead policy-makers and public to believe that its substitutes are less harmful, when in fact evidence is weak on the impacts of these substitutes as well. We argue that a broader management of uncertainty is needed and that the difference in uncertainty underlying evidence of risk for different alternatives needs to be communicated to policy-makers. We suggest that this can be done, for example, using measures of uncertainty, which take into account strength in evidence, and combine these with principles to guide decision-making.     

Is the willingness to take risks contagious? A comparison of immigrants and native-born in the United States

A number of studies have shown that immigrants are more willing to take risks than native-born populations. In this paper, we measure if the willingness to take risks is contagious and if this effect is different for immigrants and native-born individuals in the United States. We suggest that the willingness to take risks may be contagious, like emotions and generosity, i.e. an individual may be more willing to take risks if others make risky decisions. We measure if contagion has a stronger effect on willingness to take risks among immigrants than native populations using a variety of vignettes, specifically in the domains of career, financial investment, and health. Respondents were randomly assigned either to a control or experimental condition. In the experimental condition, we attempted to induce risk-taking by suggesting that other individuals made risky decisions in the lottery-choice tasks (a ‘risk shift condition’). Contrary to expectations, the risk shift condition had a positive effect on willingness to take risks among native-born, while a negative effect or no effect was found among immigrants (conservative shift). Native-born found the situations more beneficial in the risk shift condition than in the control condition, while immigrants found them less beneficial in the risk shift condition. The conservative shift was found among immigrants, as well as males and self-employed. Risk shift condition reduced the sense of power among power-motivated individuals (males and immigrants), which produced a less optimistic evaluation of risky situations. While taking into consideration that others make risky decisions, immigrants and males perceived situations as less beneficial for them. The results of the experiment have some implications for our understanding of the link between a sense of power and the willingness to take risks.     

Algorithmic portfolio choice: lessons from panel survey data

Automated asset management offerings algorithmically assign risky portfolios to individual investors based on investor characteristics such as age, net income, or self-assessment of risk aversion. Using new German household panel data, we investigate the key household characteristics that drive private asset allocation decisions. This information allows us to assess which set of variables should be included in algorithmic portfolio advice. Using heavily cross-validated classification trees, we find that a combination of household balance sheet variables—describing the ability to take risks (e.g., net wealth)—and household personal characteristics—describing the willingness to take risks (e.g., risk aversion)—best explain the cross-sectional variation in household portfolio choice. Our empirical evidence is in line with models of portfolio choice under decreasing relative risk aversion and fixed investment costs. The results suggest the utility of a more holistic modeling of household characteristics. Including background risks in the form of household leverage not only makes investment sense, but is also the new regulatory reality under MIFID II rules. Robo-advisors are strongly advised to act accordingly.     

Respect for experience and organisational ability to operate in complex and safety critical environments

The role of experience has been shown to be critical for risk management. Yet, few studies have conceptualised and explained the organisational processes that determine how experience informs risk management. We present a case study examining how experience informs the risk-based decisions of employees in a safety critical industry. Data were gathered through 28 semi-structured interviews in a power utility. Experience contributed significantly to risk-based decisions, particularly those involving complex or dynamic risks, across all functional and hierarchical divisions. Further, collective experience between organisational divisions and a widespread respect for experience promoted the sharing of experiential knowledge. This deepened the extent to which experience was incorporated into risk-based decisions and facilitated coordination between operational and strategic risk management. Respect for experience and collective experience are important contributors to organisational ability for adaptive and coordinated behaviour in complex and high risk environments.     

Consumers’ collision insurance decisions: a mental models approach to theory evaluation

Using interviews with 74 drivers, we elicit and analyze how people think about collision insurance coverage and decide whether to buy coverage, and if so, what deductible level to carry. We compare respondents’ judgments and behaviors to predictions of three models: baseline expected utility (EU) theory, which predicts that insurance is an inferior good, meaning more wealthy people buy less; a modified EU model, which incorporates income constraints and suggests that property insurance is a normal good, meaning more wealthy people buy more; and a mental accounting model which predicts that consumers budget income across consumption categories. The results suggest they purchase insurance as a normal good, guided by a cognitive model that emphasizes budget constraints. Verbal reports reveal a desire to balance two conflicting goals in deductible decisions: keeping premiums ‘affordable’ and keeping deductible level ‘affordable.’ Thus, wealth does not distinguish people by risk aversion, but by ability to pay. In other words, the behavior of less wealthy people is not driven by greater risk aversion, but by their lesser ability to pay, both now and later. We find that a simple heuristic using only vehicle value accounts for most decisions of whether to purchase optional collision coverage: out of 45 respondents who did not have loans on their vehicles, 90% of those with vehicles worth more than $1000 carried collision coverage, while less than 30% of those with lower‐valued vehicles did.     

Online monitoring and assessment of emerging risk in conventional industrial plants: possible way to implement integrated risk management approach and KPI’s

Existing methodologies and practices do not provide enough possibility for online monitoring and assessment of emerging risks occurring as a result of a change in technology, product, operating conditions, as well as in organization of activities in conventional industrial plants. Typical today’s off and online methods and corresponding software packages are used as risk assessment methods, while various risk aspects (such as: process risks, process equipment integrity risks, organizational risks, and health and environmental risks) are being assessed and treated independently. However, it is clear that risk assessment and making decisions in line with that has to be based on information collected from different (independent) sources in online mode. Also, the fact that additional risks in operations may occur due to unexpected changes in technology, accidents or unexpected process equipment degradation should be taken into account. When monitoring and process management systems are being designed and developed, only the process aspect and process risk are usually analyzed, while other risk aspects are not taken into account (like health and environmental risks). A new approach, to be presented in this paper, provides a possibility of online monitoring and assessment of risks (e.g. in petrochemical industry, power industry, etc.).     

Organic salmon farming: risk perceptions, decision heuristics and the absence of environmental accounting

This paper reports on interviews with salmon farmers exploring their decision as to whether to adopt organic production methods. Organic salmon farming has the potential to considerably reduce the social, environmental and economic risks associated with salmon farming. Salmon farming is an industry subjected to intense scrutiny and is highly controversial. The combination of these two factors was expected to reveal the use of environmental accounting in evaluating this potentially difficult, expensive strategic decision, responding to the barrage of public criticism, driven by changing environmental regulations and a potential value shift by key actors.However, interviews revealed that going organic was regarded as a normal agricultural decision, largely based on price forecasts. The shift to organic was relatively easy, unproblematic and not too expensive. The environmental pressure groups campaigns had very little impact on this decision and it was not subjected to systematic accounting evaluation. The interviews described a sector exhibiting many of the characteristics of Beck's Risk Society thesis (1992, 1995, 1996).Decision makers’ risk perception is identified as important for considering what factors are thought to be legitimate/illegitimate and powerful/weak in the decision making process. Unless risks are considered ‘real’ by the decision makers then the associated costs/benefits of doing or not doing something are not going to figure in the decision heuristics, regardless of the nature of their calculation. Environmental accounting could play a part, not necessarily at the individual farm level, but as part of a reflexive process in reconstructing the underlying knowledge of the social, environmental and economic risks of salmon farming as a whole.     

Decision making with Expected Shortfall and spectral risk measures: The problem of comparative risk aversion

We analyze spectral risk measures with respect to comparative risk aversion following Arrow (1965) and Pratt (1964) for deterministic wealth, and Ross (1981) for stochastic wealth. We argue that the Arrow–Pratt-concept per se well matches with economic intuition in standard financial decision problems, such as willingness to pay for insurance and simple portfolio problems. Different from the literature, we find that the widely-applied spectral Arrow–Pratt-measure is not a consistent measure of Arrow–Pratt-risk aversion. Instead, the difference between the antiderivatives of the corresponding risk spectra is valid. Within the framework of Ross, we show that the popular subclasses of Expected Shortfall, and exponential and power spectral risk measures cannot be completely ordered with respect to Ross-risk aversion. Thus, for all these subclasses, the concept of Ross-risk aversion is not generally compatible with Arrow–Pratt-risk aversion, but induces counter-intuitive comparative statics of its own. Compatibility can be achieved if asset returns are jointly normally distributed. The general lesson is that these restrictions have to be considered before spectral risk measures can be applied for the purpose of optimal decision making and regulatory issues.     

How do policymakers and think tank stakeholders prioritize the risks of the nuclear fuel cycle? A semantic network analysis

In recent years, the importance of stakeholder involvement and of integrating diverse perspectives into risk management has gained increasing recognition. However, it remains a challenging task to identify all potentially relevant stakeholders and to reliably describe their deeply held beliefs regarding the risks associated with complex industrial systems. For example, the development of advanced nuclear fuel cycles presents such a case. Based on a review of policy-making literatures and a content analysis of congressional records, we identify federal agencies and nonprofit policy institutes (also known as ‘think tanks’) as key stakeholders that are representative of those actively involved in making high-level decisions on the US nuclear energy policy. Using a semantic network analysis approach, we visually delineate the thematic areas of each party’s perceptions concerning fuel cycle risks. The results show that although governmental and think tank stakeholders share common concerns in areas such as nuclear waste management, the economics of nuclear facilities, and proliferation, they tend to focus on distinct aspects of each area. Moreover, while governmental stakeholders are primarily concerned with the environmental and local impacts of nuclear fuel cycles, think tank stakeholders focus more on the relative advantages and disadvantages of nuclear energy compared to other alternative energy options. Implications for risk management and risk communication are discussed.     

Portfolio choice with skewness preference and wealth-dependent risk aversion

This paper studies a dynamic portfolio choice problem for an investor with both wealth-dependent risk aversion and wealth-dependent skewness preferences. In a general economic setting, the solution is characterized in terms of a system of extended Hamilton-Jacobi-Bellman (EHJB) equations and the solution is given in closed form in some special cases. We demonstrate the effects of higher order risk preferences and state-dependent risk aversion on the optimal asset allocation decisions. We find that wealth-dependent risk aversion facilitates risk taking and the skewness preference leads to a more positively skewed portfolio in certain circumstances.