Threshold adjustment in response to asymmetric loss functions: The case of auditors' "substantial doubt" thresholds

Abstract

Thresholds play a critical role in linking judgments and choices. One way they do so is by dividing a continuous judgment variable, such as probability, into two regions that imply different choices and actions, such as operate/do not operate, admit/do not admit, or invest/do not invest. We examine this link by focusing on the tendency of professional decision makers to adjust their thresholds when the risks associated with negative decision outcomes are elevated. We report two studies involving experienced auditors that investigate thresholds in a "going-concern" setting. In this setting, the auditor assesses the probability that a business firm will be unable to continue in existence for the coming year; if that probability exceeds a "substantial doubt" threshold (also assessed by the auditor), the auditor is required to disclose the relevant information in the firm's annual report to the public. Our studies use two experimental cases based on actual business firms that differ in their objective likelihoods of not continuing as going concerns. We derive the auditors' substantial doubt thresholds from the relationship between their probability assessments and their disclosure choices, unlike all prior research which has simply asked auditors to state the probability they believe represents substantial doubt. We find that auditors' derived thresholds are adjusted downward for the more problematic firm, a result that we attribute to the asymmetric loss functions inherent in going-concern settings. The second study has some of the auditors directly provide their substantial doubt thresholds (SDTs). The downward adjustment is again found for derived thresholds but not for elicited thresholds, suggesting that the method of capturing thresholds may be an important issue in understanding judgment and choice. © 2002 Elsevier Science (USA). All rights reserved.