Sunstein, Cass R., ed. Behavioral Law and Economics.

SUNSTEIN, CASS R., ed. Behavioral Law and Economics (Cambridge University Press, New York, NY, 2000, 421 pp.)

Behavioral Law and Economics is a new addition to the Cambridge University Press Series on Judgment and Decision Making. Like others in the series, this book is a well-selected

set of articles and essays. Most have been rewritten for this book to make the text coherent. Authors of chapters include prominent scholars in psychology (e.g., Daniel Kahneman, the late Amos Tversky, David Schkade, and George Loewenstein) and behavioral economics (e.g., Richard Thaler and Jack Knetsch) who are familiar to accounting academicians.

The theme of this volume, like others in the series, is the descriptive validity of behavioral science, particularly psychology. Constraints on human information processing are (1) the number of things one can keep in mind at the same time are few, (2) thinking is a serial process, and (3) information in memory, while apparently limitless in quantity, is not accessible error-free (to put it mildly). The information-processing capabilities required for economically rational choice exceed these limitations (e.g., no instance of complete and transitive preference has been documented). Even though economic rationality conforms to the soundest of syllogistic logic, it is descriptively untrue of human judgment.

For example, a common strategy is the so-called framing of risky choices. Individuals view possible outcomes through frames of reference. The payoff of each option is measured relative to a reference point. A prize that in absolute terms brings a $5 inflow, could be measured at -$10 (if the reference point were $15) or plus $20 (if the reference point were at -$15).

The framing compatible with rational choice is ending wealth position in which the payoff from each option is integrated with current wealth, and then the best option is selected by comparing the ending wealth position given each option. The framing of outcomes around the amount at issue simplifies the comparison of the options relative to comparisons of ending portfolios.

Though strategies such as framing may result in choices that are inconsistent relative to a "reasonable person" standard in law (or an optimizing choice by the standard of the economic decision model), they are reasonable in that they conserve the limited and scarce cognitive capacities available for problem solving. That is, human information processing is not a free good.

This volume, like others in the series, is in no way negative or sensationalist. It applies this behavioral perspective to law and economics. The theme is that patterns of institutional practice in law and economics are the product of human information-processing limitations. The way humans bring the cognitive processing demands of a judgment within limits of processing capacity gives structure and content to our legal and economic institutions. Features of the decision context (e.g., extrinsic incentives involved) and individual differences (e.g., expertise) are important.

To continue the example of framing, taxpayers prefer a tax collected such that they receive only the after-tax amount to a tax system in which they receive a gross amount and then must pay the tax (experiencing a loss), even if the two options are economically equivalent. Thus, tax payment through withholding and corporate income taxes are popularly preferred to requiting taxpayers to pay the taxes directly out of total income. Also, in labor negotiations an offer of a new benefit with a fixed value (a potential gain) would not be as valuable as retaining a current benefit of the same value (a potential loss).

This book should be of interest to accounting researchers. Tax accounting, auditing, financial reporting, and cost accounting measures involve legal rights and obligations created in legislative, administrative, and contractual law. Thus, the subject matter of behavioral law is directly applicable to accounting.

One of the four sections is "The Demand for Law." Analogous to the call for understanding the economic demand for accounting from the Rochester School some 30 years ago, this section suggests that behavioral factors explain why law is as it is. For another example, one essay argues that an optimism that is helpful to the functioning of large organizations induces an environment in which managers must hide bad news. The implication for accounting research of earnings management is obvious.

Many of the behavioral features of law described here are applicable to accounting. The book is readable by persons largely unfamiliar with the extensive behavioral research that supports the analyses, including practitioners as well as accounting researchers whose work is economics-based. Accounting researchers whose work is psychology-based will find the applications intriguing.

RICHARD B. DUSENBURY
Associate Professor
Florida State University