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In this study, we examine whether an accounting choice that firms make for external financial reporting purposes influences the selling prices that managers seek to obtain when they dispose of used capital assets. From a normative perspective, managers should obtain the highest possible selling prices for used capital assets regardless of the firm’s depreciation method choice. However, theory predicts that depreciation method-induced differences in accounting book values will cause managers to systematically deviate from this normative prescription. Using multiple contexts, methodologies, and participant groups, we consistently find that managers sell used capital assets that have been depreciated using accelerated depreciation for lower prices than identical used capital assets that have been depreciated using straight-line depreciation. This effect even endures in the presence of fair value information about the asset being sold. We also provide theory-consistent evidence that depreciation method-induced differences in accounting book values influence managers’ asset selling price decisions because of the mental accounting process that they employ. Our study has economic efficiency implications for an array of situations in which depreciable assets are commonly sold.

This study examines whether an accounting choice that firms make for external financial reporting purposes influences the selling prices that managers seek to obtain when they dispose of used capital assets. Firms sell used capital assets in connection with divestitures, spinoffs, restructurings, reorganizations, downsizings, liquidations, fire sales, declining efficiency, plant and subsidiary disposals, productivity shifts, refocusing efforts, resource shortfalls, routine asset replacements, and earnings management.1 In peak expansion years during the period 1974–1992, approximately 7% of plant assets changed ownership through mergers, acquisitions, and outright asset sales (Maksimovic & Phillips, 2001). When selling used capital assets, managers should attempt to obtain the highest possible selling prices. This objective is simple and intuitively appealing, but our results suggest that it may be difficult to follow. There are at least two factors that managers should ignore when making asset selling price decisions—historical costs and accounting depreciation (Blocher et al., 2008, Garrison and Noreen, 2003, Hilton, 2002, Horngren et al., 2005 and Titard, 1993). Historical costs are irrelevant because they relate to the past and cannot be changed regardless of any current decision. Likewise, accounting depreciation is irrelevant because it represents a method of cost allocation, not asset valuation (Kieso et al., 2007 and Libby et al., 2007). Indeed, reductions in an asset’s book value need not (and usually do not) mirror the deterioration profile of the asset or changes in its fair value.2 As a result, depreciation method-induced differences in accounting book values are irrelevant when making asset selling price decisions, and these differences are even more clearly irrelevant when fair value information about the asset being sold is simultaneously available. This study draws upon research on mental accounting (Prelec and Loewenstein, 1998, Thaler, 1985 and Thaler, 1999) and mental depreciation (Gourville and Soman, 1998 and Heath and Fennema, 1996) to predict that depreciation method-induced differences in an asset’s accounting book value will influence managers’ asset selling price decisions.3 Specifically, we contend that structural and relational similarities between mental depreciation and accounting depreciation will cause managers to apply mental accounting processes from the consumer domain of their lives to seemingly parallel situations involving depreciable business assets. If so, managers may be psychologically predisposed to sell used capital assets that have been depreciated using accelerated depreciation for lower prices than identical capital assets that have been depreciated using straight-line depreciation. Further, because mental accounting is spontaneous and may occur with minimal effort (Kahneman & Tversky, 1984), we expect that depreciation method choice will have a robust effect on managers’ asset selling price decisions even when managers simultaneously receive fair value information about the asset being sold. To test our prediction, we conduct five separate experiments using: (i) multiple decision contexts (sales through trade publication, trade-in, auction, and consignment), (ii) multiple methodologies (experiments with and without financial incentives), and (iii) multiple participant groups (practicing managers, experienced MBA students, and accounting students who have in-depth accounting knowledge). In each experiment, we manipulate the firm’s depreciation method choice, which causes the asset’s accounting book value to vary. At the same time, we hold the asset’s historical cost and physical attributes constant. We also manipulate the asset’s fair value in order to examine the possibility that participants use accounting book value as a proxy for fair value. If participants use book value in this manner then depreciation method-induced differences in accounting book values should have no effect on managers’ asset selling price decisions in the presence of fair value information. Our experiments reveal a robust depreciation method choice effect even when there are compelling reasons to expect that it will be absent. In each experiment, participants sell used capital assets that have been depreciated using accelerated depreciation for significantly lower prices than used capital assets that have been depreciated using straight-line depreciation. Even when participants simultaneously receive fair value information, our experiments reveal that depreciation method-induced differences in the asset’s accounting book value continue to exert a strong influence on participants’ asset selling price decisions. These findings arise even though participants hold equivalent beliefs about the asset’s physical condition. In addition, our experiments provide theory-consistent evidence that mental accounting processes at least partly underlie the depreciation method choice effect that we document. Finally, we provide an array of tests that help rule out alternative explanations for our experimental findings. This study makes two main contributions to the accounting literature. First, our study provides initial evidence, which is consistent across contexts, methodologies, and participant groups, that the price for which managers sell used capital assets is influenced by an accounting choice that firms make for external financial reporting purposes. A number of studies argue that decision errors and biases arise because individuals fixate on summary accounting numbers without paying adequate attention to the accounting methods that were used to generate those numbers (Arunachalam and Beck, 2002, Hand, 1990 and Luft and Shields, 2001). In contrast to these studies, we provide evidence consistent with the view that depreciation method-induced differences in accounting book values influence managers’ asset selling price decisions not because managers fail to pay attention to accounting methods, but because of the particular meaning that managers ascribe to accounting information.4 Indeed, the close correspondence between mental depreciation and accounting depreciation appears to cause managers to attribute meaning to depreciation method-induced differences in accounting book values that are economically unwarranted. No prior study has documented or asserted that depreciation method-induced differences in accounting book values influence managers’ asset selling price decisions, and the results of our study cannot be inferred from prior research. Second, this study provides theory-consistent evidence that depreciation method-induced differences in accounting book values influence the way in which managers perceive and respond to sunk costs. Some studies manipulate the magnitude of sunk costs or progress towards completion (e.g., Conlon and Garland, 1993, Garland, 1990, Heath, 1995, Moon, 2001, Tan and Yates, 1995 and Tan and Yates, 2002), while other studies hold sunk costs constant and manipulate project performance, personal responsibility, and other contextual variables (e.g., Brockner et al., 1986, Davis and Bobko, 1986, Simonson and Staw, 1992 and Staw, 1976). Our study differs from sunk cost studies in that our stimulus is not sunk costs per se (we hold sunk costs constant in all of our experiments). Instead, our stimulus is depreciation method-induced differences in accounting book values (i.e., the portion of sunk cost that remains after deducting depreciation). Although accounting book values are irrelevant just as sunk costs are irrelevant, the differential transformation of sunk costs by straight-line depreciation versus accelerated depreciation appears to cognitively obscure the irrelevance of book values, causing managers to sell assets depreciated using accelerated depreciation for lower prices than assets depreciated using straight-line depreciation.5 Thus, our study extends sunk cost research by incorporating the modifying effect of accounting depreciation into our research design. This extension is important because it suggests that the sunk cost effect is modified by one of accounting’s most fundamental and enduring institutions—accounting depreciation. The remainder of this paper is organized as follows. The next section develops our hypothesis. The section after that describes five experiments and discusses their results. We then address a variety of alternative explanations for our experimental findings. The final section provides a summary and discusses certain limitations

We discuss but do not tabulate the results for Experiment 5 because the results are very similar to the results for Experiment 4. To summarize, the experimental results indicate that depreciation method-induced differences in the machine’s accounting book value have a significant effect on participants’ consignment prices (p = 0.002), which provides support for our main hypothesis. Further, we find that the significant main effect of depreciation method persists even in the presence of a significant main effect of fair value (p = 0.009). There is no significant interaction. Our experimental results also indicate that depreciation method-induced differences in the machine’s accounting book value have a significant effect on participants’ perceptions about the benefits that the used machine has provided to the company (p < 0.001), which helps to explain why depreciation method choice has its documented effect. Thus, based on the results of this experiment, we conclude that in-depth accounting knowledge does not alter any of the inferences or conclusions drawn from Experiment 4.