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April 4, 2007

Emotional Accounting

Our feelings about the ways we get money influence how -- and sometimes even when -- we spend it.

Topics: Marketing

In purely rational economic terms, money is fungible. It shouldn’t matter where the $20 in your wallet came from, whether you earned it at a job or found it on the street. But people act as if it does, and in the 1980s the concept of mental accounting emerged. According to this concept, people categorize money they receive by its source, and deposit it in different mental accounts. Money received from a windfall such as winning the lottery would go into one account, for example, whereas money received as income from a job would go in another.

Mental accounting explains why investment bankers tend to spend their bonuses on plasma TVs and exotic vacations but save money from their salaries to buy homes. Over the past few years, Professor Jonathan Levav, working with A. Peter McGraw of the Leeds School of Business at the University of Colorado at Boulder, pursued this idea further and found that in addition to mental accounting, people tend to categorize money according to the feelings they associate with it, a process he calls emotional accounting.

To illustrate how we engage in emotional accounting, Levav compares two scenarios: receiving $200 as an unexpected gift from an aunt and receiving $200 as an inheritance from an aunt who just died. Although the money is from the same source, in the first case it triggers positive feelings, while in the second it produces what Levav terms a “negative affective tag.”

The way people evaluate money becomes more complicated when mixed emotions are involved. Suppose an investment banker received a bonus but knows that a colleague who didn’t work as hard got more money. In this case, the banker is glad he got a bonus but also angry because he feels he was treated unfairly. Meanwhile, a banker who received a bigger bonus than one of his close friends may feel more guilt than happiness.

To assuage such negative emotions, Levav says, people employ various cleansing and avoidance strategies. “If I have negative feelings about money, then I’ll launder it of its negativity,” he says. “This can mean spending it in ways that are virtuous or utilitarian. So I don’t buy the plasma TV for myself, but I might buy one for an orphanage. It’s not just about the product; it’s really about the use.”

Levav and his coresearcher conducted several studies that tested how university students spent money they received under different circumstances. In one experiment, students who completed a market research survey were given a choice afterward of different $2 coupons. They could spend the coupons either on ice cream in the cafeteria or on books in the university bookstore. Half of the students were told that the grant for the coupons came from the computer firm Dell, which had positive or neutral associations within the student population. The other half were told the grant came from the tobacco company Philip Morris. About 44 percent of the students who were told the coupons were paid for by Philip Morris chose the utilitarian textbook coupons, double the percentage of those who were told the coupons came from Dell.

“In essence, people tell themselves, ‘Let me do something good with the money so I don’t feel bad about it anymore,” Levav says. When people are angry — such as the banker who feels he was cheated on his bonus — they tend to set the money aside and give their anger a chance to dissipate. People who feel guilty are more likely to donate the money to charity. When teachers at an affluent Chapel Hill, N.C., high school received bonuses based on their students’ standardized test scores, they donated the money to a rural school, and said their students’ performance was partly the result of the community’s wealth. Levav and his coresearcher hypothesize that the teachers’ donation was a way to cleanse themselves of the negative emotions they associated with the money.

“When we make the decision to spend money virtuously — paying off a chunk of our college tuition, rather than paying off debt racked up on a weekend in Vegas — we can erase any bad feelings associated with it,” says Levav. “It may not be rational, but it makes us feel a lot better.”

Jonathan Levav is assistant professor of marketing at Columbia Business School.


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