The impact of reputation and variance investigations on the
creation of budget slack
R.Alan Webb*
School of Accountancy,University of Waterloo,Waterloo,Ontario,Canada,N2L 3G1
Abstract
1.Introduction
In many organizations budgets are an integral component of the management control system.Budgets are ud to motivate employees,allocate resources and evaluate performance (Walker &Johnson,1999).An aspect of the budgeting pro-cess that has long interested management accounting rearchers is the notion of budget slack (for a review,e Dunk &Nouri,1998).
八年抗战Budget slack is the intentional biasing of perfor-mance targets below their expected levels (Chow,Cooper,&Haddad,1991).1Rearch suggests budget slack is common in organizations (Mer-chant,1985;Merchant &Manzoni,1989)and some have suggested it can be beneficial as a buffer against uncertainty (Cyert &March,1963;Mer-chant,1989).However slack may also have nega-tive implications including loweffort by managers,misallocation of firm resources and biad perfor-manc
e evaluations of managers and their respon-sibility centers (Dunk &Nouri,1998;Kren &Liao,1988;Lowe &Shaw,1968).
Given the potentially dysfunctional con-quences of slack,a considerable amount of rearch has attempted to identify the conditions under which it aris and the means by which it may be controlled.Single-period agency theory
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Accounting,Organizations and Society 27(2002)361–378
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*Tel.:+1-519-888-4567,ext 6548;fax:+1-519-888-7562.E-mail address:a2webb@uwaterloo.ca 1
Slack in revenue targets would result in budgets which understate revenue versus expectations while slack in expen budgets would lead to an overstatement of budgeted expens versus expectations.
models have frequently been employed and results generally showthat slack is highest w hen meeting budgets is important in performance evaluation (high budget emphasis),target tters have private information,and participate in tting their Chowet al.,1991;Young,1985).The agency models have also demonstrated the effec-tiveness of truth-inducing incentive contracts as a means of limiting slack Chow, Cooper,&Waller,1988;Waller,1988).
While the agency theory models have yielded insights about the factors affecting slack creation, evidence from organizational ttings rais ques-tions about the generalizability of the framework. First,despite their analytical soundness,truth-inducing incentive schemes are rarely found in practice(Dunk&Nouri,1998).A plausible reason for thisfinding is that more cost-effective means of limiting slack creation are prent within organi-zations.Second,veral survey studies report a negative association between slack creation and budget emphasis(Dunk,1993;Merchant,1985; Van der Stede,2000).This evidence contradicts the single-period agency theory studies that have shown slack is high when budgets are central to an individual’s Waller,1988;Young, 1985).Collectively the surveyfindings suggest that when budgets play an integral role in the evalua-tion of a manager,other features of the budgeting environment limit the extent to which managers create budget slack.To date,fewstudies have attempted to identify the additional features and the nature of their impact on slack creation.
This study focus on two features of the budget tting that can contribute to explaining the con-tradictoryfindings of survey and agency theory rearch:reputation concerns and the existence of a variance investigation policy.The identification of the features is bad on the fact that a budget is not an isolated,single-period event.Managers and their superiors may engage in repeated inter-actions about the budget and its contents.Budgets are reviewed and approved,performance is mon-itored and variances must be explained.This pro-cess can have conquences for future period performance evaluations,resource allocations and budget levels.Becau budgets have the impli-cations that extend beyond the current period,managers’concern for their reputation is likely to influence budgeting decisions.Managers’budget-ing decisions are also likely to be affected by the knowledge that results are reviewed against bud-get and they may be responsible for explaining variances.
Baiman(1990)and Waller(1994)suggest the agency framework can be extended by the inclu-sion of intra-firm reputation effects.They argue that if managers believe posssing a favorable reputation will lead to future economic payoffs, they will take actions to bolster their reputation. Although the impact of reputation on decision-making has been examined in a fewmanagement accounting Harrell&Harrison,1994), budget slack rearchers have yet to incorporate reputation effe
cts.The framework developed in this study predicts that managers will budget less slack when their reputation is affected by the reliability of their budget submissions.This pre-diction is consistent with the survey evidence that shows a negative association between slack and budget emphasis;when budget emphasis is high, the reliability of budget submissions is likely to be an important element of a manager’s reputation. Non-pecuniary factors prent in the budget tting are also likely to affect behavior(Stevens, 2000;Young,1985).One such feature expected to affect slack creation is the existence of a variance investigation policy.Previous rearch shows that control system strength is associated with a lower propensity to create slack(Kren,1993;Simons, 1989)but the specific control features have not been examined.The framework developed in this study predicts the existence of a policy of investi-gating large budget variances will generate accountability pressure to create less budget slack. This prediction is also consistent with the survey evidence reported above;when budget emphasis is high,control system features such as variance investigation policies are more likely to exist. Reputation concerns and the existence of a var-iance investigation policy may also have inter-active effects on slack creation.Two potential forms of this interaction are discusd in the the-oretical framework.However,becau neither form is strongly supported by theory,rearch questions are ud to explore the possibilities.
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An experiment was conducted with90business students.In the experimental tting,participants’budget decisions had conquences that extended beyond a single production period.Two indepen-dent factors were manipulated:the factors impor-tant to reputation-bad payoffs(budget reliability important or unimportant)and the likelihood of being held accountable for budget variances(var-iances investigated or not investigated).Results showthat the level of budget slack is affected by the factors affecting reputation-bad payoffs and the likelihood of being held accountable for var-iances.A significant interaction between the fac-tors affecting reputation and the variance investigation policy was also found.
This study makes veral significant contribu-tions to the budget slack literature.First,it pro-vides insights as to why empirical evidence from field ttings has contradicted the earlier agency-bad results.When budget emphasis is high, slack-reducing mechanisms such as reputation concerns and variance investigation policies are more likely to exist in the budget tting.Second, it extends the agency theory framework by moving away from the single-period ttings common in previous experimental rearch,incorporating both pecuniary and non-pecuniary features that influence behavior when budgets have con-quences beyond the immediate period.2Incor-poration of the additional features from the budget tting also has the benefit of improving the generalizability of th
e theory prented in this study to practical ttings.Finally,the results suggest reputation concerns and control system features may rve as cost-effective substitutes for exhaus-tive incentive contracting in practical ttings. The rest of the paper is organized as follows. The next ction develops the theoretical frame-work and hypothes.The third ction sum-marizes the experimental method.The fourth ction prents the results.Thefinal ction dis-cuss the contributions of the study,its limita-tions and future rearch directions.2.Hypothes development
2.1.Reputation
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The majority of studies employing an agency theory framework have been t in single-period ttings where reputation concerns are esntially non-existent(for a reviewof the literature e Dunk&Nouri,1998).The focus of this rearch has been on identifying the conditions under which slack aris and the role of incentive con-tracting in limiting its creation.The studies, using simple tasks and student subjects,generally showslack is highest w hen budget participation is high,private information exists,and the budget is important in performance evaluation(Chowet al., 1991;Waller,1988;Young,1985).However,evi-dence reported in veral survey studies casts doubt on the predictive validity of the agency fra-mework in practical ttings.The studies have found slack to be lower in the prence of condi-tions predicted by agency theory to increa slack creation(Dun
k,1993;Merchant,1985;Van de Stede,2000).Baiman’s(1990)suggestion that a uful extension of the agency framework can be achieved by inclusion of intra-firm reputation concerns offers one possible explanation for the contradictoryfindings.叶海龙
Reputation is a‘‘characteristic or attribute ascribed to one person by another’’(Wilson,1985, p.27)and is bad on an individual’s performance and actions over a period of time(De Jong,For-sythe,&Lundholm,1985;Kreps&Wilson,1982). Empirical evidence supports the theoretical link between obrved performance and reputation. For example,Tsui(1984)reports a positive asso-ciation between managers’reputation for effec-tiveness and their performance ratings.
When managers have budget responsibility their reputation will be affected by how well they per-form against their budgets.There are two compo-nents to reputation that will ari from a comparison of budget and actual.First,managers who consistently do better(wor)than budget esti-mates will likely develop a favourable(unfavour-able)performance reputation(Merchant,1989). Presumably managers would prefer to do better than budget to cultivate a positive performance
2Most but not all prior agency theory studies have exam-
ined slack in single-period ttings.For exceptions e Chowet
al.(1991)and Chow,Hirst,and Shields(1994).
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reputation.Second,there is evidence fromfield ttings indicating that managers who consistently do better(wor)than budget estimates by a sig-nificant amount develop a reputation for submit-ting unreliable budgets(Merchant,1989; Prendergast,1997).For purpos of this paper a reliable budget is defined as one that reflects a manager’s best estimate of expected performance levels;a reliable(unreliable)budget is not(is) intentionally biad above or belowexpected results by a significant amount.
The reputation literature offers two views as to why managers concerned about their perfor-mance reputations in organizations.Thefirst view is that reputation is valued becau can lead directly or indirectly tofinancial payoff bonus,rais,promotions;Baiman,1990;Dia-mond,1989);reputation is an economic commod-ity.The cond viewis that individuals’value having a reputation for being fair,honest and adhering to social norms for intrinsic reasons (Dees,1992).This socially bad viewof reputa-tion has similarities to Young’s(1985)discussion of social pressure and Nouri(1994)and Nouri and Parker’s(1996)notion of managers being com-mitted to actions that are in
the best interest of the organization.There is no evidence to suggest whether the economic or social value of reputation dominates but it is reasonable to assume both will affect behavior.However,becau of the well-documented empirical association between repu-tation and tangible payoffs in organizational t-tings(Kilduff&Day,1994;Neral&Ochs,1992; Tsui,1984).Baiman’s(1990)viewof reputation as an economic commodity is adopted in this paper.3 Baiman(1990)propos that if the future
offs of posssing a good reputation exceed its costs,managers will take actions they believe are necessary to build or maintain that reputation.The management literature has numerous examples of the types of decisions that may be affected by reputation concerns including project investment, capital structure and debt repayment(Diamond, 1989;Holmstrom&Costa,1986;Neral&Ochs, 1992).Applying reputation theory in an experi-mental tting,Harrell and Harrison(1994)find that escalation of commitment to an unprofitable project is higher when discontinuation of the pro-ject would negatively impact the project manager’s reputation in the external labor market.
As indicated above,evidence suggests budget reliability can affect managers’reputations(Mer-chant,1989;Prendergast,1997).The degree to which budget reliability affects a manager’s repu-tation will likely depend on how important the budget is within the organization for planning and control pur
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pos.If budget emphasis is low,slack may be encouraged to provide managers with the flexibility to deal with uncertainties in the operat-ing environment.In such situations,budget relia-bility may have little bearing on a manager’s reputation.However,when budget emphasis is high,evidence of unreliable budgets is likely to have a negative impact on a manager’s reputation since budgets are more central to the organiza-tion’s planning and control system.4
An assumption central to the propod rela-tionship between slack and reputation is that budget reliability can be inferred ex-post by com-paring actual results to budget,without conduct-ing a detailed variance investigation(Pope,1984). Two aspects of the budget tting could make it difficult to form the inferences.First,as Lukka (1988)points out,budget variances may have many caus including exogenous change in demand),estimation error and inten-tional slack).Identifying which of the caus accounts for a variance in any given situation could be difficult,particularly in uncer-tain or volatile environments.However,unless the operating environment is uncertain and unpre-dictable over an extended period,a consistent
3The socially bad value of reputation may also have con-quences for slack creation.For example managers may limit
slack creation becau they derive intrinsic satisfaction from tting challenging goals that are in the best interests of the organization.However,given this paper’s focus on the effects of reputation as an economic commodity,no predictions are developed for the link between the intrinsic value of reputation and slack creation.
4Van der Stede(2000)finds the strategy of an organization affects the budget control style employed(lowor high empha-sis).The assumption in this study is that when budget emphasis is high,budget reliability is likely to affect a manager’s reputa-tion.Predictions are not made about the conditions that give ri to high budget emphasis.
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pattern of significant budget variances will likely be indicative of unreliable budgets(Merchant, 1989;Prendergast,1997).
Second,in the ca of highly aggregated budget business division)it may be more dif-ficult to identify unreliable budgets given the lack of detail.Managers could offt large favourable variances(indicative of unreliable budgets and slack)on some line items with large unfavourable variances on others,which upon aggregation would net out.However,it is unclear whether managers
would commonly posss either the operatingflexibility or incentive to undertake this kind of manipulation.It would require consider-able management of results across veral line items with emingly limited returns to the man-ager.5Further complicating this concealment strategy is that at some point,a manager’s super-ior will likely review details supporting the aggre-gate report totals.
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The existence of budgetary participation,private information,and high budget emphasis leads to slack creation according to the single-period agency models adopted in prior rearch(Dunk, 1993).However,the framework developed above leads to a different prediction given the same antecedent conditions.When budget reliability affects reputation,slack will be constrained as long as the value of reputation exceeds any short-term benefits resulting from lower required effort,favorable performance appraisals, short-term bonus,etc.).The formal hypothesis stated in the alternative form is:
H1:When budget reliability affects reputation the result will be lower levels of budget slack.2.2.Variance investigations
The impact of control systems on slack creation has been examined on a limited basis empirically (Kren,1997).Simons(1989)reports that budget tightness(the difference between budget and actual re
sults)is positively correlated with the existence of reporting and monitoring controls. However,the degree to which budget tightness is the inver of budget slack is unclear.A budget that actually contains slack could look‘tight’,ex post,if factors exogenous to thefirm cau results to fall short of expectations.Two survey studies provide better evidence that the strength of the control system influences a manager’s propensity to create slack.6Merchant(1985)finds that slack is negatively associated with a superior’s ability to detect it.Similarly,Kren(1993)reports that orga-nizations’monitoring ability(budget reviews,var-iance follow-ups)is negatively associated with slack.The studies address the control system at a general level(existence/non-existence);they do not examine specific control features that lead to slack reduction nor the means by which the reduction occurs.
Merchant’s(1982)framework provides a uful starting point for identifying the particular control system elements that may affect slack creation. According to Merchant(1982)a management control system may have many objectives includ-ing control over specific actions,results and per-sonnel.Action controls can include behavioral ation of duties),action work rules,codes of conduct) and pre-action approval limits). Results controls involve holding individuals accountable for specific quality,out-put,profits),which i
mplies comparison of out-comes to a pre-defined budgets). Personnel controls include interventions such as stafftraining or the u of work groups,and have 6The studies that have examined control system effects have not measured actual budget slack but instead have asked man-agers howlikely they w ould be to create slack under certain conditions.It ems plausible to expect an association between actual slack creation and slack‘‘propensity’’but that remains an empirical question.
5It is possible that even in the ca of detailed budget
reporting,managers that create budget slack are also able to
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manipulate actual results to minimize budget variances.This
would allow them to maintain a reputation for budget relia-
bility.However,this practice would ultimately damage their
performance reputation;just achieving or barely surpassing
三元催化器清洗剂easy(slack)targets would likely show up in intra-firm or
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external benchmark analysis of gment or business unit actual
performance.
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