Corporate Budgeting Is Broken—Let’s Fix It
Corporate
Budget
i n g Is Broken Let's Fix It
Traditional budgeting processes waste time,
distort decisions, and turn honeSt managers into
It doesn't have to be that wayif you're willing to
the ties between
and compensation by Michael C.Jensen
NOVEMBER 2001
95
Corporate Budgeting Is Broken - Let's Fix It
C
ORPORATE BUDGETING IS A JOKE, and everyone knows it. It consumes a huge amount of executives' time, forcing them into endless rounds of dull meetings and tense negotiations. It encourages managers to lie and cheat, lowballing targets and inflating results, and it penalizes them for telling the truth. It turns business decisions into elaborate exercises in gaming. It sets colleague against colleague, creating distrust and ill will. And it distorts incentives, motivating people to act in ways that run counter to the best interests of their companies. Consider just two examples. At one international heavy-equipment manufacturer, managers were so set on hitting their quarterly revenue target that they shipped unfinished products from their plant in England all the way to a warehouse in the Netherlands, near the customer, for final assembly. By shipping the incomplete products, they were able to realize the sales before the end of the quarter and thus fulfill their budget goal and make their bonuses. But the high cost of assembling the goods at a distant location - it required not only the rental of the warehouse but also additional labor-ended up reducing the company's overall profit.
goals, two things inevitably happen. First, they attempt to set low targets that are easily achievable. Then, once the targets are in place, they do whatever it takes to see that they hit them, even if the company suffers as a result. Only by severing the link between budgets and bonuses-by rewarding people purely for their accomplishments, not for their ability to hit targets- will we take away the incentive to cheat Only then will we eliminate
Budget
i n g Is Broken Let's Fix It
Traditional budgeting processes waste time,
distort decisions, and turn honeSt managers into
It doesn't have to be that wayif you're willing to
the ties between
and compensation by Michael C.Jensen
NOVEMBER 2001
95
Corporate Budgeting Is Broken - Let's Fix It
C
ORPORATE BUDGETING IS A JOKE, and everyone knows it. It consumes a huge amount of executives' time, forcing them into endless rounds of dull meetings and tense negotiations. It encourages managers to lie and cheat, lowballing targets and inflating results, and it penalizes them for telling the truth. It turns business decisions into elaborate exercises in gaming. It sets colleague against colleague, creating distrust and ill will. And it distorts incentives, motivating people to act in ways that run counter to the best interests of their companies. Consider just two examples. At one international heavy-equipment manufacturer, managers were so set on hitting their quarterly revenue target that they shipped unfinished products from their plant in England all the way to a warehouse in the Netherlands, near the customer, for final assembly. By shipping the incomplete products, they were able to realize the sales before the end of the quarter and thus fulfill their budget goal and make their bonuses. But the high cost of assembling the goods at a distant location - it required not only the rental of the warehouse but also additional labor-ended up reducing the company's overall profit.
goals, two things inevitably happen. First, they attempt to set low targets that are easily achievable. Then, once the targets are in place, they do whatever it takes to see that they hit them, even if the company suffers as a result. Only by severing the link between budgets and bonuses-by rewarding people purely for their accomplishments, not for their ability to hit targets- will we take away the incentive to cheat Only then will we eliminate