Effects of Reputation and Ethics on Budgetary Plans
The Effects of Reputation and Ethics on Budgetary Slack
This paper conducts an experimental study to test the effects on budgetary slack of two potential controls for opportunistic self-interest – reputation and ethics. In the experimental study the level of information asymmetry between the subordinate and the superior regarding productive capability is manipulated and the subordinate’s reputation and ethical concerns regarding budgetary slack are measured. The paper examines how information asymmetry affects reputation and ethical concerns.
Prior experimental studies regarding the effects of risk aversion, information asymmetry, and pay scheme on budgetary slack have provided general support for agency predictions. However, the studies have also shown that subjects under slack-inducing pay schemes have created much less than the maximum amount of slack. This is inconsistent with opportunistic self-interest. By constraining their slack, subjects have significantly reduced the amount of money they earned for the same level of productive effort. Budgetary slack is defined as the amount by which subordinate understates his productive capability when proposing a budget against which his performance will be evaluated. According to a study by Kren and Liao (1998), when superiors use budgets to evaluate performance, subordinates have incentives to build slack into their budget to increase the likelihood of achieving the budget. Budgetary slack poses a problem for the firm to the extent that it inflates costs and reduces profits.
Similar experimental studies in the past have yielded different results. Young (1985) found that risk aversion was an important determinant of budgetary slack, but his information asymmetry did not have a significant impact on it. Chow (1998) found an interactive effect between information asymmetry and pay scheme. Slack was lower under a truth-inducing pay scheme than under a slack-inducing pay scheme, but only in the presence of
This paper conducts an experimental study to test the effects on budgetary slack of two potential controls for opportunistic self-interest – reputation and ethics. In the experimental study the level of information asymmetry between the subordinate and the superior regarding productive capability is manipulated and the subordinate’s reputation and ethical concerns regarding budgetary slack are measured. The paper examines how information asymmetry affects reputation and ethical concerns.
Prior experimental studies regarding the effects of risk aversion, information asymmetry, and pay scheme on budgetary slack have provided general support for agency predictions. However, the studies have also shown that subjects under slack-inducing pay schemes have created much less than the maximum amount of slack. This is inconsistent with opportunistic self-interest. By constraining their slack, subjects have significantly reduced the amount of money they earned for the same level of productive effort. Budgetary slack is defined as the amount by which subordinate understates his productive capability when proposing a budget against which his performance will be evaluated. According to a study by Kren and Liao (1998), when superiors use budgets to evaluate performance, subordinates have incentives to build slack into their budget to increase the likelihood of achieving the budget. Budgetary slack poses a problem for the firm to the extent that it inflates costs and reduces profits.
Similar experimental studies in the past have yielded different results. Young (1985) found that risk aversion was an important determinant of budgetary slack, but his information asymmetry did not have a significant impact on it. Chow (1998) found an interactive effect between information asymmetry and pay scheme. Slack was lower under a truth-inducing pay scheme than under a slack-inducing pay scheme, but only in the presence of