Business executives and academics frequently criticize budget-based compensation plans as providing incentives for subordinates to build slack into proposed budgets. In this paper, we examine whether either of two practices—using budgets to allocate scarce resources, or providing information about co-workers—reduces budget slack and increases subordinate performance when organizations use budgets for performance evaluation. The results from our experiment show that using budgets for both resource allocation and performance evaluation not only eliminates budget slack, but also increases subordinates' effort and task performance. Additionally, we find that an internal reporting system that provides information about subordinates' budgets and performance to their co-workers mitigates budget slack when superiors do not use budgets as a basis for resource allocation. These results highlight the synergies between the planning (resource allocation) and control (performance evaluation) functions of managerial accounting practices such as budgeting. Our results also suggest that by designing the internal information system to reduce information asymmetry among subordinates, the firm can increase subordinates' incentives to provide more accurate budgets.

Despite the common use of negotiations to set budgets in practice, accounting research has focused primarily on budgets set unilaterally by subordinates, while goal-setting research in management has focused primarily on budgets set unilaterally by superiors. In addition, budgeting research in accounting has focused almost exclusively on the planning aspects of budgets to the exclusion of their motivational aspects. This study complements prior research in two ways. First, the study examines how budgets and the economic consequences of the budget-setting process differ when budgets are set through a negotiation process vs. when set unilaterally. The study also considers factors associated with negotiation agreement and the relation between agreement and the economic consequences of negotiated budgets. Second, the economic consequences examined are budgetary slack and subordinate performance, allowing us to address the trade-offs between the planning and motivational aspects of budgets. Negotiated budgets differ from unilaterally set budgets in a manner consistent with social norms and/or information transfer occurring during negotiations. Both the budgets and the economic consequences of the budgetsetting process differ when budgets are set through a negotiation process where superiors have final authority in the event of a negotiation impasse vs. when set unilaterally by superiors. Further, negotiation agreement significantly affects the economic consequences of negotiated budgets. Budgets set through a negotiation process ending in agreement contain significantly less slack. A failed negotiation followed by superiors imposing a budget has a significant detrimental effect on subordinate performance.

No abstract

In this paper, we experimentally investigate the effects of budget-based contracts and budget levels (performance targets) on group performance. We compare a group piece-rate contract with two different specifications of a group budget-based contract: (1) a group budget-fixed contract that provides no remuneration for performance below the budget and a fixed bonus for performance meeting or exceeding the budget, and (2) a group budget-linear contract that provides no remuneration for performance below the budget, a fixed bonus once the budget is attained, plus a piece-rate for production in excess of the budget. We also assigned each group a budget level, set at 50 percent, 75 percent, or 100 percent of the group's performance capability. The results indicate that the group budget-linear contract led to significantly higher group performance than both the group budget-fixed contract and the group piece-rate contract. Additionally, the 75 percent budget level led to significantly higher group performance than both the 50 percent budget level and the 100 percent budget level. Finally, the variability in group performance was lowest under the group budget-linear contract and the 75 percent budget level. Collectively, these results demonstrate the efficacy of both certain types of budget-based contracts and “moderately” difficult budget goals in enhancing group performance. The results also suggest that both motivation and coordination (planning) can be enhanced by budget levels of moderate difficulty and group budget-linear contracts, as the group budget-linear contract and the 75 percent budget level not only led to the highest level of performance, but also led to the lowest variability in performance.

Employment relationships provide fertile ground for both employee and employer opportunism. Employers worry about whether employees will devote sufficient effort to work, and employees are concerned about whether employers will compensate them appropriately. In this paper, we examine whether employer discretion over the size of the total employee compensation pool and the allocation of this pool among employees influences employee and employer opportunism. The results of our experiment indicate that firm output and employees' compensation are greater when the employer does not have discretion over total employee compensation, but does have discretion over the allocation of total compensation. We find that the employer's residual profit increases with discretion over the allocation of compensation among employees; however, we find no effect on residual profit of the employer's discretion over the total amount of employee compensation. Our results suggest that firms benefit from a compensation contract that establishes total employee compensation as a predetermined function of public, aggregate measures such as accounting income, but provides the employer at least some discretion to allocate this compensation using private information. However, our results caution that employees and employers may not have similar preferences for the degree of employer discretion over the determination of total employee compensation.