The Effects of Reputation and Ethics on Budgetary Slack

Abstract

This experimental study tests the effects on budgetary slack of two potential controls for opportunistic self-interest-reputation and ethics. I manipulate the level of information asymmetry between the subordinate and the superior regarding productive capability and measure the subordinate's reputation and ethical concerns regarding budgetary slack. In this setting, I examine how information asymmetry affects reputation and ethical concerns, and test the effects of these concerns on budgetary slack. Consistent with prior findings, subordinates restrict the slack in their budgets to well below the maximum under a slackinducing pay scheme, even after five periods of experience. Budgetary slack is negatively associated with a measure of ethical responsibility from a pre-experiment personality questionnaire as well as reputation and ethical concerns expressed in an exit questionnaire. Subordinates express lower reputation concerns as information asymmetry regarding productive capability increases, thereby reducing the superior's ability to monitor the slack in their budget. Ethical concerns, however, are not diminished with increases in information asymmetry. These results suggest that reputation is a socially mediated control, whereas ethics is an internally mediated control for opportunistic self-interest.

Public and Private Forms of Opportunism within the Organization: A Joint Examination of Budget and Effort Behavior

“…Similar to prior experimental studies (e.g., Young 1985;Waller 1988;Chow et al 1988;Chow et al 1991;Fisher et al 2000, Stevens 2002, Webb 2002 producer's expected performance minus the self-set budget all divided by expected performance.…”

“…While fairness concerns reduce both budgetary slack and low effort, ethical concerns reduce low effort only. The insignificant relation between ethical concerns and budgetary slack, which is inconsistent with results in Stevens (2002), is likely due to the learning effects we observe for budgetary slack. That is, participants observe high budgetary slack as managers and thereby come to view budgetary slack as a ''social norm.''…”

“…A growing number of experiments in management accounting have found that participants constrain their opportunism, inconsistent with assumptions in agency theory (e.g., Evans et al 2001;Stevens 2002;Webb 2002;Hannan 2005;Hannan et al 2006). There is little experimental research, however, examining characteristics of opportunism within the organization.…”

The Robustness of Honesty Effects on Budget Proposals when the Superior has Rejection Authority

“…From this perspective, budgetary slack is a type of opportunistic behavior that reduces the value of participative budgeting to the firm (Baiman and Evans 1983;Merchant 1985;Kren and Liao 1988). 1 Contrary to the assumptions of traditional agency theory, prior experimental studies of participative budgeting find that subordinates exhibit honesty concerns in their budget proposals (Young 1985;Chow, Cooper, and Waller 1988;Evans et al 2001;Stevens 2002;Hannan, Rankin, and Towry 2006;Zhang 2008).…”

“…Second, the subordinate knows the actual cost with certainty when he proposes his budget, which controls for risk preferences (RSY 2008). Third, social pressure, reputation, and other multi-period effects that have been shown to affect budgetary slack (Young 1985;Stevens 2002) are controlled because the model is a single-period model and the superior never learns the true cost of the project.…”