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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 information asymmetry. Similarly, Waller (1988) found that switching from a slack-inducing to a truth-inducing pay scheme significantly reduced slack only for risk-neutral subordinates.
In these studies, one notable fact was noted and that there was relatively limited budgetary slack found under slack-inducing pay schemes. Researchers have speculated that such behaviors reflect ethics-related influences such as personal integrity. This paper tests the effects of reputation and ethics on budgetary slack in an experimental setting that carefully controls social interactions and facilitates subject learning. Student subjects set budgets in a simple production setting and earned pay based on their performance relative to the budget.
The pay scheme was slack-inducing and provided an economic incentive for subjects to set their budgets at zero. The results provide strong evidence that reputation and ethics reduce budgetary slack. While slack levels under a slack-inducing pay scheme are higher than in prior experimental studies, subjects still restrict the amount of slack in their budgets below the maximum, and thereby fail to maximize their pay. Budgetary slack is negatively associated with a measure of ethical responsibility from the pre-experiment personality questionnaire as well as reputation and ethical concerns expressed in the exit questionnaire.
Subordinates express lower reputation concerns as information asymmetry regarding productive capability increases, thereby reducing the superiors 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. In conclusion, this paper highlights an important concept and that is in an organization, providing an incentive in monetary form is not sufficient enough to motivate an employee and maximize his full potential.
The studies show that rewards and penalties that take social form have more impact than those that take monetary form. It also shows that the concerns for reputation and ethics often control opportunistic behavior in practice. Reputation and ethics are intrinsically linked to compensation in practice, and the economic cost of a loss of reputation or lapse in ethical judgment could be great. However, further empirical and theoretical research needs to be done in order further solidify the roles of reputation and ethics in the control of the organization.
Better practices for management accountants This paper talks about the importance of planning, budgeting, and forecasting. The author labels these topics as the “heart and soul” of management accounting and on others “lifeblood”. The paper looks at why these topics are so important, how the planning stage is still a major pain for most organizations is and discusses the roles that management accountants do or can play as critical influencers in the strategic planning process. Planning is a very important stage in an organization.
Management accountants and finance function professionals have been on a quest to shift their roles from shareholder value to shareholder creator. Management accountants must demonstrate technical accounting depth in order to have the “right” to influence a plethora of business operations. And through possessing the knowledge and skills in the areas of planning, budgeting, and forecasting, management accountants can achieve their quest. However, there is a considerable amount of dissatisfaction among CFO’s with the planning, budgeting, and forecasting processes.
They feel that the average cycle time for completing the annual budget process is nearly four months where the ideal average cycle time would be closer to one month. Many have also argued that traditional budgeting processes are too time-consuming, is slow to detect problems, and isn’t reliable for measuring performance. CFO’s also state that the traditional budgeting process doesn’t incent “stretch behavior” in individuals or organizations but does incent gaming. Three gaming phenomena occur at least occasionally: spending money at year end to avoid losing it, deferring necessary expenditures, and negotiating easier targets.
Practitioners are also not pleased with the existing technologies that are being used in the planning, budgeting, and forecasting processes. Almost all major corporations use Excel for their budgeting process and even though the software is very functional and user friendly, quality control issues arises when trying to achieve integration across multiple work units and rolling up the totals to the organizational level. Management accountants can significantly contribute in key planning activities. They can contribute to feedback sessions to or validate the Vision and Mission of an organization.
They can research and synthesize intelligence on key environmental factors, including regulatory environment and competitors. They can identify key market segments, inventory current product and service set, and determine the priority products and markets for resource allocation, market launches etc. Work with cross-functional teams to create and update “strategic initiatives” that overlay the multiyear baseline view to achieve strategic goals. They can play a key role for the management accountant in terms of determining goals, key financial and non-financial measures (e. . use of balanced scorecard and strategy maps), long-run forecasting of key measures, budget expense detail for first year of plan, etc. And finally, management accountants can work closely with cross-functional teams to support or lead continuous process improvement efforts for one of the organization’s most critical business processes: strategic planning, budgeting, and forecasting. Lastly, the paper talks about some “better” practices for planning and budgeting. The author feels that it is important to treat planning as a key business process.
He talks about the importance of establishing end-to-end process including accountabilities, time frames, and measures of success. He also talks about engaging everyone at some level in the plan. The critical core competency for a management accountant involved in a leadership role in an organization’s planning process is project management skills, which are vital if planning is to be implemented effectively. The author then talks about achieving excellence in strategic goals. Although, by definition excellence is never achieved, however, a passion for execution and a set of enabling tools and processes are critical success factors.
Regular reviews of the processes can be done in order to review the status of the process and make adjustments as necessary, a milestone tracker system can be used to manage the progress of the strategic initiatives, and integration of a true risk-based approach into the strategic planning process. The author then calls for taking a closer look at the traditional budgeting processes that are being employed. Many opponents of the traditional approach argue that the traditional approach should be eliminated as it constitutes a fixed performance.
Budgets should be dynamic in nature so that I can be adjusted during the period in order to meet the demand of today’s ever-changing market. The author then stresses on the need to have basic knowledge of statistical tools available in order to better utilize them for the planning, budgeting, and forecasting processes and finally communicating the strategic plan and progress on strategic goal achievement is critical to ensure that all stakeholders are appropriately engaged in executing the plan successfully.
Management accountants have a very important role to play in the planning, budgeting, and forecasting stages of an organization. Along with the basic accounting skills, a good management account must also possess project management skills and extensive knowledge on statistical tools that are available in the current market. I also believe that a good management accountant should also possess good leadership skills so that it can head such initiatives effectively and efficiently.