A Theory of Participative Budgeting

Abstract

This paper complements the ongoing empirical discussion surrounding participative budgeting by comparing its economic merits relative to a top-down budgeting alternative. In both budgeting regimes, private information is communicated vertically between a principal and a manager. We show that top-down budgeting incurs fewer agency costs than bottom-up budgeting whenever the level of information asymmetry is relatively low. Although the choice between top-down and bottom-up budgeting ultimately determines who receives private information within the firm, we find that both the principal and manager's preferences over the allocation of private information remain qualitatively similar across the two budgeting paradigms. Specifically, while the principal always prefers either minimal or maximal private information, the manager prefers an interim or maximal level of private information regardless of who is privately informed. Last, we use our model to address empirical inconsistencies relating the firm's choice of budgeting process, the resulting budgetary slack, and performance.

Reconsidering the participative budgeting–performance relation: A meta-analysis regarding the impact of level of analysis, sample selection, measurement, and industry influences

“…Second, due to the budget-based contract, this budget then induces higher effort from the agent. By combining both effects, participative budgeting increases performance (Heinle et al, 2014;Kirby et al, 1991;Shields & Young, 1993). 3 According to psychological theory, participative budgeting has a positive effect on performance via motivational and cognitive mechanisms (Birnberg, Luft, & Shields, 2007;Shields & Shields, 1998).…”

“…3 A related concern is that agents bias their information to attain slack budgets (Böckem & Schiller, 2009;Dunk, 1990;Heinle et al, 2014;Murphy, 2001). However, slack also might influence performance positively.…”

In Search of a Theory of Budgeting: A Literature Review

“…When budgeting is examined as the dependent variable, researchers are studying economic impacts on fundamentals of the budgeting process. For example, there is an impact on the budget when individuals participate in the budgeting process (Brownell and McInnes, 1986;Chow, Cooper, and Waller, 1988;Shields and Young, 1993;Heinle, Ross, and Saouma, 2014). Researchers also manipulate other communication factors (such as aggregation of information and temporal effects of feedback) to determine their effect on the budget (Cassar and Gibson, 2008;Nikias, Schwartz, Spires, Wollscheid, and Young, 2010).…”

Research on the Impact of Budgetary Participation on Management Performance Based on Meta-analysis

“…Second, budgetary decisions that result from budget-based incentive contracts can inspire higher efforts from agents. By incorporating both impacts, budgetary engagement increases management performance [5].…”