Budget Participation and Budgetary slack: A review of Literature

Abstract

The study reviews existing literature on the interaction between budget participation and

budgetary slack through some intervening variables such as fairness, managerial trust,

organizational commitment, budget pressure, budget monitoring with a view to identifying gaps

for further empirical enquiries.

The study notes that little is known about the impact of budget monitoring and budget pressure

on organisational commitment and budgetary slack as it has not been proved whether an

employee who is committed to the organization would build slack into the budget when he

perceives he is likely to be under pressure to meet targets. Similarly, it is not certain whether the

reported reduction in budgetary slack and improved managerial performance in participative

budgeting is due to the fact that the managers perceive that any slack built into the budget will be

detected as they are being monitored.

This paper proposes a model that can be used to investigate the association between

organisational commitment, budget monitoring and budget pressure to see if budget pressure

could force an employee who is committed to the organisation to build slack into the budget as

well as whether the belief that slack can be detected through budget monitoring can deter

employees from building slack into the budget.

1.0 Introduction

Planning pervades every sphere of life and it is an exercise carried out by individuals, firms and

government on daily basis either consciously or unconsciously. When the plan is expressed in

quantitative terms, it translates into a budget which now serves as a guide in allocating resources

among competing needs as well as control behaviour and assist in making better decisions.

Budgets help clarify goals and objectives, communicate and coordinate plans, allocate resources

as well as serve as a benchmark and tool for evaluating managers (Garrison & Noreen, 2003).

Budget participation remains one of the most extensively researched areas of management

accounting. Participation in budgeting affords subordinate managers and employees the

opportunity to influence decisions concerning expectations of their superiors. Thus, budget

participation can have positive or negative effect on organisational goals depending on the level

of employee commitment. Employees with low level of commitment to the organisation tends to

take advantage of the opportunity to participate in the budget process to pursue personal goals in

order to satisfy personal interest while employees with strong commitment are likely to seek

achievement of organisational goals above personal goals (Nouri & Parker, 1996). Advocates of

participation claim that it communicates a sense of responsibility, leads to improved accuracy of

the estimates and less biases as a result of information sharing. Moreover, participation may

help to create a sense of belonging and foster commitment to organisational goals.

In the views of Shillinglaw (1982) participation enables the individual manager to see the

decisions affecting their operations as joint decisions between them and their superiors and may

be used to increase the acceptability of organisation’s goal by the individual manager.

Individuals involved in setting their own standards/target tend to work harder to achieve them
(Shields & Shields, 1998), this reduces information asymmetry and provides non-monetary

incentives that lead to higher level of performance (Hansen & Mowen, 2006).

Although a positive relationship exists between budget participation and manager’s performance

(Dunk & Nouri, 1998; Maiga & Jacobs, 2007; Ogiedu & Odia, 2013) which tends to explain the

near absence of budgetary slack, interestingly, no direct relationship has been established

(Sharma, Jones & Ratnatunga, 2006; J. Shields & Shields, 1998), instead other intervening

variables (Nouri & Parker, 1998) such as environmental uncertainties (Govindarajan, 1986;

Kren, 1992); employees’ commitment to organisational goals, employees’ perception of

procedural and distributive fairness which defines their belief in the honesty and reliability of

management(Maiga & Jacobs, 2007) and so on, have been found to be responsible for this

positive association.

However, one of the behavioural problems encountered in budgeting occurs when participation

is allowed in budgeting as participation creates room for employees to communicate inaccurate

information to superiors. In the budget participation process, the managers’ privileged situation

provides them a condition for exhibiting opportunistic behaviour, taking advantage of the

information at their disposal to bargain results favourable to their own interests, especially when

the goals negotiated in the budgeting forms the basis for variable compensation. This

dysfunctional behaviour results in the creation of budget slack. Moreover, participation in

budgeting does not encourage employees to be truthful about their abilities since they can use it

to bargain result and ease pressure for achievement of targets (Faria & Silva, 2013).

Consequently, as Leavins, Karim, and Siegel (1997) asserted, managers’ perception of the

likelihood of participating in the formulation of the budget tends to increase the expectation of

being able to inject budgetary slack. Caplan (1971) also argued that participation of managers in
the budgeting process plays a crucial role in the creation of budget slack. The existence of

budgetary slack has negative impacts on the budget process because budgetary slack provides the

potential for a budget to be easily achieved and gives a false perception of mangers’ performance

(Merchant, 1985). Thus defeating the basic purpose of budgets by creating inefficiency and

wastage (Yuen, 2004) and potentially diminishing the quality of comparing actual performance

to budgeted data (Hopwood, 1972) .

In view of the forgoing, there appears to be a lack of consensus on the relationship between

budget participation and the creation of budget slack as evidenced by varying research findings.

Therefore, the objective of this paper is to review existing literature on budget participation and

budgetary slack with the aim of identifying gaps for further empirical investigation

2.0 Conceptual clarification

2.1.1 Budgetary slack

The concept of organizational slack introduced by Barnard (1938) was the watershed for

discussions on budgetary slack in the accounting literatures. Banovic (2005), opines that until

the early 1950 accounting literature and practices has largely treated budgeting as a technical

phenomenon only, but was also quick to point out that practitioners have observed that

organizations with good technical budgeting sometimes had undesirable social-psychological

events related to budgeting. Several definitions of budgetary slack have been given by

researchers, some of which are as follows:

Young (1985, p.831) defined budgetary slack as “the amount by which a subordinate

underestimates his/ her productive capability when given a chance to select a work standard

against which his/her performance will be evaluated’’.

Budgetary slack has also been defined as the intentional underestimation of revenues and

productive capabilities and/or overestimation of costs and resources needed for the completion of

a proposed task (Dunk & Nouri, 1998).

Slack involves the consumption of organizational resources by employees over and above what

is required (that is, unjustifiable consumption of resources) by employees in terms of their efforts

toward achieving the objectives of the organisation (Merchant & Van der Stede, 2007)

Budgetary slack is created when a subordinate understates their capabilities (by overestimating

costs and underestimating revenue) or the capabilities of a business unit in their budget (Hobson,

Mellon, & Stevens, 2011)

Budgetary slack is the difference (excess/shortfall) between the budgeted resources and the

resources required for attainment of the goals of the organisation efficiently (Kilfoyle &

Richardson, 2011). Steven (2002) defined budgetary slack as the amount by which a subordinate

underestimates his productive capability at the time of preparing the budget/estimates against

which his performance will be measured.

2.1.2 Budget participation

Young (1985) defined participation as “the process whereby the superior selects the form of the

compensation contract and the subordinate is permitted to select specific value for each

parameter in the contract” (p.830). Budget participation has also been defined as a means of

communicating and influencing managers in the budgetary process, and as the extent of

subordinate influence over setting budgetary targets (Mah'd, Al-Khadash, Idris & Ramadan,

2013). Budget participation is a process which entails the active involvement of subordinates and

superiors in the determination of budget targets. The subordinate thus, has influence over what

the targets should be (Ajibolade & Akinniyi, 2013; Kochik, 2011). When an organization is
confronted with environmental uncertainty, participation can be a useful tool for planning and

setting goals. Similarly, when there is task uncertainty and task interdependence, participation

helps to motivate employees as well as coordinate the various tasks (Shields & Shields, 1998).

In the views of Nerdinger (2008) participation is regarded as a fundamental part of the three

levels of organisational culture— the artefacts, values and basic assumptions. As part of

artefacts, the different forms of participation including budgetary participation are identified.

With respect to values, participation can be conceptualised as a value which is worshipped in an

organisation to a greater or lesser extent, while the assumptions held in an organisation leads to

whether or not participation is valued (Ajibolade & Akinniyi, 2013;Schein, 2004).

2.2 Budget participation and Budgetary slack

Introducing budgetary slack makes it more likely that actual revenues will exceed budgeted

amounts. The study by Onsi (1975) indicates that the greater the degree of participation of

managers in the budgetary process the greater the opportunity for managers to influence resource

allocation thereby creating budget slack. Studies by Benke and O'Keefe (1980) and Swieringa

and Moncur (1972) shows that highly participative budgetary systems provided opportunities for

the injection of budget slack. Thus, the participative budgeting process, in which the manager

negotiates with the director provides opportunity for the manager to build slack into the budget,

since he can use it to bargain results and ease achievement of the targets which will be set (Faria

& Silva, 2013; Hansen & Mowen, 2006). In the participative budgeting process, the manager’

privileged situation provides him a condition of generating opportunistic behavior, taking

advantage of the information he has to bargain results favorable to his own interests, especially

when the goals negotiated in the budgeting forms the basis for variable compensation. Thus,
managers’ perception of the likelihood of participating in the formulation of the budget tends to

increase the expectation of being able to inject budgetary slack (Leavins, Karim & Siegel, 1997).

Caplan (1971) argued that participation of managers in the budgetary process plays a crucial role

in the creation of budget slack. Budgetary slack is created by managers who are able to conceal

some private information from their supervisors and deliberately misrepresent that information in

order to maximize their own benefit through the introduction of slack (Damrongsukniwat,

Kunpanitchakit, & Durongwatana, 2013). However, the manager’s participation in the budgeting

process does not explain slack, because it is necessary that this slack is not known by the director

(asymmetry) so that the manager can establish a reserve and protect himself from an

unsatisfactory performance evaluation, prioritizing his own interests over the ones of the

organization (Dechow & Shakespeare, 2009; Junqueira, Oyadomari & Moraes, 2010; Libby,

2003;). According to Stevens (2000) “While top management has the formal power to accept or

reject the proposed budget, they may be unable to detect the level of slack in the budget due to

subordinates’ private information regarding local operating conditions” (p.4).

2.3 Intervening variables between Budget participation and Budgetary slack

2.3.1 Fairness

In budgeting literature, two forms of fairness have been identified: distributive fairness and

procedural fairness. Procedural fairness relates to how the decision making process impinges on

the attitude and behaviour of those affected by the decisions (Lind & Tyler, 1988). It thus,

acknowledges the favourable benefits of allowing employees take part in the decision making

process (Leventhal, 1980). As noted by Brockner and Siegel(1995) structurally and mutually fair

procedures generates trust in the system, the decision process and operators, while the absence

of interactional fairness tends to breed lack of trust. Distributive fairness is akin to the phrase
“fair share”. Maiga and Jacobs (2007) argues that distributive fairness results from ensuring a

balance between inputs and outputs ratio, the unitary ratio implying that one gets what “they

deserve”. Employees’ belief about the fairness of the budgeting process has the capacity of

building trust (Folger & Konovsky, 1989). However, Brockner, Konovsky, Cooper, Folger, and

Bies (1994) found an interaction between procedural and distributive fairness and posited that

when employees who lose their job and survivors of the lay-off perceive the procedural fairness

in the organisation to be low they react negatively but when the perception of fairness is high,

they react otherwise.

2.3.2 Trust

Trust as one of the bedrock of strategic partnership enhances exchanges in any relationship

(Spekman, 1998) and management rely on it so much because they require it to be able to

mobilize employees’ commitment towards achieving the goals of the organisation (Achrol, 1991;

Moorman, Zaltman & Deshpande, 1992). Supervisors require the trust of employees to ensure

the stability of process and procedure for formulating and implementing strategic decision. The

process of participative budgeting increases employees’ trust in the organisation, sense of control

and ego which together leads to less resistance to change and more commitment to budget

decisions and acceptance of final budget (J. Shields & Shields, 1998). This explains the

psychological aspect of participative budgeting. According to Qi (2010), Psychological theories

state that allowing subordinates to take part in the budgeting process tends to arouse their

motivation and commitment which helps to improve the subordinates’ job satisfaction and

performance.
Trust in the organization and management promotes employees’ commitment to the organisation

goals (Liou, 1995) and commitment to goals acts to muster effort and enhance doggedness which

ultimately impacts performance positively (Kren, 1992).

2.3.3 Organizational commitment

Although, there is no universally agreed definition of organizational commitment, some attempts

have been made at defining the concept. Ogiedu and Odia (2013) defined it “as either

employee’s attitudes or as a force that binds an employee to an organization” Organisational

commitment has also been described as the passion an employee has for the organisation he/she

works for resulting from his/her willingness to identify with the expectations (goals and values)

of the organization and a strong desire to remain loyal and continue to be a part of that

organization (Buchanan, 1974; Porter, Steers, Mowday & Boulian, 1974; Steers, 1977).

Organizational commitment is more than a passive interest in or obedience to the organization, it

encompasses the readiness of the individual employee to make sacrifices for the overall well-

being of the organization (Mowday, Steers & Porter, 1979; Mowday, Porter & Steers, 1982).

Organizations that adopt the democratic and participatory approaches to management where

employees are allowed to participate in decisions or where management delegate or share their

decision making powers with subordinates, and organizations that are less formalized and the

level of decentralization of authority is high have been noted to enjoy a great deal of

commitment from employees (Welsch & Lavan, 1981; Zeffane, 1994). Qi (2010) argues that

subordinates participation in the budgeting process has the tendency to arouse their motivation

and commitment thereby improving their job satisfaction and performance.

2.3.4 Budget monitoring and Budget pressure

Participation in budgeting process creates an opportunity for subordinate managers to build slack

into the budget. Moreover, the fear of not being able to achieve targets can be a source of

pressure which can lead to dysfunctional behaviour. While some researchers have identified

budget pressure as one of the significant factors contributing to the creation of budgetary slack

(for example Caldwell & O'Reilly, 1982; Irvine, 1979; Schuler 1980; Sweringa, 1975;

Tagwireyi, 2012; Yuen, 2007), others, like Bradshaw, Hills, Hunt, and Khanna, 2007; Nouri,

1994 have argued that the more closely subordinate managers are monitored at the point of

preparing the budget, the less the chances of the creation of slack.

Reid (1997) asserted that close monitoring of budget leads to lower level of budgetary slack. The

degree of organizational and managerial commitment to the budget has considerable influence in

determining whether or not operators will build slack into the budget (Nouri, 1994), while the

amount of emphasis placed on monitoring measured by how closely lower level subordinates are

monitored at the point of preparing the budget have the tendency of reducing likelihood of

creating slack as such practices will be detected easily (Bradshaw et al., 2007).

The budgeting process requires commitment on the part of the individuals involved and the

prospect of not achieving budgetary goals could be a source of pressure on the individual.

Moreover, Yuen (2007) has argued that tight budgets lead to undesirable behaviour by managers

who are usually under pressure to achieve such tight targets. Managers exhibit this undesirable

behaviour when they overestimate expenses or underestimate their productive capacity to

remove possible work pressure from the perceived tight budgets so as to satisfy personal

aspirations in years of good fortune, with the hope of converting the slack into profit during

years of unfavourable fortunes (Tagwireyi, 2012). Thus, it appears that the tendency to create
budgetary slack increases with budget pressure resulting from seemingly hard to achieve targets.

When managers know that they will be under pressure to meet targets which they consider

difficult to achieve, they tend to build slack into the budget to make it easy to achieve. This is so,

because individuals are economically rational and motivated solely by self-interest (Baiman,

1990). The implication is that, individuals can compute their expected utilities properly and will

most likely make choices that maximize their consumption, without giving consideration to the

utility of others or abstract values such as honesty or fairness (Koford & Penno, 1992).

However, little is known about the impact of budget monitoring and budget pressure on

organisational commitment and budgetary slack.

3.0 Review of empirical studies

Milani (1975) conducted a field survey to examine the relationship between budget participation

and supervisors’ performance and attitude. He used 82 foremen in the production plant of a

manufacturing concern and found that budget participation has weak association with

performance while participation has a significant positive association with attitudes towards the

job and the firm.

But Brownell (1982a) in a similar field experiment where he investigated budget participation

and locus of control using 48 middle level managers found that participation has negative effect

on performance when individuals habour the notion that their destinies are controlled by external

factors. In another laboratory experiment carried out by Brownell (1982b) using 48 managers of

a manufacturing firm which examined the role of accounting data in performance evaluation,

budget participation and organizational effectiveness, the result showed that high

participation/high budget emphasis and low participation/low budget emphasis are associated
with higher performance. Conversely, high participation/low budget emphasis and low

participation/high budget emphasis are associated with lower performance.

Merchant (1985) conducted a field study involving 170 managers from 19 firms in the

electronics industry to investigate budgeting and the propensity to create budget slack and found

that the tendencies to create slack are lower when managers are allowed to participate actively in

setting budget targets and especially where the budget is tight and frequently monitoring is

required to avoid budget overrun. The study also reported that where superiors has the ability to

detect slack, the propensity to create slack reduces.

In 1995, Young carried out a laboratory experiment on participative budgeting and budgetary

slack with particular reference on the effect of risk aversion and asymmetric information using

43 MBA students and found amongst others that participation in the budgeying process leads to

building slack into budget and that increasing social pressure can lead to reduction in the amount

of slack.

Leavins, Karim, and Siegel (1997), investigated the sources of budgetary slack by administering

questionnaire on 307 departmental managers in theory companies. The result of the regression

analysis showed that budget participation increases the propensity to create slack, the level of

decentralization and links budget to the reward system as modern firms appear to provide the

ambit and chance for managers to build slack into the budget for personal advantage.

Examining the incidence of budgetary slack in a field exploration, Dunk and Perera (1997) found

in part that the association between participation and slack depends on the level of budget

emphasis.

Nouri and Parker (1998) examining the relationship between budget participation and job

performance used 135 managers from large multinational corporations. The result indicated that
budget participation has both direct and indirect effect on job performance through intervening

variables such as budget adequacy and organizational performance.

Buckland (1999) in Norway examined the interaction between budget emphasis and participation

by testing a model of supervisory styles in a highly participatory environment. The study

investigated whether the combination of budget emphasis and participation in different ways

could affect the propensity to create slack by subordinates and job related tension. It also

investigated the reasons why the combination of high budget emphasis-high participation

reduces the propensity to create slack and job related tension. The study found that there is a high

participative environment in Norway due to the existence of high power distance culture and

democratic work environment. Moreover, a high budget emphasis (high participatory) situation

was found to have only a small and insignificant direct effect on job related tension and a strong

indirect effect through trust. Based on these results, the researcher concluded that high budget

emphasis and high participation jointly leads to lower job related tension as a result of trust

between subordinates and superiors.

Chong and Chong (2002) explored the effect of budget goal commitment and information of

budget participation on performance using a structural equation modeling approach. The survey

involved 79 middle-level managers from a manufacturing company. The researchers found a

positive relationship between participation and budget goal commitment; budget goal

commitment influences job related information which in turn has positive influence on

performance.

In 2002, Wentzel investigated the influence of fairness perception and goal commitment on

managers’ performance using 74 responsibility centre managers in an urban hospital. The study
revealed that greater participation fosters higher sense of fairness which in turn increases

managers’ commitment and ultimately enhances performance.

Davis, Dezoort and Kopp (2006) on their part investigated the effect of obedience pressure and

perceived responsibility on management accountant’s creation of budgetary slack in an

experiment invoiving 77 management accountants. The study found in part that despite the

pervasive perceptions of ethical conflict, about half of those interviewed violated explicit policy

and created budget slack when faced with pressure from supervisors.

Maiga and Jacobs (2007) who used data collected from a survey of 163 managers in the United

States of America and structural equation modeling, investigated the influence of participants on

budget slack. The result of the study showed that budget participation impact both procedural

fairness and distributive justice which in turn affects trust. They also found that procedural

fairness and trust have significant impact on budget goal commitment which influences the

propensity to create slack in a negative manner.

Qi (2010) investigated whether the budgeting process has any impact on the performance of

Small and Medium Enterprises (SMEs) in China and found that participative budgeting is rarely

practiced by SMEs. However, the study showed that a positive relationship exists between

budget participation and managerial performance.

Kochik, (2011) examined budget participation and department performance through a survey of

108 budget preparers and users drawn from a cross section of Malaysian local authorities and

posited that budget participation and budget users affect departmental performance indirectly

through the mediating influence of budget adequacy, organizational commitment and role

ambiguity. Thus, budget adequacy, organizational commitment and role ambiguity are important
intervening variables in the relationship between budget participation and departmental

performance.

The study carried out by Mah’d, Al-Khadash, Idris, and Ramadan (2013) explored the

relationship between budget participation and managerial performance of 131executives of both

public and private Universities in Jordan. The study which adopted both survey and library

research methods and used the Mann-Whitney test to analysis the data that was collected, found

that managers who take part in the budgeting process tends to perform better than those who do

not participate in the preparation of the budget.

Ogiedu and Odia (2013) surveyed the role played by budget participation, procedural fairness

and organisational commitment on the performance of managers by administering questionnaire

on a sample of 200 subordinate managers selected from manufacturing companies listed on the

Nigerian Stock Exchange. The ordinary least square result of the study revealed a three way

interaction between the dependent variable and the independent variables: budget participation,

organisational commitment and budget procedural fairness. The authors recommended that firms

should allow full budget participation including ensuring fair budget procedures to enhance

managers’ performance.

Ajibolade & Akinniyi (2013) conducted a study to ascertain the association between budgetary

participation, organizational culture and the propensity for holders to build budgetary slack

through data obtained from 272 budget holders in ten Nigerian Universities. The result showed

that participation in budgeting has some mediating effect on the relationship between

organisational culture and propensity to create slack. These researchers concluded that strategies

aimed at using participation to reduce budgetary slack in public sector organisations may not

yield appropriate result.

4. 0 Gaps in previous studies

There is lack of consensus in the literature on the relationship between participation in budgeting

and the building of slack into the budget. Although studies have demonstrated a positive

relationship between budget participation, managerial trust, organizational commitment and

managers’ performance as well as weak association with budgetary slack (that is, they lead to

reduction in the creation of budgetary slack), the impact of budget monitoring has not been

examined. Similarly, studies that reported positive relationship between budget participation and

budgetary slack did not indicate whether budget pressure could be responsible for the increase in

the propensity to build slack into the budget, when participation is allowed. Consequently, it is

not known whether an employee who is committed to the organization would build slack into the

budget when he perceives he is likely to be under pressure to meet targets. Similarly, we cannot

say whether the reported reduction in budgetary slack and improved performance of employees

in participative budgeting is due to the fact that they are aware that any slack built into the

budget will be detected as they are being monitored. The lack of consensus in the literature on

the relationship between participation in budgeting and the building of slack into the budget and

to the best of our knowledge, the absence of empirical research on the impact of budget

monitoring and budget pressure on organisational commitment and budgetary slack is the driving

force for this study. We therefore, propose adaptation of Maiga and Jacobs (2007) model by

including budget pressure and budget monitoring as variables that can affect organisational

commitment thus, providing a more comprehensive model that may better explain the

relationship between participative budgeting and the creation of budgetary slack. The schematic

representation of the proposed model is depicted below:

 Budget
monitorin
g

Budge Organizational Propensity

Fairnes Trust Commitment to create
t slack
partici s

Budget
pressure

Figure 1

Adapted from Maiga & Jacobs (2007), Budget Participation’s influence on budget slack: The role of fairness perception, trust
and goal commitment

The proposed simultaneous consideration of the effect of budget pressure and budget monitoring

on organisational commitment vis-à-vis budgetary slack justify the contribution to knowledge of

this study.

5.0 Conclusion and Recommendation

This study reviewed extant literature on budget participation and budgetary slack with a view to

identifying gaps which can be further investigated empirically. Although previous studies have

established that there is a relationship between participative budgeting, organizational

commitment and budgetary slack, some gaps still exist as identified in the preceding sections.

In the light of the foregoing, we propose the empirical investigation of the impact of two other

variables: budget pressure and budget monitoring on organisational commitment and budgetary

slack for further studies. It is believed that this may clarify the conflicting results on the

association between participative budgeting, organisational commitment and budgetary slack.

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