The Effect of Budget Framing and Budget-Setting Process on Managerial Reporting
Role of budgeting in the planning, control, and resource allocation process. It is all in the game if the budget allows the projects of an organization to be done. Every financial activity that a firm undergoes has to be decided with respect to the budget that has been planned with respect to the same. Under the conditions it is very important to know what a budget actually means. A budget is formal document that states the monetary capacity of a firm to plan, control and allocate its resources accordingly. In other words it is the presence of money that is converted to currency as and when it is required by the firm. IT is very important to know the company’s earnings while deciding the budget of a particular firm. The reason for the same is that it is this guarantee of income based on which a firm can plan its planning and the events that follow. So, the further processes of monitoring and resource allocation would depend largely on what the budget fixes for them with respect to the earnings that the firm can make in the near future. Before the financial activities are changed from what had been planned earlier, it is required to make the necessary changes in the budget so as to ascertain whether the changes are feasible by the firm or not. As for example, if a company thinks of up-stretching in the market, it would have to check if the allocated resources as per as the budget allows it to do so currently or in the required period or not. Accurate revelation of subordinates’ private Information via budget communication may increase budget effectiveness. Subordinates’ and superiors’ goals, however, are not. Always aligned and, as a result, self-interested subordinates may misreport their private information for personal gain, thereby. Decreasing the budget’s effectiveness. In practice, subordinate misrepresentation is well documented and can be very costly to firms. In response to this agency problem, research has sought to measure the magnitude of this problem. In this study the company investigated two choices made by firms that may affect the truthfulness of subordinates’ budget reports. The first choice was the frame used by the superior when requesting private information from the subordinate via a budget report. In they are study was the wording used in the superior’s budget request. Agency theory, which assumes personal wealth maximization, predicts that the budget frame is not relevant. Research regarding social norm activation, however, the suggestion was that framing may affect subordinates’ budget reports.
For this study has three broad objectives: (1) to provide evidence on whether the budget request frame affects subordinates. Budget reports, (2) to assess the impact of who sets the budget on subordinates’ budget reports and the potential interaction with the budget frame, and (3) to measure the welfare implications of these factors. To address these objectives, they conduct an experiment in which they manipulate the budget frame (honest, fair, and preferred) and whether the subordinate or the superior sets the budget.
The results have several important implications. First, although they do not find overall differences in slack between budget frames, the document and provide evidence that framing does not always affect reporting behavior in a budget setting. Second, although prior research has investigated settings in which superiors had some budget-setting interaction, their study extends these studies by examining a setting that incorporates some negotiation, which is common in budget settings. They counterintuitive finding that superior’s welfare is greater when subordinates set the budget than when superiors set the budget is based on two factors. First, subordinates’ budget reports are more truthful when subordinates set the budget than when superiors set the budget. Second, when superiors set the budget, they may set the budget at levels that result in subordinate rejection, resulting in no earnings for superiors or subordinates. As such, firms may want to carefully consider the level of subordinate and superior budget control in settings with information asymmetry. Subordinate control highlights the non-pecuniary dimensions of the budget and also minimizes potential budget errors by superiors. Thus, by allowing subordinates more budget-setting discretion, superiors may
Increase their welfare and avoid costly hold-up problems that occur when superiors set the budget.
Descriptive Statistics by Framing Condition and Budget-Setting Process Condition
Panel A: Subordinate-Set Budget
Cost of Production
Budget Report/Final Budget
Panel B: Superior-Set Budget
Cost of Production
Adjustment by Superior
According to economic predictions, in the subordinate-set budget setting subordinates should always report the maximum cost and, as a result, their budget reports should not be correlated with the actual cost of production. Contrary to this prediction, in the subordinate-set budget setting, subordinates reported the maximum cost in only 7 percent of their budget reports.
Motivating truthful reporting by subordinates is an important issue in organizations. In a budget setting in which superiors
and subordinates repeatedly interact, we examine two factors that may affect the truthfulness of subordinates’ budget reports:
the budget frame and whether the subordinate or the superior sets the budget.
We find that the framing of the budget does not result in significantly different levels of slack between any of the budget
frames that we examine when either subordinates set the budget or when superiors set the budget. Future research might
fruitfully examine the robustness of our framing results, either by replicating our results, by examining different frames, or by
introducing a reinforcement mechanism such as certification, similar to
Davidson and Stevens (2013)
in a budget setting.
We also find that, consistent with subordinates’ strategic concerns being heightened when superiors set the budget,
subordinates’ budget reports contain more slack when superiors set the budget than when subordinates set the budget. Despite
this result, however, we find that superiors’ earnings are actually greater when subordinates set the budget than when superiors
set the budget.
Our counterintuitive finding that superiors’ welfare is greater when subordinates set the budget than when superiors set the
budget is based on two factors. First, subordinates’ budget reports are more truthful when subordinates set the budget than
when superiors set the budget. Second, when superiors set the budget, they may set the budget at levels that result in
subordinate rejection, resulting in no earnings for superiors or subordinates. As such, firms may want to carefully consider the
level of subordinate budget control. Subordinate control of the budget highlights the non-pecuniary dimensions of the budget
and also minimizes potential budget errors by superiors. Thus, by allowing the subordinate more budget-setting discretion,
superiors may increase their welfare and avoid costly hold-up problems that can occur when superiors set the budget.
Finally, our study contributes to research that examines how superiors use the information in subordinates’ budget reports.
We find that subordinates in superior-set budget settings strategically report their private information and that superiors
anticipate the strategic reporting by subordinates and adjust their budgets to reduce the slack in subordinates’ budgets. Our
results also suggest that a participative-budgeting process can lead to budget ratcheting, which is common in budget
environments and may result in budget targets that are unattainable by subordinates