Using Budgets for Performance Evaluation: Effects of Resource Allocation and Horizontal Information Asymmetry on Budget Proposals, Budget Slack, and Performance

Business executives and academics frequently criticize budget-based compensation plans as providing incentives for subordinates to build slack into proposed budgets. In this paper, we examine whether either of two practices - using budgets to allocate scarce resources, or providing information about co-workers - reduces budget slack and increases subordinate performance when organizations use budgets for performance evaluation. The results from our experiment show that using budgets for both resource allocation and performance evaluation not only eliminates budget slack but also increases subordinates' effort and task performance. Additionally, we find that an internal reporting system that provides information about subordinates' budgets and performance to their co-workers mitigates budget slack when superiors do not use budgets as a basis for resource allocation. These results highlight the synergies between the planning (resource allocation) and control (performance evaluation) functions of managerial accounting practices such as budgeting. Our results also suggest that by designing the internal information system to reduce information asymmetry among subordinates, the firm can increase subordinates' incentives to provide more accurate budgets.