Detecting Misreporting in Subordinates’ Budgets

The participative budgeting literature typically characterizes budget slack as reflecting the magnitude of the miscommunication between senders and receivers of budget information. However, to the extent managers can recognize and adjust for subordinate misreporting we assert that slack may overstate the degree of miscommunication. We conducted an experiment where subordinates had private information about actual costs, were incentivized to create slack, and set budgets without negotiation. Managers prepared cost forecasts based only on subordinate budget submissions, and their knowledge of the actual cost distribution and subordinates’ incentives to misreport. We manipulate managers’ incentives to prepare accurate forecasts of actual costs (present or absent). Consistent with our predictions, results show that managers’ appear to distinguish between budgets containing lower versus higher slack and placed greater reliance on budgets that were more informative about actual costs. Also in keeping with our prediction, provision of forecast accuracy incentives lead managers' to increase their reliance on subordinate budgets. Managers’ budget reliance decisions partially mediate the effects of both budget informativeness and forecast accuracy incentives on forecast accuracy. We discuss our study’s implications for theory and practice.