Analysis of the organizational characteristics related to tight budget goals

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  • Analysis of the organizational characteristicsrelated to tight budget goals*

    ROBERT SIMONS Harvard University

    Abstract. This study extends our knowledge of the role of budgets in complexorganizations. Using survey methods withi a sample of Canadian firms, the analysisexamines the relationship between tight budget goals and firm performance. Additionally,the effects of business strategy and intemal structural characteristics are considered.Statistical tests suggest that tight budget goals are positively related to firm performance,and that business strategy and intemal organizational conditions are associated with tightnessin budget goals.

    Resumi. L'auteur ajoute k notre cormaissance du r61e des budgets dans les organisationscomplexes. A l'aide de m6thodes d'analyse appliqu&s k un Echantillon d'entreprisescanadiennes, il 6tudie la relation entre Ies ohjectifs budg^taires rigoureux et la performancede l'entreprise. II se penche en outre sur les cotisdquences de la strat6gie commerciale et descaracteristiques stnicturales internes de l'entreprise. Les tests statistiques donnent k penserque les objectifs budgetaires rigoureux affichent une relation positive avec la performancede l'entreprise, et que la strat^gie commerciale et la structure organisationnelle interne sontIi6es k la dgueur des objectifs budg^taires.

    IntroductionA budget is an ex ante formal statement, generally determined by negotiation andapproved byimanagement, of the resource infiows and outflows expected duringthe budget period. Thus, it is an explicit contract outlining expectations betweensuperior and ^ subordinate.;

    Budgeting research has investigated the effects of participation in the budgetsetting process (Brownell (1981), Swieringa and Moncur (1975)), the interactionof budgeting with personality variables (Seiler and Bartlett (1982), Collins(1978)), and the value of budget information on decisions and performance (Kenis(1979), Mock (1973)). Questionnaire studies based on contingency theory oforganizations have considered the relatiohship between budgeting and organiza-tional structure (Merchant (1981), Bruns and Waterhouse (1975)); other works

    * I am indebted to Haim Falk, Michael Jensen, Robert Kaplan, Kenneth Merchant, KrishnaPalepu, and two anonymous reviewers for critical comments and suggestions. Fundmg for theresearch was provided by the Division of Research of Harvard Busmess School.

    Contemporary Accounting Research Vol. 5 No. 1 pp. 267-283

  • 268 R. Simons

    have used analytic models to examine the implications of budgeting behavior(Magee (1980), Demski and Feltham (1978)).

    The view that tight budget targets are desirable and lead to better organizationalperformance is a common implicit theme in budgeting research. The purposes ofthis study are, first, to investigate whether the tightness of budget goals is in factrelated to firm performance and, second, to analyze the conditions under whichtight budgets are encountered in firms. The analysis indicates a positiverelationship between tight budget goals and the economic performance of the firm.Budgets appear to be tightest for firms following proactive market strategies andwhen budgeted performance is linked to remuneration levels and subject to ex postmonitoring.

    The concept of tight budget goals is common in the practitioner literature(Merchant (1985b p.57)). Interviews with managers during the design stage of thisstudy suggest that the concept of budget goal tightness is of practical interest andconcem to operating managers. Throughout this paper, I use the terms "tightbudget goals" and "budget tightness" interchangeably to refer to predeterminedbudget targets that are perceived to be accurate, important to achieve, and whichrequire serious effort and a high degree of efficiency in accomplishment.Depending on the research perspective, the benefits of tight budgets accrue fromeither or both of positive motivational effects and the elimination of slack.

    BackgroundOne of the first formal investigations of the effects of tight budget standards wasconducted by Stedry( 1960 pp. 61-91). Using students as subjects, Stedry devisedan experiment where the "budget" consisted of solving a predetermined numberof algebraic problems. By altering the tightness of the budget, i.e., the difficulty insolving the required number of problems, and providing economic incentives asmotivation, Stedry concluded that an individual's performance is greatest if thebudget is tight and is provided to the individual prior to the setting of personalaspiration levels.

    The finding that tight budget goals lead to improved individual performance hasbeen replicated in a number of field settings including a study at General Electric(Meyer, Kay and French (1965)) and a study of five industrial companies in TheNetheriands (Hofstede (1968 pp. 104-292)). Other studies, however, have failedto reject the null hypothesis of no relationship between budget tightness andindividual performance (Holstrum (1971); Kenis (1979)).

    Some behavioral studies have attempted to assess the extent that participationin budget goal setting leads to positive job attitudes and tightness of budget goals(see Brownell (1982a) for a review of this literature and Brownell and Mclnnes(1986) for a recent study of these phenomena). Budget goal tightness has also beenconsidered from the reciprocal perspective of budget slack (e.g.. Merchant,(1985a)). Budget slack is the outcome of setting easily attainable budget goals sothat individuals receive organizational rewards for performance that is below thelevel that would be expected if goals were tightly set.

  • Organizational Characteristics and Budget Goals 269

    Based on a study of budgeting process in a large retail chain, Lowe and Shaw(1968) concluded that managers, as rational economic individuals, are induced tobias budget goals to protect their personal interests. In a study of budgeting in threedivisions of a large corporation, Schiff and Lewin (1968) estimated that slack mayaccount for as much as 30 percent of operating expenses and personnel costs. Theyconcluded that loose budget goals are created intentionally by managers to achieveattainable budgets and to secure resources for the achievement of personal goals.'

    Most empirical studies of budget slack have focused solely on internalconditions relevant to the creation of slack. For example, Onsi (1973) identified 16factors related to internal conditions ofthe firm that were significant in explainingbudgetary slack. Merchant (1985a) also focused on internal variables as predictorsof slack creation.^

    The foregoing studies have associated budget tightness or budget slack withindjvidMfl/psychological variables and attitudes, individual task performance, andconstructs related to internal organizational characteristics. In this study, I attemptto extend our knowledge of the role of budget standards in two ways. First, 1investigate the relationship between budget goal tightness and firm performance,because this relationship underlies previous studies but has not been tested.Second, I examine competitive strategy, as well as the internal conditions ofthefirm, as a factor that may influence budget tightness.

    HypothesesTight budget goals and firm performance: Previous research on the relationshipbetween tight budget goals and performance has focused on individual per-formance measures only (e.g., Stedry (1960 pp. 63-67), Hofstede (1968 pp.126-127), Brownell (1982b)). It is important, however, to assess the effect ofaccounting design choices, e.g., budget tightness, on firm performance (Merchantand Simons (1986)). Since tight budgets have generally been linked positivelywith individual performance in the literature reviewed above, I expect thisrelationship to hold at the firm level.

    HI: A positive relationship exists between tight budget goals and firm performance.

    Tight budgets and competitive strategy: The product/market strategy of a firmrepresents its effort to position products to satisfy the demand of specified marketniches. The competitive market strategy ofthe firm may affect the extent to whichfirms attempt or are able to create tight budgets.

    How is the strategy of a firm likely to affect the tightness of budget goals? One

    1 While the papers reviewed here focus on budgeting in business firms, arguments related to budgettightness also hold for the budget process in government agencies and departments. See, forexample, Wildavsky (1974 pp. 64-126).

    2 Merehant's (1985a) variables included budget participation, production technology, the importanceof meeting budget targets, and the ability to detect slack. Due to the complexity and interrelation ofOnsi's (1973) factors, the interested reader is referred to the onginal text for a discussion of factorcomponents.

  • 270 R. Simons

    argument might predict an inverse relationship between tight budget targetsand dynamic market environments. In this view, tight budget goals may beinappropriate for firms operating in competitive environments that are con-tinuously changing. In these firms, managers may be unable to predict budgetoutcomes accurately due to unforeseen competitive events in the market. Thisargument is related to Merchant's (1985a) hypothesis that the level of budget slackis related inversely to the degree of predictability in the intemal productionprocess.'' This argument ignores, however, the active role of managers ininfonnation processing (Galbraith (1977 pp. 35-57)). Specifically, environmentaluncertainty has been shown to increase information processing through controlsystems' use (Simons, (1987a); Tushman and Nadler (1978); Ashby (1960 pp.80-137)) and to result in tighter control (Kamm (1980); Khandwalla (1972)). Asenvironments become more uncertain, managers may invest more in informationprocessing and control s


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