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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 systems thereby resulting in more accurate and tighterbudgets.

According to the arguments advanced above, budgets should be tightest whencompetitive environments are dynamic due to proactive product/market strategies.Therefore, the following hypothesis is advanced:

H2: Tight budget goals are positively associated with strategies that emphasize frequentproduct/market change.

Budget tightness and internal conditions: Budgeting procedures in organizationsrepresent an important way of setting contracts between superiors and subordi-nates. Past research (e.g., Schiff and Lewin (1968)) suggests that self-interestedmanagers will attempt to set easy budget goals for themselves. Monitoring andreporting controls can be used by superiors, however, to gather data about past andpresent performance of individuals, departments, and divisions throughout theorganization. This information can be used during negotiation of budget goals tocounter the tendency of subordinates to set easy budget goals.

H3: Tight budget goals are positively associated with ex post monitoring of budgetedactivity outcomes.

To the extent that compensation is determined by a formula based on theachievement of budget targets, subordinates will be motivated to create budgetslack. For example, a relatively low revenue budget target allows an individual toachieve the target by less effort than would be necessary with a tight budget goal.Given the rational expectations of managers - that subordinates will act to biasbudget targets to maximize compensation - 1 expect, however, that budgets will berelatively tight in situations where compensation is formula based. In cases whencompensation for subordinates is determined by reference to budget goalachievement, managers will strive to ensure that budget goals are tight andaccurate.

3 Merchant's results in regard to this hypothesis were inconclusive.

Organizational Charactedstics and Budget Goals 271

H4: Budget goal tightness is associated positively with the use of remuneration formulasbased on achieving budget targets.

Pardcipation in budgeting has generally been studied by focusing on thepositive effects of participation on personal sadsfaction and individual per-formance (see Brownell (1982a) for a comprehensive review of this literature).Recently, researehers have considered budget participation in an agency perspec-tive (Ramakdshnan (1985); Baiman and Evans (1983); Magee (1980)) andconcluded that the participadon of subordinates in setdng budget targets can bejusdfied economically when the subordinate has better information than thepdncipal. A problem may adse, however, due to the subordinate's desire to createeasily achievable targets through participation in budget setting. In the absence ofmonitodng by supedors, participadon in budget setting is expected to lead to lowbudget targets. Following this reasoning, rational managers can be expected toincrease monitodng and reporting controls if subordinates participate in budgetsetting. The following two hypotheses emerge:

H5: Budget participation is positively associated with monitodng and reporting controls.

H6: Participation in budgeting is inversely associated with tight budget goals aftercontrolling for the effects of monitodng and reporting controls.

Sample selection and data collectionThe hypotheses of the study were tested by analyzing questionnaire data providedby 86 Canadian firms. The relative importance of the reladonship between budgetgoal tightness and the idendfied intemal and extemal vadables was examinedusing regression procedures. The following section descdbes those procedures.

Using the Dun and Bradstreet Canadian Key Business Directory, 108 firms inthe Montreal and Toronto areas were selected from 19 industdes for inclusion inthe study (see Appendix I for a descdption of the selecdon procedures). Of thesefirms, 86 agreed to provide data for the analysis. The firms included in the studyreported sales of less than two million dollars to over one billion dollars; meansales were $236 million. The average number of employees was 1,320. No singleindustry represented more than ten percent of the sample.

Questionnaires were completed in each firm by expedenced senior managers:*respondents had been associated with their businesses an average of 12 years; ninepercent were chief executive officers (CEO); 65 pereent reported directly to theCEO; 26 pereent were two or more levels below the CEO. To ensure thatrespondents understood both the instructions and the questions, each respondentwas contacted by telephone in the week following receipt of the questionnaire, atwhich time any necessary cladficadon was provided.

4 In 16 firms, two managers independently completed and returned the questionnaire; for flieremaining firms, only one response was received. In the case of duplicate responses, the ratings ofthe most senior officer were used as the firm's response. Where any scale item differed between thetwo respondents by more than two points, responses were averaged (this occurred for 5.0 percent ofduplicate scores). Scores among raters in the same firm correlated at 0.60 or higher for all scales usedin the study. The minimum acceptable level of intercorrelation for using a measure is generally 0.60(Price and Mueller (1986 p. 6)).

272 R. Simons

TABLE 1Reported variable distributions

Tight budget goalsMonitoring and reporting controlsFormula-based remunerationBudget participationROIIndustry-adjusted ROI

Number ofresponses

868686867070

Reportedrange'

3.2-7.03.3-7.01.0-7.01.0-7.0- 6.0% to 46.3%-17.9% to 20.4%

Mean

5.665.104.794.54

18.1%0.0%

Standarddeviation

0.770.921.891.26

11.749.49

'All variables except ROI are scored on anchored, seven-point, Likert-type scales with 7 indicatingmaximum value (e.g., maximum budget tightness) and 1 indicating minimum value (e.g., minimumbudget tightness).

MeasuresExcept for retum on investment data, all responses were measured on anchoredseven-point Likert-type scales. Scale questions (described below) were refined bythe following procedures: first, they were adopted from previous studies wheneverpossible (e.g., Hofstede (1968 p. 179); Khandwalla (1977 pp. 639-657); Millerand Friesen (1984 pp. 277-280)); second, to reduce ambiguity, questions wereedited by three faculty colleagues; third, questions were pretested with seniormanagers and chief financial officers in 20 firms not included in the study and theircomments conceming applicability and clarity were solicited and incorporated inthe final questiotmaire.

Budget goal tightness: The budget goal tightness attribute was measured bycomputing the mean of four Likert-type scales. The first scale rated the tighmess ofbudgetary goals affecting managers from "very tight" to "very loose." The secondscale rated budget performance standards from "not at all accurate" to "extremelyaccurate." The third and fourth scales rated the importance of "meeting budgettargets" and "achieving operating efficiencies (i.e., maximum output for givenlevels of inputs)."

The internal reliability of the measure was estimated using Cronbach's alpha at0.79 which was judged to be safely above the 0.60 to 0.70 level of intercorrelationgenerally considered to be acceptable (Nunnally (1978 pp. 245); Price and Mueller(1986 p. 6)). Table 1 presents details conceming the distribution of this variable(and others used in the study).

Monitoring and reporting controls: This attribute was measured by computing themean of six Likert-type scale questions. Sample questions included asking for thestrength of a respondent's agreement or disagreement with the statement: "controlsystems monitor virtually all tasks in the organization" and the extent to which:"written explanations are provided to managers in budget reports for changesbetween current year results and the results of previous years." The intemalreliability of the measure was computed as Cronbach a = 0.70.


Formula-based remuneration: Formula-based remuneration was measured using asingle item, seven-point, anchored scale that asked the extent to whichperformance remuneration to managers was based on meeting quantitative budgettargets versus the discretion and personal assessment of superiors.

Budget participation: The budget participation scale used in the study was a singleitem, seven-point, anchored scale from Hofstede (1968 p. 179). The scale hasbeen validated in previous studies of budget participation (Brownell (1983,1982b)).

Firm strategy: Firms in the sample were classified by strategy according to the rateof change in their products and markets in accordance with the strategic typologydeveloped by Miles and Snow (1978). Thirty-seven of the firms were classified as"Prospectors" (coded 1): these firms compete through new products and marketdevelopments and are constantly seeking new market opportunities with changingproduct lines. The remaining 49 firms were classified as "Defenders" (coded 2):these firms engage in little product/market development, operate in relativelystable product areas, offer more limited products than competitors, and competethrough cost leadership, quality, and service. Appendix I describes the proceduresfollowed in making this classification and Appendix II shows the distribution ofthe firms by industry.

Performance: Each firm in the sample provided accounting-based, retum oninvestment (ROI) data for the three most current years. The performance measureused was the average three year ROI for the business. Reported ROI figures foreach firm^ were checked against published financial statements where possible andfound to be substantially accurate. The median three year ROI for sample firmswas 16.9pereentwitharangeof-6.0to46.3pereentandamean of 18.1 percent.

To control for possible performance effects due to industry-specific factors,(e.g., capitalization policies in high research industries), performance was alsomeasured as the industry adjusted, average three year ROI for the business. Tocalculate this second measure, the mean three year ROI for each industry wascomputed by summing across the individual ROI figures reported by all samplefirms in that industry. Then, each firm's ROI was adjusted by subtracting the meanthree year industry ROI from the firm's reported three year ROI. The median forindustry-adjusted ROI was 1.0 percent with a range of -17.9 percent to 20.4pereent and a mean of 0.0 percent.

Analysis

Relationship between tight budget goals and firm performance (HI):To gain a preliminary understanding of the nature of the relationship between

5 To overcome the impossibility of independently obtaining ROI information for privately heldcompanies (and multinational subsidiaries), which make up the majority of the sample, respondentswere asked to provide ROI infonnation for their businesses in the questionnaire.

274 R. Simons

TABLE 2Spearman coirelations between budget goal tightness and ROI for all firms that provided ROI data(n = 70)

ROI

Industry-adjusted ROI

Budget goal tightness

0.38 (All)0.45 (P)0.30 (D)0.30 (All)0.30 (P)0.27 (D)

a < (one tail test)

0.0010.0050.0500.0050.0500.050

Correlations reported<A11) = Spearman correlation for all firms in sample; n = 70.(P) =Speannan correlation for Prospector firms in sample; n = 32.(D) = Spearman correlation for Defender firms in sample; n = 38.

budget tightness and firm performance, data for budget tightness, absolute ROI,and industry-adjusted ROI were correlated for the 70 sample firms that providedfull data sets (16 firms declined to provide ROI data). Table 2 shows a positive0.38 correlation between tight budget goals and ROI; a significance test using theSpearman correlation allows rejection of the null hypothesis at the 0.001 level.The Spearman correlation using industry-adjusted ROI is 0.30 (a < 0.005).

Tight budget goals and competitive strategy (H2):Hypothesis 2 predicts that firms following a proactive Prospector strategy wouldreport tighter budgets than would firms following a more conservative Defenderstrategy. To test Hypothesis 2, budget tightness scores were compared betweenProspector and Defender firms using a Mann-Whimey U test which is based on thenull hypothesis that the two populations are not different (Conover (1980 pp.215-223)). The result ofthe one-tailed test was an a level of less than 0.06, withProspector firms scoring a higher mean rank than Defender firms. Thus, the secondhypothesis is weakly supported.

Since Hypothesis 2 is supported weakly by the data, it is appropriate toreconsider the results of testing the first hypothesis in which a positive relationshipwas found between budget tightness and ROI. Is the strength of this relationshipmodified by the strategy followed by the firm? To answer this question, the samplewas split by strategy and the correlation between budget tightness and ROI wascomputed separately for the 32 firms following proactive Prospector strategies andfor the 38 firms following conservative Defender strategies (Table 2). Thisanalysis revealed that the correlation was positive for both strategic groups but thatthe relationship was stronger for Prospectors (ot = 0.45) than for Defenders (a =0.30). This result supports the argument made by Miller and Friesen (1982) thatformal controls may be especially important to innovative firms that must monitorand constrain innovative excess in order to prosper.

The correlations using industry-adjusted ROI, however, showed little differ-ence in the positive relationship between budget goal tightness and performance


TABLE 3Spearman correlations between budget goal tightness and intemal variables for Ml satnple andsubsamples split by strategy-type

Monitoring and reporting controls

Formula-based remuneration

Budget participation

Budgetgoaltightness

0.38***0.49***0.31**0.29***0.27*0.37***0.15*

-0 .060.30**

(AM)(P)(D)(All)(P)(D)(All)(P)(D)

Monitoring& reportingcontrols

0.03 (All)0.13 (P)0.01 (D)0.21* (All)0.16 (P)0.26* (D)

Formula-basedremuneration

0.24* (All)0.40*** (P)0.15 (D)

Correlations reported(All) = Spearman correlation for all firms in sample; n = 86.(P) = Spearman correlation for Prospector firms; n = 37.(D) = Spearman correlation for Defender firms; n = 49.

One-tail level of significance* = a < 0.10* = a < 0.05

** = a < 0.01*** = a < 0.005

for Prospectors and Defenders. Taken together, these results indicate that (1) apositive relationship exists between budget goal tightness and performance forall firms, (2) this relationship is stronger for Prospector firms following pro-active product/market strategies, and (3) Prospectors, which generally reporttighter budgets than Defenders, may operate in more profitable industries thanDefenders.*^

Tight budget goals and internal conditions (H3 to H6):These four hypotheses predict an association between budget tightness andintemal conditions: monitoring and formula-based remuneration are expected tobe positively associated with budget tightness; participation in budgeting isexpected to reduce budget tightness subject to the moderating effects ofmonitoring and reporting controls. Table 3 highlights the correlations relevant forHypotheses 3,4 and 5. Three correlations are presented for each relationship: thecorrelation for all sample firms (i.e.. Prospectors and Defenders together), thecorrelation for Prospector firms only, and the correlation for Defender firms only.

As predicted by Hypothesis 3, budget tightness is positively associated withmonitoring and reporting controls (p = 0.38; a < 0.001). Although highlysignificant for both Prospectors and Defenders, the relationship is strongest for theProspector firms in the sample, for which a correlation of 0.49 was computed,

6 See Simons (1987b) for an exammation of the industry performance effects of Prospectors andDefenders.

276 R. Simons

supporting arguments that formal controls are especially important for innovativefirms competing in uncertain environments (Simons, (1987a); Miller and Fdesen(1982)).

Budget tightness is also positively associated with formula-based remuneration(p = 0.29; a < 0.005), which allows rejection of the null for Hypothesis 4. Thisrelationship is stronger for Defenders (p = 0.37) than for Prospectors (p = 0.27).

Hypothesis 5 predicts a positive reladonship between monitodng and budgetparticipation. Indeed, participation in setting budget targets appears to beassociated with increased monitodng and repordng controls for all firms (Table 3:p = 0.21; a < 0.05) and especially for Defenders (p = 0.26).

Hypothesis 6 was not supported by the data. After controlling for the effects ofmonitodng and reporting controls, H6 predicts an inverse relationship betweenbudget dghtness and budget participation. The partial correlation (not reported inTable 3) between budget tightness and budget participation, however, is positive(p = 0.18; a < 0.06)."^ Moreover, splitting the sample by strategy type reveals anonsignificant negative relationship for Prospectors (p = -0.16; n.s.) and apositive relationship for Defenders (p = 0.29; a < 0.05).

Relative relationships of independent variables to tight budget goalsTo understand better the relative importance of the relationship between tightbudget goals and intemal and extemal factors, multiple regressions were run forthe sample data. Table 4 reports the results. The overall R^ including all fourindependent vadables in the study was 0.278 (adjusted R^ = 0.252) with amultiple /? of 0.535. The overall F stadstic was 8.14 which was significant beyondthe 0.001 level with 4,81 degrees of freedom. Intemal vadables (monitodng andreporting controls, formula-based remuneration, and budget participation) con-tdbuted 0.242 to R^\ the strategy vadable contdbuted 0.036 to R^.

A significant amount of the vadance in tight budget goals can be explained bythe vadables identified in this study. The relative strengths of the relationships inthe sample data indicate that monitodng/reporting controls and formula-basedremuneration are the most important predictors of tight budgets, followed by afirm's strategy. Budget participation was not significant in the multiple regression.

Data relationships not addressed through formal hypotheses:The hypotheses reported above were developed to test the relationship of budgetgoals to firm performance and to conditions under which tight budget goals wereencountered in firms. The vadables measured in the study may also be interrelatedin other ways. Figure 1 highlights the statistical correlations in the sample dataamong the five vadables used in the study.

Since strategy may affect these relationships, correlations are presented for allsample firms, for Prospector firms only, and for Defender firms only.^

7 Table 3 shows the zero order correlation between budget tightness and budget participation as 0.15.8 Simple correlations, rather than a formal path analysis, are presented. To apply path analysis,

theories of causality among the five variables must be specified to predict the interacting path effectsof the ten possible bivariate relationships.


TABLE 4Multiple regression with budget goal tightness as dependent vadable(n = 86)

Coefficients

Independent variableStandarderror

Constant 3.633 0.551

Extemal variable:(4) Strategy" -0.281 0.140

6.59

-2.01

.0001

Intemal variables:(I) Monitoring and reporting controls(2) Formula-based remuneration(3) Budget participation

0.3760.0780 039

0.0890.0400.067

4.231.960.58

.0001

.0530n.s.

0.047

Sum of squares and relative importance of intemal and extemal variables:Sum of Degrees of

Source squares freedom AR' a<

Internal variables (1,2,3)External variable (4)Regression (1,2,3,4)Residual

Overall R^ = 0.278Adjusted R^ = 0.252Multiple R = 0.0535

11.5781.703

13.28134.524

47.805

314

81

85

0.2420.036

9.1684.0468.141

0.00010.05000.0001

11 In the regression model. Prospector firms were coded 1 and Defender fUms were coded 2. Thenegative coefficient for the strategy variable indicates that Prospector firms reported tighter budgetgoals than did Defender firms.

The relationship between budget participation and firm performance (ROI) isnonsignificant.' This is not surprising given the complexity of the phenomenathat are argued to provide benefits from participative budgeting (see, for example,Mclnnes and Ramakrishnan (1987)). Budget participation seems, however,to be associated witti different effects for Prospector and Defender firms.For Defenders, budget participation is related to tightness of budget goals (p =0.30), monitoring controls (p = 0.26), and only weakly related to the use ofpredetermined formulas in awarding bonuses (p = 0.15). To the extent thatparticipation in setting budgets is allowed or encouraged. Defenders that operate instable environments may increase monitoring to ensure tight budget goals.

For Prospectors, which operate in uncertain environments, participation inbudget setting is not associated with tightness of budget goals, but is stronglyassociated with the use of formula-based remuneration (p = 0.40) and weaklyassociated with monitoring (p = 0.16). This result may reflect the differencebetween Prospectors that change goals frequently and assign rewards subjectively

9 The relationship between budget participation and industry-adjusted ROI is also nonsignificant.

278 R. Simons

Fignre 1 Speaiman correlations among variables lepoited in the study for full sample andsubsamples split by strategy type

0.02 (All)0.13 (P) /0.01 (D) /

/ 0.21* (All)/ 0.16 (P)

Monitoringand Importing

controls0.38* (AI10.49* (P)0.31* (D)

()0.26* (D)

Formula-basedremuneration

I \

I

0.24 (All)()

\0.15(D)\

\

0.29* (All)0.27* (P) ^0.37* (D) i.

0.12 (All)0.06 (P)0.14(D)

0.38* (All)0.45* (P)0.30* (D)

0.15 (All)—V-0.06 (P) * '

0.30t (D),

L

Budgetparticipation

Budget goaltightness

' 0.03 (AU)0.01 (P)

-0.02 (D)

ROI

0.10 (All)0.07 (P)0.14 (D)J

Correlations reported(All) = Spearman correlation for all firms in sample; n = 83 except for ROI correlations where

n = 70.(P) = Spearman coirelation for Prospector firms in sample; n = 36 except for ROI correlations where

n = 32.(D) = Spearman correlation for Defender firms in sample; n = 47 except for ROI correlations where

n = 38.* = a < 0.05 (one-tail),t = a < 0.05 (two-tail).Solid lines indicate hypotheses developed and tested in the study; dashed lines show relationships

not explicitly tested.

versus Prospectors that fix goals periodically through a formal participativeprocess and tie rewards to a formula based on achieving those goals.

Other relationships noted by dashed lines are not significant.

Discussion and conclusionsThe sample data show a positive relationship between tight budgets andfirm performance. Previous empirical researeh suggests that the increase inperformance associated with tight budget goals may be partly due to positivemotivational effects (Stedry (1960 pp. 86-91)). Profitable firms may alsobe successful in eliminating slack in budget goals thereby improving theirperformance, at least on a short term basis, by such actions. While thisinterpretation lends validity to the actions of accountants and others who work toensure the accuracy and tightness of budget goals throughout the organization, itmust be recognized that the results of this study do not attribute directionality to theeffects under examination. For example, an equally plausible explanation may be


that individuals working in successful firms perceive budget goals to be tight (or,alternatively, if a firm is perfonning poorly, the budget is seen as being inaccurateand loose). Thus, the interpretation of cause and effect remains speculative.

The strategy followed by the firm appears to influence the tightness of budgetgoals. Prospector firms (Miles and Snow (1978)), which concentrate oncontinuous product/market changes, report tighter budgets than Defender firms,which operate in more stable environments. Moreover, the data suggest that tightbudgets are beneficial for both Prospector and Defender firms as shown by thestrong positive correlation between this variable and firm performance. While thisresult is not surprising in respect of Defender firms, it is at odds with the belief thattight budgets are inappropriate for firms that operate in changing competitiveenvironments. Tight budgets may reflect the need for firms operating in uncertainenvironments to process more information and to control activities more tightly(Simons (1987a); Miller and Friesen (1982); Kamm (1980); Galbraith (1977 pp.174-184); Khandwalla (1972)).

The importance of internal structural conditions in explaining budget tightnessis consistent with previous empirical research focusing on budget slack.'° Forexample, the perception of subordinates concerning the ability of their superiors todetect slack has been shown by Onsi (1973) and Merchant (1985a) to be negativelyassociated with the creation of budget slack. In this study, the variable labeled"monitoring and reporting controls", which encompassed the extent of use ofinternal audits, variance reports, and task monitoring, was positively related totight budget goals. It seems that rational managers use organizational accountingtools to counter the loose budget goals which subordinates might otherwise create.

The use of compensation formulas based on achieving budget targets showed astrong positive relationship with tight budget goals for all firms, implying thatmanagers ensure that budget goals are tight if remuneration levels of subordinatesare determined by budget-related formulas.

Participation in setting budget goals was associated with increased monitoringand reporting controls for all firms in the sample. The relationship between budgettightness and budget participation was more complex, with Defenders reporting astrong positive correlation and Prospectors showing a nonsignificant inverserelationship. Controlling for strategy appears to be necessary in future studies ofbudget participation; the omission of strategy as a control variable may explain thedivergent results reported by Merchant (1985a) and Brownell and Mclnnes(1986). Based on his analysis. Merchant (1985a) has argued that participation inbudget setting may reduce the defensiveness of subordinates concerning budgettargets and thereby lower the propensity to create budget slack (i.e., participationwill lead to tighter budgets). Using an expectancy model, however, Brownell andMclnnes (1986) showed a positive relationship between budget participation and

10 The concept of slack in the organizational literature has been described as a multiperiodphenomenon which enables an organization to adapt overtime (Cyert and March (1963 pp. 36-38);Bourgeois (1981)). It should be noted, however, that the cross-sectional measures used in thisstudy (and other accounting studies) are not designed to consider multipenod effects.

280 R, Simons

"the expectancy that goal-directed behavior will lead to work-goal accomplish-ment." They argued that this result may be due to participation providingsubordinates with the opportunity to negotiate loose budgets. This study suggeststhat the veracity of these arguments may be conditional on the strategy of the firm.

Although the intemal and extemal variables included in the model explained 27percent of the variance in tight budget goals, the variables of this study requireelaboration and refinement. The effects of organizational context may beaddressed in future research. Consideration must be also given to integrating thebehavioral research which suggests that tight control in the wrong setting can leadto dysfunctional results (Merchant (1987); Argyris (1952 pp. 15-25)).

Other limitations must also be acknowledged. Self-reported ROI infonnationwas used as the performance measure in the analysis since public data were notavailable for most of the firms in the sample. Other performance measures basedon cumulative market adjusted retums may have provided more sensitive results.Also, questionnaire data which attempt to capture perceptions are alwayssusceptible to misinterpretation by respondents. Notwithstanding these limita-tions, this study contributes to our understanding of the role of the budget processin complex organizations.

Appendix I

Description of procedures for classifying firms by business strategyFollowing procedures introduced by Snow and Hrebiniak (1980), firms wereclassified by strategy as part of a previous study (Simons (1987b)) that focused onthe relationship between accounting control systems and business strategy. In thatstudy, two generic strategies were identified from the Miles and Snow (1978)typology: these firms were labeled as Prospectors and Defenders. Prospectorscompete through new products and market development; product lines changeover time and this type of firm is constantly seeking new market opportunities.Defenders, by contrast, operate in relatively stable product areas, offer morelimited products than competitors, and compete through cost leadership, quality,and service. The Miles and Snow typology has been validated by Hambrick(1979), Snow and Hrebiniak (1980), and Hambrick (1983).

A one-paragraph description of Prospector and Defender strategies wassupplied to over 250 CEOs in 38 industries in Quebec and Ontario with a requestthat they identify any firms in their industry that exhibit this type of strategicbehavior, A total of 171 firms (66 percent) completed and retumed thequestionnaires. A firm was classified as either Defender or Prospector when morethan two-thirds of the respondents within its industry agreed on the category.Firms that respondents agreed fitted neither type (i.e., fell in another category ofthe Miles and Snow typology) were eliminated from the sample. Additionally, ifthe responding executive from any firm disagreed with the extemal consensusconceming his own firm, that firm was dropped from further analysis. Following

Organizational Charactedstics and Budget Goals 281

these procedures, 49 Defenders and 37 Prospectors were classified for use in thisstudy. The mean agreement among respondents as to the final rating category forthe selected firms was in excess of 85 percent, indicating a high level of confidencethat the firm was consistently regarded within its industry as either a Defender or aProspector.

Since the sample used in this study was previously classified into two distinctstrategic categodes as part of an earlier study, the resulting sample is not random.However, because of the broad representadon of types and sizes of businesses andbecause no industry dominates the sample (the 19 industdes in the sample includechemicals, computers, toys and games, food, greeting cards, fumiture, phono-graph records, etc.), these findings should allow a reasonable degree ofgeneralizability.

For more details conceming these procedures and their justification, see Simons(1987b).

Appendix II

Manufacturing firms included in the sample by industry and strategy type

ChemicalsPharmaceudcalsTiresFootwearConstruction equipmentElevatorsComputersTelevision and radioPhonograph recordsSignal transmissionAircraftIndustdal controlsMedical suppliesToysFoodBaked goodsChocolateBeerLiquorFumitureGreeting cards

Prospectors

4413

—1113211123221112

37

Defenders

512412414231153121222

49

282 R. Simons

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