You are on page 1of 19

SNA VII DENPASAR – BALI, 2-3 DESEMBER 2004

Budgetary slack and its antecedents
Does manager’s power distance matter?
By
Fuad & Arifin Sabeni

Abstract
Studies have provided insights on control systems, but results have not
developed into a widely accepted theory of management control in explaining the
antecedents of budgetary slack. This study attempts to answer the peculiarities and
anomalies shown by prior researches by examining direct effect of diversification,
business unit strategy on budgetary slack, or passing through the intervening
variables, budget emphasis and incentive systems. Manager’s power distance was
postulated to affect the extent of the relationship between the rigidity of budget
emphasis and budgetary slack.
A hundred and one responses from the independent-subsidiaries companies
were gathered and then analyzed by Structural Equation Modeling set up in Lisrel 8.5
and moderated regression analysis with dummy variable. The study found that while
both diversification and business unit strategy significantly affect budgetary slack and
indirectly through budget emphasis, incentive system insignificantly affects the
presence of budgetary slack. Surprisingly, the results suggest that the relationship
between budget emphasis and budgetary slack is negative and stronger for managers
with low power distance than for managers with high power distance, as opposed to
the positive interactions hypothesized that high power distance managers react
favorably to the high emphasis on meeting the budget rather than managers with low
power distance.
Key words: budgetary slack, power distance, business unit strategy, diversification
I. Introduction
The budgetary control systems have been examined widely by many researchers
for almost five decades. One of important areas has been focused on supervisory
style, which has been used to evaluate subordinate’s performance relying on
budgetary information. It was first pioneered by Hopwood’s (1972) seminal paper,
where recent budgeting literature has shown great interest in understanding possible
effects of budgetary control styles.
Later, Most of prior empirical evidences generally maintained that the incidence
of dysfunctional behavior is affected by the tightness of budgetary controls; which is
the condition when employees, mostly at the management organization levels, are
evaluated primarily on whether or not they achieved their budget. It implies,
therefore, all aspects of job prospects and facilities strongly depend on the managers’
ability to attain the budget target. Managers who miss the targets may face the
prospect of interventions by upper management, the loss of organizational resources,
the loss of annual bonuses/incentives, and worst, perhaps, the loss of their job
(Merchant & Manzoni, 1989). Under these circumstances, managers may look for
ways to protect themselves from the downside risk of missing budget targets and the
stigma normally (Stede 2000).

95

please compare. Kaplan 1990. even if corporate managers were able to detect slack. Moreover. the budget target determined by the corporate may not as precise as the less diversified firms. business unit strategy is expected to be an important factor for explaining the presence of slack in business unit budgets. and hence. In order to minimize the existence of budgetary slack. p. corporate are likely to provide the great extent of incentive to their subordinates. Nevertheless. the results have been inconclusive or in some cases. 2-3 DESEMBER 2004 However. Nevertheless. according to agency literature. for instance.e. Organization theory has suggested that slack may be needed to successfully pursue competitive strategies that require a high degree of flexibility to respond effectively to changes in the environment (Bourgeois 1981). Miller and Friesen 1982. budgetary slack is presented. With respect to the existence of national culture (power distance) that was developed by Hofstede (1980) to moderate the relationship between budget emphasis and budgetary slack is likely to exist. relates to favorably/unfavorably reaction to a high/low budget emphasis in a high/low manager’s power distance. the business units (BU) managers may react unfavorably to the target determined by the corporate by underestimating their “real performance” to easily achieve the budget target.g. Rather than investing in “high-cost” information systems. Simons 1987. Power distance. those kinds of strategies that pursued by the business unit may also influence the extent of slack. budgetary slack can also be explained by the uncertainty involved in a particular industry facing different business unit strategy. These findings contrast with the “popular views” (e. 98. maintaining that innovation and differentiation (which is the case of differentiated companies) is best achieved in organizations that minimize formal controls (i. Hence. In addition. 1995). since corporate may not have all specific and wide information about the operation of their subsidiaries. and. as is the case of the more diversified firms (Campbell et al. The favorably (unfavorably) reaction indicates the lower (higher) extent of manager’s intention to create budgetary slack. Govindrajan (1988). the management accounting literature has maintained that the way in which a business unit competes in its market also influences the design of the management control system (Langfield-Smith 1997) Therefore. More slack reduces the chance of a target being missed. Again. the less the overload on the top. Govindrajan and Fisher (1990)). Bourgeois (1981) concluded that slack may be required to successfully pursue competitive strategy that requires a high degree of flexibility to respond effectively to changes in the environment (e. low budget emphasis). On the other hand. Langfield-Smith (1997) moreover found that the way in which business units competes in their markets influence the design of management control systems. found that prospectors emphasize rigid budgetary controls to a greater extent than defenders.SNA VII DENPASAR – BALI. that was defined as “the difference between the extent to which the superior (in this case corporate) can determine the behavior of subordinate (business unit managers)” (Hofstede 1980. 1988). Simons (1987.g. emphasize added). the fewer the exceptions that need to be investigated. Govindarajan 1988). the results of this research have been inconclusive in some cases. Porter’s differentiation and/or Miles and Snow’s prospector). contradictory (for example. 96 . corporate tend to let this slack exist in their business units. they may actually tolerate slack in business unit budgets as a conscious strategy to reduce information overload at the top (Galbraith 1973).

job satisfaction and locus of control to 83 Mexican managers. outcomes. Particularly. This main purpose of this study is to determine the situational. 97 .e. Therefore. we posit that: H1: more diversified firms experienced more budgetary slack in their business units. Corporate managers in the diversified firms are less familiar with the operations of the distinct business (Campbell et al. Therefore. Diversification can improve debt capacity. to contribute to the accounting literature by advancing “the paths” of determinants of budgetary slack that might have not been examined by prior researchers. Instead. national culture measures can be adopted in the setting of specific country as well.SNA VII DENPASAR – BALI. 1 Frucot and Shearon (1991) for instance. 357) and national culture (Hofstede 1985). no research has been done in Indonesia that uses this measure as moderating variable to examine the variables hypothesized. 2-3 DESEMBER 2004 Although Chenhall (2003). reduces the chances of bankruptcy by going into new product/markets (Higgins and Schall 1975. A diversified firm can transfer funds from a cash surplus unit to a cash deficit unit without taxes of transaction costs (Bhide 1993). Moreover. II. Therefore. The next section develops in more detail the hypotheses formulation and then followed by methodology of the study in Section III. can also increase labor and capital productivity. 2) This research hopefully will be an advance solution for providing the “generally accepted results” pertaining the antecedents of budgetary slack. corporate managers are at disadvantage to detect slack. use or usefulness) of management control systems implemented over business units may be affected by the extent of diversification. in some specific ways: 1) Indonesia as the third world countries and “western” countries have shown contrasted value (Noesjirwan 1977. Skill developed in one business transferred to other businesses. we believe that the study of national culture have not always to compare the behavior of managers in various countries as the contingent factors. as well as firm’s administrative systems antecedents in the presence of budgetary slack. preliminary test of this study showed that each individual have “wide variance” of score based on the Hofstede’s questionnaires. Gluck 1985). performance. The type (i. Inline with prior researches. argued that national culture differs in particular cultural characteristics. some corporate tend to let slack exist in their business unit to control the information-processing need by corporate management (Galbraith 1973). There are many advantages that a firm can get by doing diversification. The remainder of the study is organized as follows. Results are reported in Section IV while limitations and avenues for further research are discussed in the final Section. Hypothesis Development Corporate diversification is defined as the extent to which a firm is simultaneously active in “distinct” businesses (Pitts and Hopkins 1982) and a means by which a firm expands from its core business into other product markets (Andrews 1980. Lewellen 1971). Contingent argument will also be examined by the moderating role of power distance in the relationship between budget emphasis and budgetary slack.1 It is interesting therefore. quoting Hofstede (1980). as previously stated. they examined the effect of manager’s power distance and uncertainty avoidance on the budgetary participation. 1995). more diverse firms may influence the ability of the corporate to detect the budgetary slack in their business units. p.

Govindrajan (1984. In fact. the business unit operations as such. diversification leads to an increase in the capacity of information processing by the corporate. principal (corporate manager) wanted the agent (business unit manager) to provide high effort. H3: diversified firms tend to intensively give a larger extent of both business unit and corporate performance-based incentive There are two typologies that were used widely by behavioral-based budgetary accounting researchers to measure business unit strategy. customer service. much of the control in diversified firms will be achieved through financial-results or budgetary controls (Salter 1973. Since effort is unobservable (Dirsmith 1998). Moreover. and hence. monitoring financial results requires less intimate knowledge of the activities of the various business units. they create something that is perceived by the customer as unique by pursuing superior product features. since corporate managers in diversified firms lack specific operation knowledge about the various activities of their business units. Berg 1969). Often. 2-3 DESEMBER 2004 In accordance with the above preposition. H2 : more diversified firms put more emphasis on budget target. which is an advantage issue for more diversified firms. 1988) reconciled the Hopwood (1973) and Otley’s (1978) results relating to performance. and having a great understanding of. 1986. etc. incentives were provided for business managers to motivate them to behave in a manner consistent with the corporate interests. In the other hand. Fortunately. as previously stated in H2. differentiators and prospectors actively engage in market and product development. product innovation. In other words. in accordance with H1 above. Business unit managers in diversified firms are likely to have discretion about more aspects of their work. Moreover.SNA VII DENPASAR – BALI. On the other hand. Costleadership and defenders for instance. exploit economies of scale and produce undifferentiated product. which are Porter’s (1980) Cost-leadership/Differentiator and Miles and Snow (1978) Defender/Prospector. most interactions between corporate and business unit managers of diversified firms are likely to evolve mainly from budget-related issues. it is expected that they will emphasize accounting-based budget performance. argued that defenders face relatively low 98 . agency theory predicts that incentives should be most intense when business unit managers are able to respond to them (Milgrom and Roberts 1992). have greater marginal impact on performance (Bruns and Waterhouse 1975). This would make the corporate almost impossible to use direct informal interventions in business unit operations as a tool of control. Both are assumed to be similar since they have the “same sense of market oriented”. we expect that the greater autonomy of business unit managers and the greater reliance on outcome-based budgetary controls in diversified firms is associated with a higher percentage variable compensation. as opposed to the operational details of the business. Agency theory once again suggests that formal monitoring of outcome-based performance and incentives are complementary. corporate managers in diversified firms primarily monitor outcome-based budget results without getting involved in. Furthermore. Thus. they focus on achieving a low cost position relative to competitors and therefore pursue cost reduction. brand image.

where if they do. Merchant (1985b) argued that the ability to set accurate budget and to measure performance precisely. and the adoption of relatively subjective performance measures. differentiators/prospectors will make limited use of budgetary controls. which is likely to be the case for cost-leaders/defenders. which conflicts with the widely held view that innovation and differentiation are best achieved in organizations that minimize formal controls. corporate management may not wish to reduce slack in the differentiators/prospectors business units. suppliers. Nevertheless. it would chokes innovation and prevents managers from exploring new market opportunities (Stede 2001). He argued that differentiators/prospectors face relatively more uncertainty than costleaders/defenders because they have broad product lines. Prior research has not produced conclusive evidence on the relationship between management control systems and competitive strategy (Langfield. etc. 1988) found that prospectors emphasize rigid budgetary controls to a greater extent than defenders. With respect to the incentive system. However. deal with products that have not yet crystallized. keep their essentially undifferentiated product offerings relatively stable over time (Fisher and Govindrajan 1993. H5: differentiators/prospectors put less emphasis on meeting the budget than cost leaders/ defenders. Govindrajan (1988) and Govindrajan and Fisher (1990) maintained that prospectors tend to set tight budgets. managers in charge of DIF/PRO businesses are likely to receive a lower portion of their salary tied to accounting-based budgetary performance because of the uncertainty involved in pursuing DIF/PRO strategies. competitors and regulatory groups. where it chokes innovation and experimentations. In addition. For example. the reliance on formal accounting-based budgetary controls is less suitable and they will also require a higher degree of flexibility to respond effectively to changes in the environment. Accounting controls (budget) in general tend not to be associated with innovation. Simons (1987. Therefore we conclude that H4: differentiators/prospectors have more budget slack than cost leaders/defenders. whereas differentiatiors/prospectors (DIF/PRO) are likely to rely on scanning the environment for new opportunities. both defender and prospector also typically operate in dissimilar settings that may affect the ability of corporate management to detect slack. Hence. although they will be important in the case of defenders. Bourgeois (1981) and Cyert and March (1963) suggested the slack creation to hedge against uncertainty. Incentives contingent on 2 He defined environmental uncertainty as the unpredictability of the actions of customers. future earnings. For instance. 99 . in contrast. trend monitoring and efficiency. 1988). On the other hand. comprehensive planning. hence. provides the opportunity to prevent the introduction of slack.Smith 1997). 2-3 DESEMBER 2004 environmental uncertainty2 rather than prospectors. Govindrajan 1986. which provide a cushion to support the exploitation of market opportunities and a source of funds to experiment with product innovation. engaging in product and market innovation may require investments that decrease current-period accounting profits despite their potential to generate substantial.SNA VII DENPASAR – BALI. but uncertain. Costleaders/defenders. many strong evidences have suggested that costleadership/defenders (CL/DEF) will emphasize cost control. engage in produuct innovation.

Controls can also diminish the intentions of managers to create slack in their business unit budgets. etc.SNA VII DENPASAR – BALI. Recent management accounting studies incorporating some or all of Hofstede’s dimensions of national culture are mostly applied in the area of behavioral researches. generally is viewed in the (economicsbased) accounting literature as an effective way to stimulate goal-directed management behavior. 1995). procedural controls. (1997). both used the same 100 .. but many of them revealed the contradictory results. 1996. adequate monitoring of performance in these areas. Oddly. expectancy. either because these systems produce pressures on business unit managers and/or affect the likelihood that slack is detected (Merchant 1985a). Nicholson et al. Power distance and uncertainty avoidance) on the relationship between control system tightness. while Chow et al. (1996) examined the effect of three Hofstede’s national culture dimensions (Individualism. if accounting-based measures of performance are a less adequate reflection of the managers’ actions in DIF/PRO units than in CL/DEF units. Harrison (1992) showed the contradictory results. A strong (if not exclusive) emphasis on budgetary performance should provide clear guidance to managers as to what is considered important. The presence of slack in business unit budgets is affected by the design of the budgetary control and incentive system. Collectively. Clinch 1991). (1996). and then followed by numerous researchers such as Harrison (1992. Although they were a sign of the widening area in the behavioral accounting research. 2-3 DESEMBER 2004 accounting-based measures may therefore discourage managers from undertaking such investments. Since the critical success factors underlying DIF/PRO strategies tend to be longterm in nature and more difficult to quantify. and centralized directives and found the significant ones. H7: tight budgetary controls are negatively associated with slack Incentives can be considered using the theory of operant conditioning as well as the other motivation theories (e. it is expected that incentive payments to managers in DIF/PRO units will be conditioned on subjective performance evaluations by corporate management to a greater extent than in CL/DEF units (Bushman et al. agency.g. equity and goal setting). Holding business unit managers responsible for clearly defined results areas. A high percentage variable compensation should increase the likelihood that bonus amounts are significant enough for managers to influence their behavior. this suggests that: H6: incentives for managers in charge of differentiation/prospector business units are less intensive compared to incentives for managers in charge of cost leader/defender business units. For example. 1993). (1991) who found the insignificant relation between individualism and performance by controlling team pay. It was pioneered by Chow et al. Lal et al. incentives tied to accounting-based budgetary performance become less suitable because they potentially encourage managers to be myopic in their decisions (Baber et al. O’Connor (1995). Operant conditioning theory suggests that an individual’s behavior will be modified by the rewards or punishments that occur as a result of some action or failure to act on the part of the individual. H8: business unit performance-based incentives are negatively associated with slack. Similarly. and providing compensation for good results.

understandability and clarity of the 101 . there is likely to be a greater need for consultations between superiors and subordinates. 179). decisive leadership style in high power distance societies is also likely to produce a preference for high RAPM (reliance on accounting performance measure) in evaluative style (Harrison 1993. subordinates in low power distance societies are likely to “react favorably to a low budget emphasis evaluative style because this style provides the opportunity for subordinates to be consulted” (Lau et al. With low budget emphasis. The sample H6 Incentive Pilot study was conducted to the 34 respondents that represent the sample by conducted interview to ensure feasibility. which were Anglo-American managers and Singaporean manager. In contrary. postulate that a significant interaction of power distance in mediating the relation between budget emphasis and budgetary slack is likely to happen.SNA VII DENPASAR – BALI. 322). 2-3 DESEMBER 2004 measurement and samples. Therefore. Figure I: Conceptual Framework Budget Emphasis H2 H5 PD H7 H9 H1 Diversification Slack H4 Strategy H3 H8 III. p.1. A favorable subordinate’s reaction to a performance evaluative style is likely to be associated with less slack in achieving the budget target. Subordinates or managers are likely to react favorably to a high budget emphasis evaluative style in a high power distance society because a preference for a non-consultative. Method 3. hypothesis 9 is stated as: H9: the interaction term between budget emphasis and budgetary slack is determined by power distance. We. greater reliance will be placed on non accounting performance measures. however. 1997. As non accounting performance measures are likely to be more subjective and applied in more flexible measures than accounting performance measures. p.

using 5 items Likert’s scale. The slack measurement consists of 5 items (items 1-4. This study identified 246 firms from 36 parents of manufacturing public listed firms and randomly allocated 500 questionnaires to them. Measurement of Variables Corporate diversification was measured by the number of separate entities in each company as a proxy for the degree of diversification at the highest organizational level. the more achieving the budget is emphasized. 3. The higher the score.120). managers that were responsible in attaining the budget target. 1995). However.SNA VII DENPASAR – BALI. We received 45 and 56 usable responses from subsidiaries of go-public and non-go public firms. A questionnaire 5 was attached to a cover letter explaining the purpose of the study and assuring anonymity was mailed (and e-mailed) to the managers. there were many revisions suggested. Furthermore. The original and back-translated versions were compared. The Indonesian version was then revised based on the detected differences. Chosen managers were until three levels below the top management in order to hinder the bias results. We examine both the subsidiaries from both go public and non go public parents.752. Budgetary participation construct developed by Milani (1975) has been revised significantly by Pope and Otley (1996). The construct reliability of budget emphasis was 0. 2-3 DESEMBER 2004 questions. then translated into Indonesian and back-translated into English by different individuals. A budget contains slack if the business unit manager has intentionally set his/her budget target lower than his/her honest forecast about the future so that the budget becomes easier to achieve (Lukka 1988). A complete questionnaire is presented in the appendix A. A reply-paid self-addressed envelope was also attached to the cover letter requesting the participants to return the completed questionnaires directly to the researcher. test for equality of variances and means showed no differences between those different characteristics (all variables exceed the threshold level of observed probability 0. Another 200 questionnaires were allocated to the non go public subsidiaries.124 (see Hofstede 1980. that is. respectively. 102 . Brownell (1982. and item 5 is fully anchored 3 Modification of construct is common in behavioral-based accounting research. Budget emphasis was measured by the questionnaire survey consist of 7 items that scores from 1 (definitely false) to 5 (true) adopted from Stede’s (2000. There were many remaining differences had to be resolved to finalize the Indonesian version. since respondents did not clearly understand the meaning after it was translated into Indonesian according to the methodological sequences. (Please refer to footnote 3). and the most significant revision made was the omission3 of one of Hofstede’s (1980) power distance constructs no C. 4 “There are few qualities in a man more admirable tha dedication and loyalty to his company” 5 The questionnaires were initially developed in English by prior researchers. higher incentives are given to the middlehigh level managers. then translated back into English and again compared to the original English version. (1967). and hence the tighter the budgetary control process is perceived to be. Therefore. because commonly. p. so they are not included in the study. this study inherently found no problem. Companies with less than 100 companies were not expected to have clearly defined areas of responsibility to which managers could be appointed (Dunk 1993). 2001) published researches. 1983) and harrison also made changes in job satisfaction’s widely-used questionnaires developed by Weiss et al.2. Sampling was restricted to managers of budget-related functional area. Although prior researchers concluded that the subsidiaries of non-go public and go-public firms might have different characteristics based on their ownership and equity financing (Singh.1).

the lower score proves that the business units run in cost-leadership/defender strategy. Business strategy as Govindrajan and Fisher (1990). At present. “This instrument was based on subordinates’ perceptions of whether their peers are afraid to disagree with their superiors. The higher score indicates that the business units operate in differentiation/prospector strategy. 109).316 20.034 : Unidentified IV. we assumed that there is no other antecedent (i. Second. De ruyter and Wetzels 1999). Therefore. Nevertheless. The construct reliability was 0. it is the only available instrument for measuring power distance. p.158 27. we asked respondents to indicate the percentage of their compensation that is performance-dependent. Brand image. 1997. as well as their business units. p. The average of these measures was employed to determine the extent of incentive systems based on the performance of corporate. while vice versa. The business unit managers were asked to position their business unit relative to competitors (on a seven-point scale from significantly lower to higher) in terms of Product selling price. R&D expenditures. this test produced a better confirmation about factor dimensions and the causality relationship between those factors. 183).e. Product quality.Dev () 5 2 0 7 7 14 18.861 5.434 4. and Product features.641 0. First. Variable STRATEGY DIVRSFTCN INCENTIVE EMPHASIS BDGSLACK Pow Dist N 101 101 101 101 101 101 Table 1: Descriptive Statistics Actual Range Theoretical Range Min Max Min Max Mean() Std. 2-3 DESEMBER 2004 question asking whether the budget is very easy to attain until impossible to attain).074 5. their own business unit performance (Gupta and Govindarajan 1986).716 Power distance was measured by a nine-item instrument developed by Hofstede (1980). as the nine-items of PD’s construct used in this study would be more precisely explain the extent of power distance (Hofstede 1980.05 Simplis. The reliability was 0. (Lau et al. we asked respondents to indicate the percentage of their bonus that depends on total corporate performance v.837 Incentives were measured using two aspects of monetary incentives.101 27. rather than the latent variables (unobserved variables). as well as their peers’ perceptions of and preferences for their superiors’ decision making styles”. this is the common method in a behavioralbased accounting research (Stede 2001. Despite the model were threaten as the observed variables.SNA VII DENPASAR – BALI. H 9 was analyzed by moderated regression analysis.3 35 25 37 5 0 0 7 5 8 25   35 25 40 3.435 25 19 0. Results and Discussion H1 to H8 were analyzed by Structural Equation Modeling in LISREL 8.867 4.706 5.663 0. In fact. 103 . Power Distance Index (PDI) was not adopted as many prior researchers did. using Porter’s (1980) Low cost – Differentiation and Miles and Snow’s (1978) Defender-Prospector were used in this study.

seem do not significantly correlated in the predicted directions.087 -.002 0.158 . Differentiators/Prospectors experience more slack in their budgetary outcome. The purpose of this method is to figure out the role of managers’ power distance in the relationship between the rigidity of budget and the likelihood of managers to create budgetary slack. have a direct effect on budgetary slack or whether this effect is (in part) attributable to how rigidly the control system is implemented and/or how the incentive system is designed.002 104 . power distance (moderating variable) and budgetary slack are independent and dependent variables. The purpose of this multivariate analysis is to test whether the one to one correlations reported in Table 2 hold significant in the presence of other intervening variables. surprisingly.212 0.337 0. budget emphasis. respectively. Table 3 reports the output of a structural equation model.253 H7 Emphasis Slack -0. In other words.002 0. The tight budgetary controls also seem to have less slack in their budgets. Table 2 Correlations Strategy Slack Emphasis Diversification Incentive Slack .192 0.00) exceeds 0.05 (one-tail) Table 2 reports the correlation between variables.219* .085 . although they have more slack in their budgets.395** .048 -0. In other words. it tests whether corporate diversification and business unit strategy.66).064 H3 Diversification Incentive 0. 2-3 DESEMBER 2004 diversification and strategy) affecting the extent of budget emphasis and budgetary slack.609** Emphasis -. indicating lack of operational knowledge about the various activities of their business units. without be affected by other determinants of budgetary slack.574 0.9.SNA VII DENPASAR – BALI. Table 3 Structural Equation Modeling Results Path from …to Sig.004 H6 Strategy incentive -0. The structural equation model tests the hypothesized relationships with all variables entered simultaneously in the model. Model fit is adequate: (2 is insignificant (p = 0. * p < 0. Further methodologies details are provided in the footnotes to table 3. the comparative fit index (CFI=1. The structural model was set up in LISREL 8. Incentive system and other variables.000 H5 Strategy emphasis -0. all variables in the model were treated as the observed variables (by using the aggregate scale for each construct) and not as latent variables with multiple indicators.105 PD -0.  H1 Diversification Slack 0. While business unit strategy and budgetary emphasis seems to negatively correlated.238* -.047 Notes: N=101.390 0. using dummy (dichotomous variable).305** Diversification .168 -0. Diversified companies do not put more emphasis on their budgets.01.179 0. **p < 0. respectively.120 Incentive -.05 Simplis. Because of sample size limitations.221* -0.000 H2 Diversification Emphasis 0.198 H4 Strategy Slack 0.

p= 0. physiological. security. (H 1.338 0. The success factors underlying DIF/PRO strategies tend to be of a long term nature and difficult to quantify. the extent of budgetary slack could be higher indeed. or reduce the amount of information. incentive in charge of 105 . Following Galbraith’s (1973) model in which corporate management deals with the overload information processed. more diversified firms are not likely to give higher incentive to their business units manager (H3: p=0. as has been argued by stewardship theorists (e. 7 per cent). normed fit index (NFI) is 0.90). above the recommended acceptance level (0. Donaldson 1990). as hypothesized.00. 1991.2531. This study contained both the univariate and multivariate outliers. agency theory may not work well on upper level management.g. Instead. 1995) The results showed. =-0.988.g. In addition. Differentiators seem to induce more slack in their budget. which is above a common recommended value 0. where they were the sample of this study. (1995) mentioned that “outliers should be retained to ensure generalizability to the entire population… (p.998.000. differentiators do not give more incentive to their managers (H6) because the differentiated company’s ability to satisfy a customer need in a way that its competitors can not means that it can charge the premium price (p=0. In addition. 66)” Model fit is very good: (2 = 0. since investing in information systems is a high cost investment. achievement. economic) as the motivation drivers for their managers. did not attempt to delete ones. tend to produce less slack (H4: p=0. while cost-leadership companies. =0. much of the control in diversified firms will be achieved through financial results-oriented or budgetary controls (Merchant 1981.e.5745).3371). comparative fit index (CFI) is 1. as the number of subsidiaries controlled by the corporate is increasing. Moreover. corporate tends to let the slack exist in their business units.90 (Hair et al. Monitoring financial results requires less intimate knowledge of the activities of the various business units and simplifies top management information processing (Hill and Hoskisson 1987).000 proving the perfect fit (Arbuckle and Wothke 1999). as shown by significant effect on diversification to the budget emphasis (H 2: p= 0.3904). because outliers must be viewed within the context of the analysis and should be evaluated by the types of information they provide. root mean square error of approximation = 0. =0. but also requires a higher degree of flexibility to respond effectively to changes in the environment. 1994. and self-actualization) are more determined by the corporate rather than lower order/economic needs (e. which not only make reliance on formal accountingbased budgetary controls less suitable.198. it is more likely that more diversified corporate are less familiar with the operations of their businesses.212) at the moderate cut-off (i. Since business unit managers may underestimate their productive capabilities. Therefore.000. However. Differentiators seem do not put higher pressure to attain the budgetary targets. 2-3 DESEMBER 2004 H8 Incentive Slack -8. adjusted goodness of fit index (AGFI) is 0. However. this study b.. Salter 1973.0022). higher order needs (growth.061 Notes: a. However.064. as to be the case of cost-leadership companies (H5= 0. Hence. Donaldson and Davis 1989.002). in contrast. = -0. the reliance on performance-based incentive was not the only option the corporate has. The ability to increase revenues by charging premium prices (rather than by reducing costs like the cost-leadership) allows the corporate to gain above-average profits. =0. =0.SNA VII DENPASAR – BALI. Hair et al. which make them at a disadvantage to uncover slack (Onsi 1973). corporate management can either increase the capacity to handle more information.193.0045. Nevertheless. Instead. Berg 1969). Fox and Hamilton 1994.

reduces the propensity of BU managers to build slack (Milgrom and Roberts 1992). It can be observed from the table that the interaction term is negative and significant (p < 0. and 0. it would mean that the relations between the management control feature and budgetary slack is stronger for managers with high power distance than for managers with low power distance. assuming that managers seek to maximize personal income. As previously stated.SNA VII DENPASAR – BALI.884 2. and therefore. p. In addition. To support the hypothesis. p < 0. curtailed (H 7: p= 0.0026. =0. this study found the significant one.011). F = 6.307 X3 interaction term A3 -0. we also found that there is a negative effect between incentives and budgetary slack at 10 per cent cut-off (H8: p=0.588 Sig. The model explains 25. we divided the sample into high power distance and low power distance based on the mean score. R2 = 0. 0.3382).350.4 per cent of the variance (adj. Does managers’ power distance matter? H9 implies that manager’s power distance moderates the relation between budget emphasis and budgetary slack. In other words. This. =-8. power distance and the rigidity of the budget interact to influence the extent of budgetary slack.011 106 . To test the hypothesis. The hypothesis was tested using the following regression equation: Y = a0 + a1X1 + a2X2 + a3X1X2 Y X1 X2 (1) = budgetary slack = budget emphasis = manager’s power distance (0 for low power distance and 1 for high power distance) Using the value of power distance = 1. 2-3 DESEMBER 2004 differentiation/prospector business units is more intensive rather than in costleaders/defender business units.069 -0. equation (1) can be reconstructed for managers with high and low power distance respectively as presented below: For low managers power distance: Y = a0 + X1 (2) For high managers power distance: Y = (a0 + a2) + (a1 + a3) X1 (3) H9 posits that there is a significant interaction between budget emphasis and manager’s power distance affecting budgetary slack. but the negative sign was not expected as displayed in table 3.01) Table 4: Moderated Regression Results Variables Coefficient Coefficient value T-stat value () X1 budget emphasis A1 -0. If the interaction is significant.436 -2. high business unit performance will be pursued since it translates directly into higher personal income.023 0. However.164.646 X2 manager’s PD A2 10.0617.1920). however.520 0. We also found that rigid budgetary controls should increase the likelihood that slack gets detected (Williamson 1967). a 3 in equation (1) must be significant and positive.

R = 0.042 0.000 To present more clearly the difference in the slope of the relationship between budget emphasis and budgetary slack with respect to the low and high power distance.674 – 0. the question arises as to whether the responses obtained are representative of the population.505BE (3a) The results clearly indicate that the relationship between budget emphasis and budgetary slack is negative and stronger for managers with low power distance (PD) than for managers with high power distance.001 8. 2-3 DESEMBER 2004 Constant A0 22. A comparison of the regression coefficient of budget emphasis in equation (2a) and (3a) indicates that a unit decrease in budget emphasis has at least a seven-fold effect on the extent of budgetary slack for managers with high PD than for managers with low PD (see figure). F = 6. p < 0.SNA VII DENPASAR – BALI. which was by 107 . the values from table III for the relevant coefficient in equation (1) are inserted to obtain equation (2) and (3) For low manager’s power distance Y = 22.350.830 – 0. Limitations and Avenues for Further Research This study carries several inherent limitations.069BE (2a) And For high manager’s power distance Y = 33. Since the satisfaction of managers with directive or persuasive superior is large for managers with high power distance (Hofsede 1980) greater reliance will be placed on non-accounting performance measures in the low budget emphasis 5. Figure 2: Relationship between budgetary slack and budget emphasis: low and high manager’s power distance Budgetary Slack High PD Low PD Budget emphasis Surprisingly.25%. The use of questionnaire also introduces the possibility that the respondents may place a different interpretation on the questions than did the researchers.164. although the moderating effect of power distance is significant. business unit managers with high power distance tend to react favorably to a low budget emphasis evaluative style in achieving the budget target rather than managers with lower power distance. Efforts were made to overcome this limitation. therefore. totally 11. Since the very low response rate. the negative sign is not expected. It means.830 2 Notes: Adj.

1982. P. there are some determinants of budgetary slack which are not included in the study. Managerial Value Systems for Working in Saudi Arabia: An Empirical Investigation.. 1981. K. 1980. In addition. Spring: 12-27 _________. By overcoming the data difficulty. and M. Organization and Society 24: 189-204. Further study can also incorporate other measures of incentives such as group-based incentive Vs tournament-based incentive suggested by Drake et al. A. and M. Budgetary slack may actually be influenced by other variables than those considered in the study. The Role of Budgets Facing Strategic Change: An Exploratory Study. The Role of Accounting Data in Performance Evaluation. W. References: Abernethy. R. Kang. by combining the national and organizational culture would clearly determine the “true effect” of cultures in each variable hypothesized. al. Investment Opportunities and the Structure of Executive Compensation. IL: Richard D. 2-3 DESEMBER 2004 conducting the pilot study. Organizational Design for Business Units.SNA VII DENPASAR – BALI. uncertainty avoidance. as this dummy variable can precisely determine the exact threshold value of differentiator/prospectors and cost-leadership/defender companies based on its median or mean value. 1999). Market intensity may affect the extent of accounting control and the intentions of manager to create slack in their business unit budgets. Journal of Accounting Research 33: 205-229. and S. (1997) The role of national culture can also be extended by incorporating other dimensions of national culture such as individualism. Journal of Accounting Research. Larcker. Rajan. organizational systems variables can also be proxied by use of non-financial performance measures that have been done by Perera et al. Govindarajan. 1996. 1995. A.. conclusions can be made only with respect to those situational factors and firm’s administrative systems. Margaret. Al-Shakis. Irwin. Journal of Accounting and Economics 21: 297-318. S. Homewood. Brownell. 1998. Anthony. 1985.e. Autumn: 502-512 108 . Management Control Systems. Accounting. McGraw-Hill. (1999). Further research can also change the business unit strategy’s scale. or masculinity. compensation level and/or compensation change (Ke et. Bourgeois.. porter’s five forces). 1999. Ali. 1985. and Peter Brownell. The Concept of Corporate Strategy. On the Measurement of Organizational Slack. or use of long term incentives (Merchant 1995). Therefore. L. or perhaps. The dichotomous variable may be better. as well as the external forces of industry (i.. Academy of Management Review 6: 29-39. Janakiraman. and V. Budgetary Systems and the Control of Functionally Differentiated Organizational Activities. Group and Organizational Studies 10: 135-51 Andrews. Budgetary Participation and Organizational Effectiveness. Irwin- Baber. Baiman. S. R. D. Journal of Accounting Research.

The Effect of Budget Emphasis and Information Asymmetry on the Relation Between Budgetary Participation and Slack. Accounting Review 68: 400-410. R. 1991. Moran. Wetzels. 1988.. _________ and A. Journal of Accounting Research 33 supplement: 101-127 Campbell. Designing Complex Organizations. Accounting. Boston: Houghton Mifflin Company Hofstede.A. and M. 1990. J. A Contingency Approach to Strategy Implementation at the Business-unit Level: Integrating Administrative Mechanisms with Strategy. Stewardship Theory or Agency Theory: CEO Governance Shareholder Returns. and P. H. R. S. CA 109 . 1996. V. Gupta. Indjejikian. and Davis.SNA VII DENPASAR – BALI. _________ and J.. 1995. Govindrajan. Strategy. Jones. S.. The Ethereal hand: Organizational Economics and Management Theory. Academy of Management Review 21: 13-47.. 1999. Organizations and Society 24: 57-75 Donaldson. 2-3 DESEMBER 2004 Bushman. Academy of Management Journal 33: 259-85 Gluck. and Resource Sharing: Effects on Business Unit Performance. Goold.. Ownership and Diversification: Agency theory or Stewardship theory. Harvard BusinessReview March-April: 120-132. Fisher. Australian Journal of Management 16: 4964 Donaldson. Journal of Management Studies 31:. Control Systems. A. Aggregate Performance Measures in Business Unit Manager Compensation: the Role of Intrafirm Interdependencies. Commitment in Auditor-Client Relationships: Antecedents and Consequences. 1990. MA. and Hamilton R. Culture’s Consequences: International Differences in Workrelated Values. Organizations and Society 10: 51-66. C. L. L. Boards and Company Performance: Research Challenges the Conventional Wisdom. and M. Alexander. Gupta. Smith. K. Sage. F.. Academy of Management Journal 29: 695-714 Hill. The Journal of Business Strategy. 1994. Ghoshal.. A. De Ruyter. L. 1980. J.Reading. 1995. Journal of Accounting Research 29: 59-78. 1985. Fox. Strategic Management Theory: An integrated approach. Beverly Hill. Employee Compensation and Firms’ Research and Development Activity. A. T. Addison-Wesley. A Fresh Look at Strategic Management. Clinch. 69-81 Galbraith. Bad for Practice: Critique of the Transaction cost Theory. Accounting. Academy of Management Review 15: 369-81 Donaldson. and Davis. Resource Sharing among SBUs: Strategic Antecedents and Administrative Implications. and A. J. Govindrajan. 1986. M. and G.. Corporate governance: An international review 2: 151-73 Dunk. 1985. M. H. Corporate Strategy: the Quest for Parenting Advantage. Linking Control Systems to Business unit Strategy: Impact on Performance. 1994.. K. G. 1995. and V. Academy of Management Journal 31: 828-853.R. 1973. G.K. 1993. 1991.

1978. Journal of Accounting and Economics 28: 185–209. 1973. Organizational Strategy. 1978. Firm Diversity: Conceptualization and Measurement. 1988. Chatman. 274-284 Miles. M. Safieddine. Journal of Accounting Research 10: 156-182.T.. 1975. Organizations and Society 22: 207-32. R. 1997. 1982. Merchant. K. E. Contrasting Cultural Patterns of Interpersonal Closeness in Doctors’ Waiting Rooms in Sydney and Jakarta. Structure. 1999. Otley D. Accounting.A. A.. 1993. Caldwell. K. Management Control Systems and Strategy: a Critical Review. Lukka. W. J. Snow. 1989. and A. Budgetary Biasing in Organizations: Theoretical Framework and Empirical Evidence. 1972.. Accounting. Accounting. and C. Manzoni. The Relationship of Participation in Budget-Setting to Industrial Supervisor Performance and Attitudes: a field study. The Accounting Review 64: 539-558. 1977. Journal of Cross-Cultural Psychology 8 O’Really. McGraw-Hill. and Sorbom.. and Sorbom. Academy of Management Review 9: 389-398 Hopwood.1988. Langfield-Smith. Factor Analysis of Behavioral Variables Affecting Budgetary Slack. The Cultural Relativity of the Quality of Life Concept. Budgeting and the Propensity to Create Budgetary Slack.. Organizations and Society 10: 201-210 _______. B. Organizational Controls and Discretionary Program DecisionMaking: a Field Study. Organizations and Society 13: 281-301. 1985a.F. K. G. _______. The Accounting Review. and H. New Jersey: Prentice-Hall Milani.G. Organizations. 535-548. K. Accounting. People and Organizational Culture: A Profile Comparison Approach to the Assessing Person Organisation Fit. and Society 10: 67-85.NY. K. C. Uppsala University: Scientific Software Ke. The Accounting Review. An empirical study of the role of accounting data in performance evaluation.SNA VII DENPASAR – BALI. Modern Management Control Systems. LISREL 8: Structural Equation Modeling with the SIMPLIS Command Language. 122-149 Pitts. Noesjirwan.G. K. Academy of Management Review 7: 620-629.F. Academy of Management Journal 34: 487-516. 1985b. J.. _______. and D. K. LISREL 8 User’s Reference Guide. 1996. Budget Use and Managerial Performance. 110 . Ownership Concentration and Sensitivity of Executive Pay to Accounting Performance Measures: Evidence from Publicly and Privately Held Insurance Companies. Onsi. 2-3 DESEMBER 2004 _________ 1984. Petroni. D. Hopkins. and Process. Joreskog.A.. Uppsala University: Scientific Software Joreskog. Journal of Accounting Research Spring.. D. 1991. and J. New York. K. The Achievability of Budget Targets in Profit Centers: a Field Study.

Budgetary Criteria in Performance Evaluation: a Critical Appraisal Using New Evidence.W. 1967. 1988. The Economics of Discretionary Behavior: Managerial Objectives in a Theory of the Firm.e. Contemporary Accounting Research 5: 267-83. Porter. Organization. 1996. 1987.T. Accounting Organizations and Society 12: 357-374 _______. G.. 2-3 DESEMBER 2004 Pope. 2. Organizations and Society. M. 2000. 25: 483-496 Williamson. Accounting. P. 1964. England. J. Free Press: New York. 1980. Singh..V. D. A. 4.. 3. Competitive Strategy: Techniques for Analyzing Industries and Competitors.NY. Technical Paper 2 Stede. Budgetary Control and Performance Evaluation: an Empirical Analysis of Bank Branches. Wim A. 2001. Manual for Minnesota Satisfaction Questionnaire. and Society 25: 609-622 _______. Accounting. Corporate Financial Patterns in Industrializing Economies: A Comparative International Study. World Bank and IFC. Working Paper: University of Lancaster. The following statements listed below are values that have been found prevalent in different individuals. and Accountability Journal 14: 30-52 Weiss..E. Appendix Instruments assessing manager’s power distance Every individual have its own culture which is a set of values that might be expected or implicitly required of members of that organization. 1995. D. 1. Auditing.SNA VII DENPASAR – BALI. and Otley. Prentice-Hall. H. R. The Relationship Between Two Consequences of Budgetary Controls: Budgetary Slack Creation and Managerial Short-term Orientation. Accounting. Simons. In Otley and Pollanen. 2000. The Effect of Corporate Diversification and Business Unit Strategy on the Presence of Slack in Business Unit Budgets. V. Please place one number (i. O. and Lofquist. Accounting Control Systems and Business Strategy. an Empirical Analysis.E. Davis.. L. 5) against each of the following eight items to indicate the extent of your individual’s power distance 1 2 3 4 5 Not at all To a slight extent To a moderate extent To a great extent To a very great extent (1) Employees lose respect for a consultative manager 1 2 3 4 5 (2) A good manager gives detailed instructions 1 2 3 4 5 (3) My manager is not concerned with helping get ahead 1 2 3 4 5 (4) An employee should not ask for a salary increase 1 2 3 4 5 111 . R. Englewood Cliffs. Analysis of the Organizational Characteristics Related to Tight Budget Goals.

2-3 DESEMBER 2004 (5) Employees in industry should participate more in the decisions taken by management 1 2 3 4 5 (6) The average human being has an inherent dislike of work and will avoid it if he can 1 2 3 4 5 (7) Most employees want to make a real contribution to the success of it 1 2 3 4 5 (8) By and large. This instruments measure the rigidity of budget emphasis 1 2 3 4 5 Definitely false False Neutral True Definitely true (1) I am constantly reminded by the corporate parent of the need to meet budget targets 1 2 3 4 5 (2) Corporate superiors judge my performance predominantly on the basis of attaining budget goals 1 2 3 4 5 (3) Control over my business is achieved by the corporate parent principally by monitoring whether my budget is on target 1 2 3 4 5 (4) In the eyes of my corporate superiors. companies change their practises much too often 1 2 3 4 5 Business Unit Strategy Please position your business unit relative to competitors 1 2 3 4 5 Lowest lower Not bad higher highest (1) Product selling prices 1 2 3 4 5 (2) Product quality 1 2 3 4 5 (3) Brand image 1 2 3 4 5 (4) R&D expenditures 1 2 3 4 5 (5) Product features 1 2 3 4 5 Budget emphasis A high emphasis on meeting the budget is the condition when subordinate managers are evaluated primarily on whether or not they achieve their budget. achieving the budget is an accurate reflection of whether I am succeeding in my business 1 2 3 4 5 (5) Not achieving my budget has a strong impact on how my performance is rated by my corporate superiors 1 2 3 4 5 (6) My promotion prospects depend heavily on my 1 2 3 4 5 112 .SNA VII DENPASAR – BALI.

very easy to attain 2. attainable with considerable effort 4.SNA VII DENPASAR – BALI. 1 2 3 4 5 Definitely false False Neutral True Definitely true (1) Succeed to submit budgets that are easily attainable 1 2 3 4 5 (2) Budget targets induce high productivity in my business unit 1 2 3 4 5 (3) Budget targets require costs to be managed carefully in my business unit 1 2 3 4 5 (4) Budget targets have not caused me to be particularly concerned with improving efficiency in my business unit 1 2 3 4 5 (5) How do you judge your business units’ budget target? (please circle one) 1. attainable with reasonable effort 3. impossible to atttain 113 . not achieving the budget reflects poor performance 1 2 3 4 5 Budgetary slack This instruments measure whether you as the business unit managers intentionally set your budget target lower than your honest forecast about the future so that the budget becomes easier to achieve. practically unattainable 5. 2-3 DESEMBER 2004 ability to meet the budget (7) In the eyes of my corporate superiors.