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Budgetary slack and its antecedents

Does managers power distance matter?

Fuad & Arifin Sabeni


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. Managers 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 subordinates performance relying on
budgetary information. It was first pioneered by Hopwoods (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).


However, since corporate may not have all specific and wide information about
the operation of their subsidiaries, as is the case of the more diversified firms
(Campbell et al. 1995), 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. In addition, the budget target determined by the
corporate may not as precise as the less diversified firms, and hence, budgetary slack
is presented. In order to minimize the existence of budgetary slack, according to
agency literature, corporate are likely to provide the great extent of incentive to their
Nevertheless, even if corporate managers were able to detect slack, they may
actually tolerate slack in business unit budgets as a conscious strategy to reduce
information overload at the top (Galbraith 1973). More slack reduces the chance of a
target being missed; and, the fewer the exceptions that need to be investigated, the
less the overload on the top. Rather than investing in high-cost information systems,
corporate tend to let this slack exist in their business units.
On the other hand, budgetary slack can also be explained by the uncertainty
involved in a particular industry facing different business unit strategy. 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.g. Porters differentiation and/or Miles and Snows prospector).
Langfield-Smith (1997) moreover found that the way in which business units
competes in their markets influence the design of management control systems.
Nevertheless, the results of this research have been inconclusive in some cases.
Simons (1987, 1988), for instance, found that prospectors emphasize rigid budgetary
controls to a greater extent than defenders. These findings contrast with the popular
views (e.g. Govindrajan (1988), Govindrajan and Fisher (1990)), maintaining that
innovation and differentiation (which is the case of differentiated companies) is best
achieved in organizations that minimize formal controls (i.e. low budget emphasis).
Moreover, 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, those kinds of strategies that pursued by the business unit may also
influence the extent of slack. 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).
Hence, business unit strategy is expected to be an important factor for explaining the
presence of slack in business unit budgets. Again, the results have been inconclusive
or in some cases, contradictory (for example, please compare, Miller and Friesen
1982; Simons 1987; Kaplan 1990; Govindarajan 1988).
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. Power distance, 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, p.
98; emphasize added), relates to favorably/unfavorably reaction to a high/low budget
emphasis in a high/low managers power distance. The favorably (unfavorably)
reaction indicates the lower (higher) extent of managers intention to create budgetary


Although Chenhall (2003), quoting Hofstede (1980), argued that national culture
differs in particular cultural characteristics, preliminary test of this study showed that
each individual have wide variance of score based on the Hofstedes questionnaires.
Therefore, we believe that the study of national culture have not always to compare
the behavior of managers in various countries as the contingent factors. Instead,
national culture measures can be adopted in the setting of specific country as well.1
It is interesting therefore, to contribute to the accounting literature by advancing
the paths of determinants of budgetary slack that might have not been examined by
prior researchers, in some specific ways: 1) Indonesia as the third world countries and
western countries have shown contrasted value (Noesjirwan 1977, p. 357) and
national culture (Hofstede 1985). Particularly, no research has been done in Indonesia
that uses this measure as moderating variable to examine the variables hypothesized.
2) This research hopefully will be an advance solution for providing the generally
accepted results pertaining the antecedents of budgetary slack.
This main purpose of this study is to determine the situational, as well as firms
administrative systems antecedents in the presence of budgetary slack. Contingent
argument will also be examined by the moderating role of power distance in the
relationship between budget emphasis and budgetary slack.
The remainder of the study is organized as follows. The next section develops in
more detail the hypotheses formulation and then followed by methodology of the
study in Section III. Results are reported in Section IV while limitations and avenues
for further research are discussed in the final Section.

II. 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; Gluck 1985). There are many advantages that a firm can get by doing
diversification. Diversification can improve debt capacity, reduces the chances of
bankruptcy by going into new product/markets (Higgins and Schall 1975; Lewellen
1971). Skill developed in one business transferred to other businesses, can also
increase labor and capital productivity. A diversified firm can transfer funds from a
cash surplus unit to a cash deficit unit without taxes of transaction costs (Bhide 1993).
The type (i.e. outcomes, use or usefulness) of management control systems
implemented over business units may be affected by the extent of diversification. In-
line with prior researches, more diverse firms may influence the ability of the
corporate to detect the 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. 1995). Therefore, corporate managers are at disadvantage to detect
slack. Moreover, as previously stated, some corporate tend to let slack exist in their
business unit to control the information-processing need by corporate management
(Galbraith 1973). Therefore, we posit that:
H1: more diversified firms experienced more budgetary slack in their business units.

Frucot and Shearon (1991) for instance, they examined the effect of managers power distance and
uncertainty avoidance on the budgetary participation, performance, job satisfaction and locus of control
to 83 Mexican managers.


In accordance with the above preposition, diversification leads to an increase

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


environmental uncertainty2 rather than prospectors. He argued that

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

He defined environmental uncertainty as the unpredictability of the actions of customers, suppliers,
competitors and regulatory groups.


accounting-based measures may therefore discourage managers from undertaking

such investments.
Since the critical success factors underlying DIF/PRO strategies tend to be long-
term in nature and more difficult to quantify, incentives tied to accounting-based
budgetary performance become less suitable because they potentially encourage
managers to be myopic in their decisions (Baber et al. 1996; Clinch 1991). Similarly,
if accounting-based measures of performance are a less adequate reflection of the
managers actions in DIF/PRO units than in CL/DEF units, 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. 1995). Collectively, 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.
The presence of slack in business unit budgets is affected by the design of the
budgetary control and incentive system, either because these systems produce
pressures on business unit managers and/or affect the likelihood that slack is detected
(Merchant 1985a). A strong (if not exclusive) emphasis on budgetary performance
should provide clear guidance to managers as to what is considered important.
Controls can also diminish the intentions of managers to create slack in their business
unit budgets.
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.g., agency, expectancy, equity and goal setting).
Operant conditioning theory suggests that an individuals 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. Holding business unit managers responsible for clearly
defined results areas, adequate monitoring of performance in these areas, and
providing compensation for good results, generally is viewed in the (economics-
based) accounting literature as an effective way to stimulate goal-directed
management behavior. A high percentage variable compensation should increase the
likelihood that bonus amounts are significant enough for managers to influence their
H8: business unit performance-based incentives are negatively associated with slack.
Recent management accounting studies incorporating some or all of
Hofstedes dimensions of national culture are mostly applied in the area of behavioral
researches. It was pioneered by Chow et al. (1991) who found the insignificant
relation between individualism and performance by controlling team pay, and then
followed by numerous researchers such as Harrison (1992, 1993), OConnor (1995),
Lal et al. (1996), Nicholson et al. (1997), etc. Although they were a sign of the
widening area in the behavioral accounting research, but many of them revealed the
contradictory results. For example, while Chow et al. (1996) examined the effect of
three Hofstedes national culture dimensions (Individualism, Power distance and
uncertainty avoidance) on the relationship between control system tightness,
procedural controls, and centralized directives and found the significant ones,
Harrison (1992) showed the contradictory results. Oddly, both used the same


measurement and samples; which were Anglo-American managers and Singaporean

We, however, postulate that a significant interaction of power distance in
mediating the relation between budget emphasis and budgetary slack is likely to
happen. 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, 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, p. 322). A favorable subordinates
reaction to a performance evaluative style is likely to be associated with less slack in
achieving the budget target. In contrary, 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. 1997, p.
179). With low budget emphasis, greater reliance will be placed on non accounting
performance measures. As non accounting performance measures are likely to be
more subjective and applied in more flexible measures than accounting performance
measures, there is likely to be a greater need for consultations between superiors and
subordinates. Therefore, hypothesis 9 is stated as:
H9: the interaction term between budget emphasis and budgetary slack is determined
by power distance.
Figure I: Conceptual Framework

H2 Emphasis PD

H5 H9

Diversification H1


H3 H8
III. Method
H6 3.1. The sample
Pilot study was conducted to the 34 respondents
Incentive that represent the sample by
conducted interview to ensure feasibility, understandability and clarity of the


questions. However, there were many revisions suggested; and the most significant
revision made was the omission3 of one of Hofstedes (1980) power distance
constructs no C.124 (see Hofstede 1980, p.120), since respondents did not clearly
understand the meaning after it was translated into Indonesian according to the
methodological sequences. (Please refer to footnote 3).
We examine both the subsidiaries from both go public and non go public
parents. This study identified 246 firms from 36 parents of manufacturing public
listed firms and randomly allocated 500 questionnaires to them; Another 200
questionnaires were allocated to the non go public subsidiaries. Companies with less
than 100 companies were not expected to have clearly defined areas of responsibility
to which managers could be appointed (Dunk 1993), so they are not included in the
study. Chosen managers were until three levels below the top management in order to
hinder the bias results, because commonly, higher incentives are given to the middle-
high level managers.
Sampling was restricted to managers of budget-related functional area; that is,
managers that were responsible in attaining the budget target. 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. 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. We received 45 and 56 usable responses
from subsidiaries of go-public and non-go public firms, respectively.
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, 1995), test for equality of variances and means showed no
differences between those different characteristics (all variables exceed the threshold
level of observed probability 0.1). Therefore, this study inherently found no problem.

3.2. 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. Budget emphasis was measured by the questionnaire survey consist of 7 items
that scores from 1 (definitely false) to 5 (true) adopted from Stedes (2000, 2001)
published researches. The higher the score, the more achieving the budget is
emphasized, and hence the tighter the budgetary control process is perceived to be.
The construct reliability of budget emphasis was 0.752. A complete questionnaire is
presented in the appendix A.
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). The slack measurement consists of
5 items (items 1-4, using 5 items Likerts scale, and item 5 is fully anchored

Modification of construct is common in behavioral-based accounting research. Budgetary
participation construct developed by Milani (1975) has been revised significantly by Pope and Otley
(1996). Furthermore, Brownell (1982, 1983) and harrison also made changes in job satisfactions
widely-used questionnaires developed by Weiss et al. (1967).
There are few qualities in a man more admirable tha dedication and loyalty to his company
The questionnaires were initially developed in English by prior researchers, then translated into
Indonesian and back-translated into English by different individuals. The original and back-translated
versions were compared. The Indonesian version was then revised based on the detected differences,
then translated back into English and again compared to the original English version. There were many
remaining differences had to be resolved to finalize the Indonesian version.


question asking whether the budget is very easy to attain until impossible to attain).
The construct reliability was 0.837
Incentives were measured using two aspects of monetary incentives. First, we
asked respondents to indicate the percentage of their compensation that is
performance-dependent. Second, we asked respondents to indicate the percentage of
their bonus that depends on total corporate performance v. their own business unit
performance (Gupta and Govindarajan 1986). The average of these measures was
employed to determine the extent of incentive systems based on the performance of
corporate, as well as their business units.
Business strategy as Govindrajan and Fisher (1990), using Porters (1980)
Low cost Differentiation and Miles and Snows (1978) Defender-Prospector were
used in this study. 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; Product quality; Brand
image; and Product features. The higher score indicates that the business units
operate in differentiation/prospector strategy, while vice versa; the lower score
proves that the business units run in cost-leadership/defender strategy. The
reliability was 0.716
Power distance was measured by a nine-item instrument developed by
Hofstede (1980). At present, it is the only available instrument for measuring power
distance. This instrument was based on subordinates perceptions of whether their
peers are afraid to disagree with their superiors, as well as their peers perceptions of
and preferences for their superiors decision making styles. (Lau et al. 1997. p.
183). Power Distance Index (PDI) was not adopted as many prior researchers did, as
the nine-items of PDs construct used in this study would be more precisely explain
the extent of power distance (Hofstede 1980, p. 109).

Table 1: Descriptive Statistics

Variable N Actual Range Theoretical Range
Min Max Min Max Mean() Std.Dev ()
STRATEGY 101 5 25 5 25 18.861 3.867
DIVRSFTCN 101 2 19 0 5.663 4.641
INCENTIVE 101 0 0.3 0 0.101 0.074
EMPHASIS 101 7 35 7 35 27.316 5.434
BDGSLACK 101 7 25 5 25 20.158 4.706
Pow Dist 101 14 37 8 40 27.435 5.034
: Unidentified

IV. Results and Discussion

H1 to H8 were analyzed by Structural Equation Modeling in LISREL 8.05
Simplis. Despite the model were threaten as the observed variables, rather than the
latent variables (unobserved variables), this is the common method in a behavioral-
based accounting research (Stede 2001; De ruyter and Wetzels 1999). In fact, this
test produced a better confirmation about factor dimensions and the causality
relationship between those factors. Nevertheless, H 9 was analyzed by moderated
regression analysis. Therefore, we assumed that there is no other antecedent (i.e.
diversification and strategy) affecting the extent of budget emphasis and budgetary


slack. In other words, budget emphasis, power distance (moderating variable) and
budgetary slack are independent and dependent variables, respectively, using
dummy (dichotomous variable). 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, without be affected by other
determinants of budgetary slack.
Table 2
Strategy Slack Emphasis Diversification Incentive
Slack .609**
Emphasis -.238* -.305**
Diversification .219* .395** .120
Incentive -.087 -.158 .085 .105
PD -0.168 -0.179 0.221* -0.048 -0.047
Notes: N=101; **p < 0.01; * p < 0.05 (one-tail)
Table 2 reports the correlation between variables. While business unit strategy
and budgetary emphasis seems to negatively correlated, Differentiators/Prospectors
experience more slack in their budgetary outcome. The tight budgetary controls also
seem to have less slack in their budgets. Incentive system and other variables,
surprisingly, seem do not significantly correlated in the predicted directions.
Diversified companies do not put more emphasis on their budgets, although they
have more slack in their budgets, indicating lack of operational knowledge about the
various activities of their business units.
Table 3 reports the output of a structural equation model. The structural
equation model tests the hypothesized relationships with all variables entered
simultaneously in the model. 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. In other words, it tests whether corporate
diversification and business unit strategy, respectively, 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.
The structural model was set up in LISREL 8.05 Simplis. Because of sample
size limitations, 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. Model fit is adequate: (2 is insignificant (p = 0.66); the
comparative fit index (CFI=1.00) exceeds 0.9. Further methodologies details are
provided in the footnotes to table 3.
Table 3
Structural Equation Modeling Results
Path from to Sig.
H1 Diversification Slack 0.337 0.000
H2 Diversification Emphasis 0.212 0.064
H3 Diversification Incentive 0.002 0.198
H4 Strategy Slack 0.574 0.000
H5 Strategy emphasis -0.390 0.004
H6 Strategy incentive -0.002 0.253
H7 Emphasis Slack -0.192 0.002
H8 Incentive Slack -8.338 0.061


Notes: a. This study contained both the univariate and multivariate outliers. However, this study
did not attempt to delete ones, because outliers must be viewed within the context of the
analysis and should be evaluated by the types of information they provide. In addition,
Hair et al. (1995) mentioned that outliers should be retained to ensure generalizability to
the entire population (p. 66)
b. Model fit is very good: (2 = 0.193; root mean square error of approximation = 0.000;
adjusted goodness of fit index (AGFI) is 0.988, above the recommended acceptance level
(0.90); normed fit index (NFI) is 0.998; comparative fit index (CFI) is 1.000 proving the
perfect fit (Arbuckle and Wothke 1999), which is above a common recommended value
0.90 (Hair et al. 1995)
The results showed, as hypothesized, as the number of subsidiaries controlled by
the corporate is increasing, the extent of budgetary slack could be higher indeed. (H 1;
p= 0.00; =0.3371). Following Galbraiths (1973) model in which corporate
management deals with the overload information processed, corporate management
can either increase the capacity to handle more information, or reduce the amount of
information. However, since investing in information systems is a high cost
investment, corporate tends to let the slack exist in their business units. Moreover, it is
more likely that more diversified corporate are less familiar with the operations of
their businesses, which make them at a disadvantage to uncover slack (Onsi 1973).
Therefore, much of the control in diversified firms will be achieved through
financial results-oriented or budgetary controls (Merchant 1981, Salter 1973, Berg
1969), as shown by significant effect on diversification to the budget emphasis (H 2:
p= 0.064; =0.212) at the moderate cut-off (i.e. 7 per cent). 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).
Nevertheless, more diversified firms are not likely to give higher incentive to their
business units manager (H3: p=0.198; =0.002). Since business unit managers may
underestimate their productive capabilities, the reliance on performance-based
incentive was not the only option the corporate has. Instead, as has been argued by
stewardship theorists (e.g., Donaldson and Davis 1989, 1991, 1994; Fox and Hamilton
1994; Donaldson 1990), agency theory may not work well on upper level
management; where they were the sample of this study. Instead, higher order needs
(growth, achievement, and self-actualization) are more determined by the corporate
rather than lower order/economic needs (e.g. physiological, security, economic) as the
motivation drivers for their managers.
The success factors underlying DIF/PRO strategies tend to be of a long term
nature and difficult to quantify, which not only make reliance on formal accounting-
based budgetary controls less suitable, but also requires a higher degree of flexibility
to respond effectively to changes in the environment. Differentiators seem to induce
more slack in their budget, while cost-leadership companies, in contrast, tend to
produce less slack (H4: p=0.000; =0.5745). In addition, Differentiators seem do not
put higher pressure to attain the budgetary targets, as to be the case of cost-leadership
companies (H5= 0.0045; =-0.3904). However, differentiators do not give more
incentive to their managers (H6) because the differentiated companys ability to satisfy
a customer need in a way that its competitors can not means that it can charge the
premium price (p=0.2531; = -0.0022). 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. Hence, incentive in charge of
differentiation/prospector business units is more intensive rather than in cost-
leaders/defender business units.


We also found that rigid budgetary controls should increase the likelihood that
slack gets detected (Williamson 1967), and therefore, curtailed (H 7: p= 0.0026; =-
0.1920). In addition, we also found that there is a negative effect between incentives
and budgetary slack at 10 per cent cut-off (H8: p=0.0617; =-8.3382). As previously
stated, assuming that managers seek to maximize personal income, high business unit
performance will be pursued since it translates directly into higher personal income.
This, however, reduces the propensity of BU managers to build slack (Milgrom and
Roberts 1992).
Does managers power distance matter?
H9 implies that managers power distance moderates the relation between
budget emphasis and budgetary slack. In other words, power distance and the rigidity
of the budget interact to influence the extent of budgetary slack. If the interaction is
significant, 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. To test the hypothesis, we divided the sample into
high power distance and low power distance based on the mean score. The hypothesis
was tested using the following regression equation:

Y = a0 + a1X1 + a2X2 + a3X1X2 (1)

Y = budgetary slack
X1 = budget emphasis
X2 = managers power distance (0 for low power distance and 1 for high power

Using the value of power distance = 1, and 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

managers power distance affecting budgetary slack. To support the hypothesis, a 3 in
equation (1) must be significant and positive. However, this study found the
significant one, but the negative sign was not expected as displayed in table 3. It can
be observed from the table that the interaction term is negative and significant (p <
0.011). The model explains 25.4 per cent of the variance (adj. R2 = 0.164, F = 6.350, p
< 0.01)

Table 4: Moderated Regression Results

Variables Coefficient Coefficient value T-stat value Sig. p.
X1 budget emphasis A1 -0.069 -0.646 0.520
X2 managers PD A2 10.884 2.307 0.023
X3 interaction term A3 -0.436 -2.588 0.011
Constant A0 22.830 8.042 0.000
Notes: Adj. R = 0.164; F = 6.350; p < 0.001


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, the values from table III for the relevant coefficient in equation (1) are
inserted to obtain equation (2) and (3)
For low managers power distance Y = 22.830 0.069BE (2a)
For high managers power distance Y = 33.674 0.505BE (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. 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).

Figure 2: Relationship between budgetary slack and budget emphasis: low and high
managers power distance

Budgetary High PD

Low PD

Budget emphasis

Surprisingly, although the moderating effect of power distance is significant,

the negative sign is not expected. It means, therefore, 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. 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. Limitations and Avenues for Further Research

This study carries several inherent limitations. Since the very low response
rate, totally 11.25%, the question arises as to whether the responses obtained are
representative of the population. The use of questionnaire also introduces the
possibility that the respondents may place a different interpretation on the questions
than did the researchers. Efforts were made to overcome this limitation, which was by
conducting the pilot study. In addition, there are some determinants of budgetary slack
which are not included in the study. Budgetary slack may actually be influenced by


other variables than those considered in the study. Therefore, conclusions can be made
only with respect to those situational factors and firms administrative systems.
Market intensity may affect the extent of accounting control and the
intentions of manager to create slack in their business unit budgets, as well as the
external forces of industry (i.e., porters five forces). Further study can also
incorporate other measures of incentives such as group-based incentive Vs
tournament-based incentive suggested by Drake et al. (1999), compensation level
and/or compensation change (Ke et. al. 1999), or use of long term incentives
(Merchant 1995). By overcoming the data difficulty, organizational systems variables
can also be proxied by use of non-financial performance measures that have been
done by Perera et al. (1997)
The role of national culture can also be extended by incorporating other
dimensions of national culture such as individualism, uncertainty avoidance, or
masculinity; or perhaps, by combining the national and organizational culture would
clearly determine the true effect of cultures in each variable hypothesized. Further
research can also change the business unit strategys scale. The dichotomous variable
may be better, 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.

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Instruments assessing managers 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. The following statements
listed below are values that have been found prevalent in different individuals.
Please place one number (i.e. 1, 2, 3, 4, 5) against each of the following eight items to
indicate the extent of your individuals power distance
1 2 3 4 5
Not at all To a slight To a moderate To a great To a very
extent extent extent great extent
(1) Employees lose respect for a 1 2 3 4 5
consultative manager
(2) A good manager gives detailed 1 2 3 4 5
(3) My manager is not concerned 1 2 3 4 5
with helping get ahead
(4) An employee should not ask for 1 2 3 4 5
a salary increase
(5) Employees in industry should 1 2 3 4 5
participate more in the decisions
taken by management


(6) The average human being has an 1 2 3 4 5

inherent dislike of work and will
avoid it if he can
(7) Most employees want to make a 1 2 3 4 5
real contribution to the success
of it
(8) By and large, companies change 1 2 3 4 5
their practises much too often
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. This instruments
measure the rigidity of budget emphasis
1 2 3 4 5
Definitely False Neutral True Definitely
false true
(1) I am constantly reminded by the corporate 1 2 3 4 5
parent of the need to meet budget targets
(2) Corporate superiors judge my performance 1 2 3 4 5
predominantly on the basis of attaining budget
(3) Control over my business is achieved by the 1 2 3 4 5
corporate parent principally by monitoring
whether my budget is on target
(4) In the eyes of my corporate superiors, 1 2 3 4 5
achieving the budget is an accurate reflection
of whether I am succeeding in my business
(5) Not achieving my budget has a strong impact 1 2 3 4 5
on how my performance is rated by my
corporate superiors
(6) My promotion prospects depend heavily on my 1 2 3 4 5
ability to meet the budget
(7) In the eyes of my corporate superiors, not 1 2 3 4 5
achieving the budget reflects poor performance


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.

1 2 3 4 5
Definitely False Neutral True Definitely true
(1) Succeed to submit budgets that are easily 1 2 3 4 5
(2) Budget targets induce high productivity in my 1 2 3 4 5
business unit
(3) Budget targets require costs to be managed 1 2 3 4 5
carefully in my business unit
(4) Budget targets have not caused me to be 1 2 3 4 5
particularly concerned with improving
efficiency in my business unit
(5) How do you judge your business units budget target?
(please circle one)
1. very easy to attain
2. attainable with reasonable effort
3. attainable with considerable effort
4. practically unattainable
5. impossible to atttain