3.

0 THE ROLE OF BUDGET PARTICIPATION IN ORGANIZATIONAL CONTROL As defined above, budget participation is the process by which managers have influence on the setting of their budget goals, even if they are subsequently evaluated on them. Two criterion variables related to budget participation have been studied in the accounting literature. The first is the relation between budget participation and performance (and related factors such as job satisfaction and motivation), and the second is the relation between budget participation and the budgeting managers propensity to bias budget estimates, i.e., to create budget slack. Accounting researchers have examined two mechanisms to explain the link between participation and individual performance. The first is motivational, arising from participations anticipated positive effect on job satisfaction, and from its positive effect on the expectancy of achieving work-related rewards. The second mechanism is cognitive, related to the opportunity for acquisition of decision-facilitating (job-relevant) information by budgeting managers during participative budgeting. Job-relevant information can be used by managers to subsequently improve their performance because it allows more accurate predictions of environmental states, more effective selection of appropriate courses of action, and clarifies objectives and the means to achieve objectives. Behavioral theory research has argued that participation motivates budgeting managers to acquire job-relevant information from the external environment and from peers, subordinates, and superiors (Kren 1992b). 10 Participation has no performance role, per se, in agency theory. Instead, participations value arises from the principals ability to use it to extract private decision-facilitating information from budgeting managers who presumably acquire private information because they are loser to the decision environment than their superiors. The value of the budgeting managers private information is its potential to improve planning, coordination of business unit activities, and resource allocation. Analytical agency theory research has demonstrated that gains accrue to the agency from honest communication of private information by the agent (Magee 1980; Christensen 1981; Baiman and Evans 1983; Penno 1984). Of course, the propensity of budgeting managers to disclose their private information is the central issue in the budget slack problem. With only a couple of exceptions, accounting research in this area has examined the consequences of budget participation (group 2 in figure 1). That is, the relation between participation and performance, and participation and budget slack. This research is described in the next two subsections. The following brief subsection describes the literature that has examined the antecedents to budget participation. 3.1 The Consequences of Budget Participation: The Relation to Performance, Job Satisfaction, and Motivation The positive effects of budget participation on job satisfaction has had relatively consistent empirical support in the accounting literature (Collins 1978; Kenis 1979; Cherrington and Cherrington 1973; Milani 1975; see also Locke et al. 1986 and Cotton et al. 1988). The positive effect of budget participation on performance has also been suggested for some time (Argyris 1952; Hofstedt 1967), but empirical research has yielded inconsistent results when examining the participation-performance relation. In fact, few questions in accounting research have generated more controversy (Murray 1990). In a comprehensive review of the accounting and organizational behavior literature, Brownell (1982c) concluded that an unequivocal statement about the relation between participation and performance cannot be made: sometimes participation works and sometimes it does not. Perhaps the first direct empirical test of the performance effects of budget participation in the accounting literature was by Milani (1975). Building on the work of

Argyris (1955), among others, Milani expected that participation would increase job satisfaction thereby positively affecting performance. He found inconsistent evidence for the positive effects of budget participation on performance. Milanis sample of manufacturing foreman often exhibited better performance if they perceived themselves to participate, compared to those foreman who did not participate. However, the effects were sporadic, evident during some periods, but often absent. Similarly, Kenis (1979), also using a questionnaire-based field study, found an inconsistent relation between participation and performance. Contingency theory explanations for budget participation effects on performance and other criterion variables soon emerged in the literature. Brownell (1982c) identified four classes of variables shown by researchers in several disciplines to impact the relation between participation and performance: cultural, organizational, interpersonal, and individual. In accounting contexts, several contingent relations have been studied. For example, Brownell (1981, 1982b) found that locus of control affected the participation-performance relation such that internals performed better under high levels of participation and externals performed better under low levels. 11 Brownell argued that internally oriented individuals prefer the control over heir own destiny and freedom for personal initiative allowed by participation, while externally oriented individuals prefer a more directed leadership style since participation may appear insufficiently structured and frustrating (Furnham 1986; Gregory 1978; Schilit 1986). Similar results were reported later by Kren (1992a) who found, in a wider context, that external orientation diminished the performance effect of participation. The moderating effects of environmental uncertainty (defined as complexity and dynamism) on the participation-performance relation was examined by Brownell (1985). Citing Galbraith (1977), Brownell argued that greater participation is required to deal with uncertain environments because such environments require rapid response allowing fewer decisions to be referred upward through the organizational hierarchy. He proposed that a research and development business unit is typically exposed to more environmental uncertainty than a business unit like marketing so budget participation would be more valuable and thus more strongly associated with managerial performance in the former than the latter. He provided survey and interview data consistent with his proposition. Similar arguments were later made by Govindarajan (1986). He found evidence that participation interacted with environmental uncertainty such that participation was positively related to performance in the presence of high uncertainty, but not when uncertainty was low. Govindarajan also argued that when uncertainty is low, more decisions are routine and involving subordinates in decisions with obvious solutions is a waste of time. Brownell (1983a) found that the leadership style of the superior moderated the participation-performance relation. Brownell proposed that in the absence of a considerate leadership style, the subordinate manager will question the substance of participation.12 Thus, a considerate leadership style acts to legitimize participation and thereby positively affect performance. A different personality trait of the superior, authoritarianism, was examined by Chenhall (1986). Chenhall argued that the relation between budget participation and job satisfaction would be affected by the relative authoritarianism of the superior and the subordinate because poor job attitudes and poor communication can result when the level of authoritarianism differs between the superior and the subordinate. In Chenhalls study, budget participation in homogeneous dyads was associated with higher job satisfaction. Beyond examining whether participation positively affects performance and other criterion variables, the focus of accounting research has often turned to examining the process by which it may happen. One explanation for a possible participation-performance link is based on the expectancy model which suggests that participation is related to

performance through motivation (Ronen and Livingston 1975). Merchant (1981), for example, in studying a wide variety of organizational control tools concluded that a link from participation to motivation and ultimately to performance was present. Brownell and McInnes (1986), however, were unable to confirm such a relationship. They specifically designed their study using an expectancy theory framework to confirm a path-analytic model linking participation to performance through motivation. They argued that prior research evidence confirming a motivation-performance link was rather clear, but that prior evidence linking participation and motivation was equivocal. Their results failed to confirm a relation between participation and motivation, although a positive relation between participation and performance was found. They concluded that the mechanism for the participation-performance relation was not motivation. These results prompted Brownell and McInnes (1986) to suggest that future research should examine performance benefits of participation that are not mediated by motivation. As an alternative to motivation, researchers have recently proposed that cognitive mechanism may be important to explain the participation-performance relation. Brownell and McInnes (1986), for example, proposed that participation provides information to managers to clarify the relation between formal rewards and budget goals. Kren (1992b) similarly argued that participation clarifies objectives and the means to achieve objectives for managers. It seems plausible to expect that participations cognitive effects provide performance payoffs because information acquired by managers during participation can be used to formulate ore accurate predictions of environmental states and more effective selection of appropriate courses of action. In particular, by actively participating in discussions about job-related tasks and job objectives with their superiors (potentially another expert) and jointly determining their completion targets, subordinate managers can gain specific insights into more effective approaches for task completion. This could be particularly useful for difficult jobs, such as managing organizational business units. When jobs are simple, effective task procedures may be more obvious so that discussions with superiors will provide fewer insights and have a more limited effect on performance (see Campbell and Gingrich 1986). Moreover, in preparing a participatory budget, a manager may become more involved in considering and evaluating alternative budget goals and more prone to search the external environment for decision-facilitating information and to discuss potential courses of action with peers and subordinates. In an early empirical test of the cognitive effects of participation, Kenis (1979) proposed that participation acted to increase goal and task clarity for managers. Kenis failed to find support for the posited relation. Nonetheless, participations cognitive effects have since been studied extensively and empirical support has lately emerged. In fact, the premise that participation affects performance through cognitive effects has recently had more consistent empirical support than efforts to link participation to performance through motivation. Chenhall and Brownell (1988), for example, reported strong evidence that participation reduced role ambiguity and thus had positive effects on satisfaction and performance. In a later study, Mia (1989) found that participation was positively related to performance, but only for difficult jobs, consistent with a cognitive role for participation. Brownell and Merchant (1990) similarly found evidence that participation was most useful to managers when job standardization was low because it provided an opportunity for managers to pool their experience and knowledge with their superiors. Finally, Kren (1992b) directly tested whether participation was related to information acquisition by managers and found that budgetary participation was positively related to acquisition of job-relevant information, and that job relevant information, in turn, was positively related to managerial performance. In a different cognitive role for participation, Dunk (1993b) proposed that

participation moderated the effects of JRT on performance because participation acted to clarify job requirements which should ultimately reduce JRT. In addition, Dunk also proposed that participation provided an opportunity for managers to increase their control over job circumstances further reducing JRT. Dunk did not find complete support for his propositions, however, although he did find a positive relation between participation and performance. Chalos and Haka (1990) also studied the participation-performance link but shifted the focus from individual to firm-level performance. Using an agency theory framework, they proposed that both the principal and the agent gain from budget participation when the agent possesses private information because of the potential for information sharing. They argued that budgeting managers possessing unfavorable state information would be more willing to share it with their superiors to avoid unreasonable budget expectations. In contrast, budgeting managers with favorable information would be less willing to share it with their superiors and participation would decrease firm (agency) performance (returns). Chalos and Haka (1990) also found that when superiors were able to discern subordinates skill level (reduce information asymmetry), higher returns were obtained because low-skill subordinates were required to absorb higher budgets (greater risk) and lower expected-value contracts. 3.2 The Consequences of Budget Participation: The Relation to Budget Slack Managers acquire private information because they are closer to the decision environment than their superiors. The resulting information asymmetry can form the basis forself-interested behavior by managers, perhaps at the expense of the organization's objectives. The organization prefers that managers disclose their private information in their budgets to improve resource allocation, planning, control, and coordination of business unit activities (Tiessen and Waterhouse 1983; Baiman 1982). Otherwise, suboptimal resource allocation can lead to lower firm returns because the cost function of the firm is not minimized (Onsi 1973). Moreover, if managers decisions are based on private information, the organization cannot determine if a manager has made optimal decisions given the managers better information. Thus, the decision-facilitating impact of private information is unknown to the organization and it is in the awkward position of not being able to determine accurately the true profit potential of its segments (Choudhury 1985). Budgeting managers, however, are motivated to bias their budget estimates to ensure that their budgets are more easily achieved (Kren 1993; Merchant 1989; Onsi 1973). Bias in budgets (i.e., budget slack) represents attempts by managers to adjust budgets based on selfinterest rather than based on factors that will influence actual results. Budget slack is usually evident as overstated expenses, understated revenues, or underestimated performance capabilities (Schiff and Lewin 1970). 13 In general, three arguments have been proposed in the accounting literature to explain budgeting managers motivation to create budget slack (withhold private information). First, managers often perceive that their performance will look better to their superiors when a cautious budget is surpassed than when an aggressive budget is not met. Second, if managers withhold their private information and do not use it to improve organizational outcomes, slack can provide the means for managers to shirk more effectively (Baiman and Demski 1980). 14

Finally, budget slack is created by managers as a protection against uncertainties that affect outcomes (Cyert and March 1963; Schiff and Lewin 1970). Onsi (1973) provided consistent interview evidence for this last motivation from a sample of managers who explicitly stated that they bargain for budget slack to hedge against uncertainties affecting outcomes. Behavioral accounting theorists have traditionally argued that budget participation will motivate managers to reveal their private information in their budgets (e.g., Becker and Green 1962; Schiff and Lewin 1970). This argument is based on the premise that participation allows positive communication between superiors and subordinates, reducing the pressure to create slack (Onsi 1973). In contrast, agency theory provides no behavioral role for participation in budget slack. Participation merely provides the opportunity for budgeting managers to insert slack into their budget. Thus, agency theory would predict a positive participation-slack relation to the extent that the agent knows, a-priori, that the information will be used to set performance standards. Budget-based incentives provide adequate motivation for managers to withhold or distort private information (see e.g., Baiman 1982; Demski and Feltham 1978). In fact, agency theory suggests that without constraints, the optimal course of action for a budgeting manager is to withhold all private information and attempt to set the budget standard at zero (Christensen 1981). There are two fundamental differences in the way that behavioral theory and agency theory researchers have operationally measured budget slack that can potentially affect the conclusions drawn from this research. Behavioral theory researchers have operationalized budget slack by measuring managers propensity to create budget slack using mailed questionnaires. This measure is based on assessments of managers attitudes toward slack and their perceptions of budget target attainability. Questionnaire measures appraising whether managers actually understate performance capabilities have not been attempted, presumably because of the sensitive nature of such inquiries. In contrast, agency theory-based researchers, using laboratory experiments, have measured slack as the difference between subjects (usually self-reported) performance capability and actual performance budgets prepared during experimental sessions. The other difference between behavioral theory and agency theory-based research in the measurement of slack is that the latter is based on experiments in which participative budgeting is operationalized by allowing subjects to unilaterally set their own budget at any desired level. Behavioral theory field research, however, shows clearly that participative budgeting is a negotiation process. Several factors that appear to affect a budgeting manager's propensity to create slack have been empirically examined in the literature. As noted above, budget participation has been associated with (the propensity to create) budget slack, at times. In addition, the effects of control system tools that improve monitoring of budgeting managers performance capability, the effects of truth-inducing (TI) incentive schemes that provide motivation for truthful budget disclosures, and budgeting managers risk preferences have also been examined. These studies are described next. Merchant (1985b) tested the proposition that participation reduced the pressure to create slack by allowing positive communication between superiors and subordinates. Merchant found that budget participation was negatively related to mangers propensity to create slack, especially when the technology (workflow) was predictable. Similar results had also been reported earlier by Collins (1978) and Onsi (1973). Merchant (1985b) also found that budgeting system emphasis, per se, did not lead to budget slack, but only if the budget

emphasis caused subordinate managers to feel required to engage in budget manipulations to avoid budget overruns. Kren (1993) proposed that an important factor that prevents managers from putting slack into their budgets is the superior's knowledge of the budgeting manager's performance capability (Waller 1987). If superiors know how well the subordinate manager can perform, slack can be more easily uncovered, and sanctions can be applied. A more effective assessment of the subordinate manager's performance capability can be made if the organization can monitor his or her actions and decisions through the organizational control system. With information about the budgeting managers performance capability from the control system, the organization can improve ex ante inferences about the level of budget slack. Control system capabilities that enhance monitoring include, for example, pre-action reviews, budgeting and variance analysis systems, and policy and procedure practices (Merchant 1982). Thus, an important factor determining an organization's ability to control slack is the extent to which information is available about a budgeting manager's actions and decisions. Kren reported that the presence of formal control tools, such as pre-action reviews, formal and informal contacts with superiors, and formal requirements for variance explanations, which presumably were tools to detect slack, were negatively associated with slack. Merchant (1985b) had also reported earlier that slack was negatively related to subordinate managers perception of their superiors ability to detect slack. In a later study, Dunk (1993a) examined whether participation, the level of private information, and budget emphasis were interactively related to the propensity to create budget slack. Dunk argued that the level of private information is an indication of the potential seriousness of the slack problem, participation gives managers the opportunity to create slack, and budget emphasis provides the motivation. Thus, high levels of all three variables should be associated with increased budget slack. The interaction found in Dunks study was the opposite of predictions, however. Slack was found to be lowest when all three independent variables were high. Dunk was unable to explain these findings. Nouri (1994) examined managers organizational commitment, defined as identification with an organizations values and desire to remain with it, and job involvement, defined as the relation between job and self-image, as factors that influence budget slack. Nouri proposed that committed managers would not create slack because they understood the detrimental effects it could have on the organization. Moreover, if highly committed managers were not involved with their jobs, Nouri predicted that they would have little motivation to create slack. In contrast, managers with low commitment and high job involvement would be highly motivated to create slack because they prefer easy budget targets regardless of the effects on organizational planning and resource allocation efforts. A multiplicative regression model indicated a statistically significant negative interaction between the two variables in their effects on the propensity to create budget slack. A laboratory experiment by Young (1985) was the first in a series of agency theorybased studies examining the budget slack problem. This stream of research has focused primarily on the effects of truth-inducing (TI) incentive schemes,15 private information, and budgeting managers risk preferences on budget slack. Some of this research has investigated the performance implications as well as the slack effects of these factors. The results related to the performance effects of these factors are discussed in Section 4.0. Consistent with the agency theory concepts noted above, Young proposed a positive participation-slack relation for subjects working under a budget-based TI incentive scheme. In addition, subjects with private information were expected to include more slack in their budgets than subjects without private information. Young expected that as information

asymmetry (private information) decreases, budget slack would decrease because the budgeting manager feels more social pressure to disclose information and because the budgeting manager is aware that the superior can directly evaluate the level of slack in the budget. Young also proposed risk aversion would be positively related to budget slack because budget slack is created by managers as a protection against uncertainties that affect outcomes. Finally, Young argued that one tool available to the organization to prevent budgeting managers from misrepresenting their private information is social pressure, a behavioral factor which arises when budgeting managers believe that their true performance capabilities may become known to the organization. The mechanism for the latter effect relies on dissatisfaction that a budgeting manager is likely to feel at being viewed a shirker by superiors or coworkers. Implicitly, budgeting managers are assumed to find utility in being viewed as a hard worker and are willing to exchange some distasteful effort for that utility. Young found, as expected, that risk-aversion exacerbated the budget slack problem, and that social pressure was negatively related to slack.16 Young was unable to confirm a positive relation between the presence of private information and budget slack. Waller (1987) examined the joint effects of risk preferences and TI incentives on slack. All subjects participatively set budgets. Waller (1987) found that when a TI compensation contract was introduced, slack decreased for risk-neutral subjects, but not for risk-averse subjects.17 The incentive for truthful revelation provided by a TI contract was only effective under conditions of risk neutrality. In a similar study, Chow et al. (1988) found that slack was negatively related to TI compensation contracts, in the presence of private information. Chow et al. (1991) investigated some multi-period implications of TI incentives on slack. Repeated observations of subordinates performance is likely to allow a superior to make increasingly accurate assessments of their performance capabilities. Thus, a superior could directly limit budget slack by imposing a lower limit on the budget standard which could be increased in successive operating periods. They found that imposing such a ratchet (a minimum budget standard based on previous actual performance) and using a fixed-payplus-bonus incentive was as effective as a TI incentive at reducing slack once information on performance capability was developed. Waller and Bishop (1990) significantly extended this line of research by examining budget disclosures by managers when it affected their share of allocated resources. A Groves compensation scheme was examined (Groves and Loeb 1979). In this scheme, compensation is a function of a managers actual profit plus other managers budgeted profits. In a oneperiod setting and assuming risk neutral managers who do not collude, this model has been shown to motivate truthful budget disclosures and still maintain incentives for profit maximization given central managements resulting resource allocation decision. Waller and Bishop also examined a unit profit compensation scheme in which pay was linearly related to actual profit, and a unit profit-plus-penalty scheme which contains a large penalty for unfavorable profit variances. As expected, the unit profit scheme was the least effective at motivating truthful budget disclosures. Unexpectedly, the unit profit-plus-penalty scheme was more effective than the Groves scheme. Waller and Bishop speculated that the latter result may have reflected failed attempts at collusion by budgeting subjects or a poor understanding of the Groves scheme. They also examined consumption versus investment decisions by allowing subjects to exchange investable resources for immediate payouts and found that the unit profit-plus-penalty scheme was more effective than the Groves scheme at controlling unproductive resource consumption. Like Waller and Bishop (1990), Chow et al (1994) examined slack when budget disclosures affected managers share of allocated resources. They examined the truthinducing properties of a Groves compensation scheme and a unit profit scheme. Rather than a

unit profitplus- penalty scheme, however, as used in Waller and Bishop, Chow et al included a traditional TI incentive contract. Under Chow et als experiment, subjects budgeted profits at a vector of resource allocation levels. Misrepresentation of profits at the optimal resource allocation level was called direct misrepresentation and misrepresentation at suboptimal resource allocation levels was called indirect. Only direct misrepresentation becomes apparent, ex post, when budgeted profit levels are not achieved. As expected, the unit profit scheme was the least effective at limiting direct misrepresentation and only the Groves scheme was able to reduce indirect misrepresentation. Young et al. (1993) provided a different perspective on the slack problem. A series of interviews at firms using group-based incentive systems, revealed that a major reason for their use was to reduce slack. Central management was convinced that easily attainable standards were being chosen by their managers and they felt that group-based incentives would help to lessen the problem. Young et al. tested this supposition in a laboratory experiment. They posited that groups receiving feedback that they are always ahead in competition for group-based incentives will build in more slack than groups that receive negative or alternating negative and positive feedback because the always ahead group would become complacent. They found some support for the hypothesis across the successive periods of the experiment. 3.3 The Antecedents of Budget Participation Only two studies were found in the literature that explicitly examine the antecedents of budget participation (group 1 in figure 1). In a behavioral theory-based study, Licata et al. (1986) found that internal superiors (on the Locus of Control scale) were more willing to accept participation from subordinates. These results were linked to prior research demonstrating that internal subordinates performed better when participation was high. In an agency theory-based study, Shields and Young (1993) examined arguments that participations value arises from its potential to extract private decision-facilitating information from budgeting managers. They provided survey evidence that the demand for participative budgeting is positively related to the degree of information asymmetry between budgeting managers and their superiors. Thus, private information is an antecedent variable determining the use of budget participation in control. Shields and Young proposed a pathanalytic model to explain the participation-performance relation. They argued that information asymmetry generated the demand for participative budgeting, and in turn, participative budgeting was positively related to the use of budget-based incentives, which was ultimately related to firmwide performance. Their empirical results supported their model. However, it was not clear from their arguments why budgeting managers would honestly disclose their private information knowing that it would be used to set budget-based incentives. Another significant body of accounting research has studied the antecedents of budget participation in a wider control system context where budget participation is only one dimension of the control system. This research is described in Section 5.0 on the antecedents and consequences of individual and organizational factors in the design of control and budgeting systems. 3.4 Summary Evidence does not support a direct relation between participation and managerial performance. The participation-performance relation seems instead to be dependent in predictable ways on individual and organizational moderating factors. Several moderating factors have been empirically identified, including individual manager differences, such as locus of control and leadership style, and environmental uncertainty.

Research exploring the mechanism by which participation affects performance first focused on motivation. This relation has not had consistent empirical support, however, primarily because of a failure to consistently link participation and motivation. Despite support for a participation-motivation link in some research (e.g., Collins 1978; Merchant 1981; Searfoss 1976; Searfoss and Monczka 1973), other research has reported conflicting evidence (e.g., Brownell and McInnes 1986; Ferris 1977). Comparison across studies, however, has been difficult. Even though expectancy theory is usually used to operationally measure motivation, several variations of the expectancy model have been used in the literature. Some researchers, for example, have focused on both intrinsic and extrinsic dimensions of motivation, while others have focused only on one of the two dimensions. In addition, there is some question whether the expectancy model provides an adequate framework to link motivation to performance (see e.g., Mento et al. 1980). Kren (1990), for example, proposed that a combined model integrating both goal theory and expectancy theory concepts has greater potential to explain the participation performance link (Locke et al. 1981). Kren provided empirical evidence indicating that motivation was not directly related to performance. Instead, motivation affected an intervening variable, commitment to performance goals, and it was commitment to performance goals that acted to mobilize effort and increase persistence and thus was the most direct determinant of performance. As with behavioral theory research on RAPM, attempts to examine the motivational effects of budget participation seem to be hindered by the lack of an adequate theoretical foundation and the resulting ad-hoc theoretical development. As noted by Brownell and McInnes (1986), in the absence of adequate theory in which to ground hypotheses, it is not clear from the theoretical frameworks in the literature whether participation can be directly linked to performance as a causal factor or whether the causality is actually reversed. Perhaps it is not participation that causes budgeting managers to improve their performance, but rather it is that budgeting managers who perform well are allowed to participate. Moreover, in the absence of a cohesive theory, it is difficult to conceptually eliminate a third factor as a causal variable for both participation and performance. A positive and supportive corporate culture, for example, could lead simultaneously to both high performance and participative management (and participative budgeting). The cognitive effects of participation as a mechanism to explain the participationperformance relation has recently received more attention in the behavioral accounting literature. Results seem to indicate that the cognitive effects of budget participation are more consistent determinants of performance than motivational effects. An important component of these cognitive effects appears to be the acquisition and use by the subordinate of job-relevant information. Performance improvements then accrue from the subordinate managers betterinformed effort (Kren 1992b). Agency theory-based evidence is also consistent with behavioral survey research in suggesting that information sharing is an important benefit arising from budget participation. In contrast to behavioral theory, however, where participation provides an opportunity for budgeting managers to develop job-relevant information, participations value in an agency theory model is a function of its potential to motivate agents to disclose private information to the principal (Shields and Young 1993). The agency (and/or principal) then gains through improved resource allocation and more efficient incentive system design (Magee 1980; Christensen 1981; Baiman and Evans 1983; Penno 1984). Since the agents propensity to disclose private information is a function of the incentive system, the presence of private information is another incentive contracting problem in the organization. A substantial amount of evidence has been developed about the factors that motivate managers to reveal their private information, i.e., reduce budget slack. Early behavioral theory arguments of a negative relation between budget slack and budget participation have not held up under

empirical testing in the laboratory. However, evidence is more consistent that control system characteristics that enhance a superiors ability to monitor managers performance capability are negatively associated with slack. The evidence about the effects of budget emphasis on slack is mixed, with both positive and negative relations reported. One pervasive measurement problem with behavioral theory field research is that budget slack is a sensitive issue for most managers, so operational measurement has been difficult. Behavioral theory research has measured the propensity to create slack which may not be the same as the actual slack created by managers. Thus, measurement issues temper empirical conclusions reached from behavioral theory research. The results from laboratory experiments have been quite consistent in examining the slack phenomenon. Indications are that private information is positively related to slack, and that budgeting managers risk preferences moderate the relation. Recent evidence indicates that single-period, TI incentive models are useful for examining predictions about such managerial behavior as private information disclosure and risk preference, but they are not descriptive of slack behavior across multiple periods (Chow et al. 1991), when resource allocation decisions are explicitly considered (Waller and Bishop 1990; Chow et al 1994), and when behavioral factors such as social pressure are explicitly considered (Young 1985). Additional evidence in each of these three areas is acutely needed. The joint effects of behavioral factors and incentives remain puzzling. Some critics have noted that little progress has been made in the effort to integrate behavioral and economic theories of information disclosure (see Waller 1994 for a strong criticism along these lines). For example, even when information asymmetry and a slack-inducing pay scheme are present, subjects did not set slack at the maximum (i.e., zero budget), as suggested by agency theory. This may be a methodological artifact but it seems more likely to be caused by unidentified behavioral factors, perhaps related to social pressure (Young 1985). Clearly, it is another interesting phenomenon that deserves additional study. Accounting research could also benefit from a sharper delineation of the slack problem. Specifically, the question of how achievable budget targets should be has not really been addressed. The implied assumption in behavioral and agency theory-based research has been that all budget slack is undesirable (Waller 1994). Merchant and Manzoni (1989) and Merchant (1989), however, in their examination of budget targets found that eighty percent, or more, of profit center managers in their sample expected to achieve their budget goals. Thus, they evidently viewed their budget targets as relatively easy to achieve and some slack was apparently present in their budgets. Merchant and Manzoni concluded that both superiors and subordinates benefit from achievable budget targets. Achievable budgets are apparently desired by profit center managers for flexibility and responsiveness to environmental uncertainties. Superiors evidently allow achievable budgets (i.e., budget slack) to increase the predictability of earnings, reduce time spent on control of profit center operations, and reduce the risk of dysfunctional behavior by subordinate managers. Additional research in this area could yield immediate payoffs.
11

. Locus of control defines individuals along two dimensions: internal or external. Those classified as internals feel that reaching or failing to reach objectives is determined by their own actions, while external individuals feel that outcomes are determined by fate or forces beyond their control. 12 . Participation in which the superior has predetermined that the budgeting manager will have very little influence on the budget has been called pseudo-participation in the literature (Hopwood 1976; see also Cotton et al 1988). 13 . Organizational slack, in contrast to budget slack, occurs whenever resources used by an organization exceed the minimum dictated by optimization principles. Organizational slack is not necessarily detrimental to organizational success. It differs from budget slack in that it may be created by design for strategic purposes. For example, a firm may purposely maintain excess inventories with the goal of providing exceptional service to

its customers. Cyert and March (1963) also suggest that organizational slack serves a positive function by absorbing fluctuations in an uncertain environment. Thus, organizational slack is created when the organization is performing well and serves to prevent the development of unrealistic expectations. Conversely, organizational slack is used in poor times to maintain aspiration levels. 14 . While it may be unlikely that executive-level managers who have proven their propensity for hard work are unwilling to provide needed effort in an organization, shirking is more broadly defined in agency theory to include a variety of self-interested actions. As suggested by Kaplan and Atkinson (1989), for example, shirking may include refusal to engage in inconvenient travel or other time-consuming activities to develop strategic information for new investments, projects, or markets 15. An example of a truth-inducing incentive plan, often called the Soviet incentive plan, is the following (Weitzman 1976): R = w + k1XB + k2(X - XB) if X XB = w + k1XB - k3(X B - X) if X < X B Where R is compensation to the budgeting manager, w is a certain wage, X B is a target performance measure, X is the actual outcome, and k1, k2, and k3 are bonus coefficients setby the superior. If 0 < k2 < k1 < k3, there is incentive for the budgeting manager to set the standard equal to expected performance, i.e., to disclose private information by reducing budget slack. In contrast, if 0 < k1 < k2 < k3, the scheme provides incentive for the subordinate manager to set the standard at zero (X B = 0), i.e., induce slack. Raising k1 has the effect of inducing a less conservative (higher) budget; and relatively higher values for k2 and k3 have the opposite motivating effect. Finally, assuming that the marginal utility of compensation (k2) exceeds the marginal disutility from effort, the scheme will provide incentive for expending effort even after the budget has been achieved. Note, however, that to be effective, this scheme requires that real resources be transferred based only on a forecast (k 1 > 0) (Jennergren 1980). 16 . Young (1985) used a standard lottery to measure risk preferences. A subject is asked to specify the certainty equivalent of a lottery in which there is a probability (p) of winning rize. A and a probability (1-p) of winning prize B. Risk averse subjects will select a certainty equivalent that is less than the expected value of the lottery. 17 . Rather than using a conventional lottery technique to measure risk preference, as done by Young (1985), Waller (1987) induced risk preferences in his experiment. Subjects are given points as performance incentives. The points are accumulated to determine the probability of winning a certain payoff, so that more points increase the probability of winning. For risk-neutral subjects, the relationship between the number of points earned and the probability of winning is made linear, while for risk-averse subjects, the relationship is made non-linear (e.g., exponential). As long as the subject prefers the payoff to nothing, any utility function can be artificially imposed (Selto and Cooper 1990).