A New Perspective on the Benefits of Slack Building Under Participative Budgeting

Abstract

In contrast to authoritative budgeting, participative budgeting may improve the superior's knowledge and increase the subordinate's motivation, but often comes at the costs of padding budgets and slack building. Consequently, most analytical studies identify slack as one of the major costs of participative budgeting that signifcantly reduce its benefits. Despite these research findings, participative budgeting is widely used in corporate practice. In this paper, we identify a beneficial effect of participative budgeting that has been neglected so far in analytical accounting research. In particular, we argue that slack might have benefits for the firm if the impact of participative budgeting on the firm's supply side is taken into account. We employ a tractable adverse selection model to capture the interactions between budgetary slack and decisions made inside the firm with the firm's choice of production quantity and the supplier's input price decision. We demonstrate that slack building induces an increase in the costs of production, but at the same time might soften supplier pricing. Overall, the interplay between frictions within the firm that are due to agency problems and the supplier's pricing response crucially affect the firm's choice of participative budgeting over authoritative budgeting. The main insight of our paper is that an exclusive focus on intra-firm aspects of budgeting might miss important effects of participative budgeting. It seems fruitful to consider the interaction between external stakeholders and a firm's budgeting approach in future empirical research.