Budget Difficulty and Performance in Unstable Production Environments

Abstract

Budgets serve an important role in motivating employee performance. We examine how the difficulty of meeting a budget target (“budget difficulty”) and the stability of the budget environment affect performance. We use a controlled experiment where employee-participants perform a task under incentivized budgets. The budget is either stable, with a constant difficulty, or unstable, with difficulty occasionally increasing from the typical difficulty to a high difficulty level. We find that performance is higher in unstable than stable environments and is higher when the typical budget difficulty is moderate rather than low. Further, we find that learning in unstable environments is greater when the typical budget difficulty is moderate rather than low. This yields greater preparedness for – and greater performance in – unstable periods with heightened difficulty. We contribute to the debate regarding the usefulness of budgets by highlighting benefits of fixed budget targets under environmental uncertainty: increased performance and learning.