How Top‐down and Bottom‐up Budgeting Affect Budget Slack and Performance through Social and Economic Exchange

Abstract

This paper investigates the effects of a top‐down (TD) versus bottom‐up (BU) orientation in different stages of the budgetary target‐setting process on slack and managerial performance. We use social exchange theory to explain the outcomes of these alternative budgetary arrangements, and complement the traditional focus on budgetary participation in target setting with a process‐oriented perspective. We develop hypotheses predicting that TD and BU orientations in the subsequent stages of the budgeting process have different effects on managers’ exchange relationships with the firm, and their behavioural responses. Using survey evidence from German managers across 127 firms we find that a TD orientation in the issuance of guidelines enhances economic exchange and that a BU orientation in the development of the initial budget proposal enhances social exchange, which in turn are associated with reduced slack and higher performance, respectively.