The Effect of Budget Authority and Budget Frame on Managerial Reporting and Welfare

Abstract

One principle use of budgets is to elicit private information from subordinates in order to allow superiors to make better decisions. However, self-interested subordinates may bias their budget reports for personal gain, thus reducing the value of their budget reports to superiors. We examine whether the framing of the budget request and who has authority to set the budget affect subordinates’ budget reports, budget levels, production, and subsequent welfare. Research and practice use various budget frames when subordinates are requested to submit budget information. In addition, firms structure the budget setting process in different ways. One key budget structure variable is which party has final authority to set the budget. As such, understanding how budget frames and budget authority affect subordinates’ behavior is important for interpreting the results of past research and informing practice. We find that the framing of the budget request does not affect subordinates’ budget reports. However, we find that who has authority to set the budget has a substantial impact on subordinates’ budget reports. Specifically, we find that subordinates’ reports are more accurate when subordinates have authority to set the budget than when superiors have this authority. Furthermore, many budgets are rejected by subordinates when superiors have authority to set the budget. As a result, in our setting, superiors’ welfare is greater when subordinates have authority to set the budget than when superiors have authority to set the budget. Our results suggest that superiors may be better off relying on subordinates’ non-pecuniary preferences instead of instituting formal controls in budget settings with information asymmetry.