The Effect of Participative Budgeting on Performance-to-Goal

Abstract

Despite continued popularity of participative budgeting, prior studies in this area resort to proprietary survey data, laboratory experimental evidence, or data from single firms with multi-business units due to a lack of detailed information related to participative budgeting. Using a sample of 633 firm-year observations from S&P 1500 firms for fiscal years 2009 to 2011, I examine the relation between the use of participative budgeting and performance-to-goal. First, I find that the performance-to-goal of participative budgeting firms is higher than that of non-participative budgeting firms. Second, I investigate whether higher performance-to-goal is driven by motivational effects or slack building activities triggered by participative budgeting. I decompose performance-to-goal into effort level and budgetary slack using analysts’ forecasts as the benchmark to show that motivational effects dominate and result in higher performance-to-goal for participative budgeting firms. Overall, this study reaffirms the continued popularity of participative budgeting in a budget-setting process.