The Importance of Budgetary Integrity in Controlling a Non-Residual Income Organizations (NRIO) Administrator

Abstract

In this paper, we discuss the role of budgetary integrity, the role of monitoring execution of the budget and the role of incentive contracts based on the performance when the principal controls the administrator of an NRIO via analytical research based on agency theory. In addition, we examine complement or substitution of these roles. We assume additive separation of the principal’s utility function, and risk neutrality regarding goal achievement (outcome) and compensation payment. After assuming these simple conditions, we can analyze the utility function of the principal as residuals of outcome. Then, we can simplify a mathematical model. In addition, we model budgetary integrity as a psychological cost factor that may result in over- or under-budgeting.In this setting, we show that if the principal is able to observe the agent’s budget execution efforts, the agent execute the budget completely without budget integrity nor the incentive contracts. On the contrary, when the principal cannot observe budget execution effort, the agent never exceeds the best level of budget execution effort, and never exerts the best level unless budgetary integrity is infinity. In other words, it is optimal for the effort averse agent not to execute the entire budget. Moreover, to close to the best level of effort, the principal should offer incentive contracts based on ex post performance.However, we show that the incentive coefficient can be a decreasing function of budgetary integrity, and budgetary integrity antithetically impacts on each of the constituent elements of remuneration. On the other hand, we show that the higher budgetary integrity, the higher the utility of the principal. Therefore, if the ability is same, an agent with greater budgetary integrity is better for the principal.