Budgetary Slack

 

Globalization, intense business competition, the rapid development of information technology, and shorter product life cycles are some of the factors that transform business processes. Changes in business processes will also prompt changes to the budgeting process (Ahmad et al. 2003), which play an essential role in organizational planning and control. Budget is used as a basis for evaluating the actual performance of managers (Anthony and Govindarajan, 2009). Manager's achievement on budget targets may tell his performance. A manager who exceeds their budget target is usually rewarded with several forms of compensation to maintain success. Notwithstanding the incentives, unethical behavior may also arise if managers deliberately lower their budget targets to achieve the target quickly. 

The practice is designated as a budgetary slack. Some factors that promote budgetary slack are the uncertainty of achieving budget targets, the desire of managers to control organizational resources (Nouri 1994), and the existence of asymmetric information between superiors and subordinates (Young 1985; Dunk 1993; Faria and Silva 2013). Budgetary slack may result in the use of organizational resources to be inefficient and futile (Yuen 2004). 

Budgetary slack is necessary to investigate as it may be present in all kinds of organizations. There is always asymmetric information on subordinates who understand more about the company's operational conditions than their superiors (Lau and Eggleton 2003). Besides, budgetary slack also has a detrimental effect because the company must spend excess resources (compensation and other resource allocations) for the manager who has undermined his actual production capacity. 

Budgetary slacking, especially in the private sector, is interesting because there is no transparency in budget reports; hence it is difficult to detect. Earlier research has examined ways to reduce the practice of budgetary slacking through informal control (Chong and Ferdiansah 2011; Rodríguez and Naranjo-gil 2016) and formal control (Chen 2012; Yuen 2004). Chong and Ferdiansah (2011); Rodríguez and Naranjo-gil (2016) employed informal control of subordinates' trust in superiors to reduce budgetary slack. Formal control in the form of rewards and punishments may also reduce budgetary slack (Chen 2012; and Yuen 2004). 

Another effective formal control to reduce budgetary slack in private information conditions is the feedback control policy (Chong and Ferdiansah 2012). Feedback control policy requires subordinates to report their budget performance to superiors for evaluation. This control can reduce information asymmetry because superiors know their subordinates' capabilities so that budgetary slacking can be easily detected. However, previous research has not distinguished two types of impacts from feedback, namely, positive and negative feedback. Positive feedback contains information that shows that someone has exceeded a goal (Klein 1989) whereas negative feedback indicates weakness, wrong response, and failure to achieve goals (Finkelstein and Fishbach 2012).

Budgetary slack occurs when subordinates downplay their productive capabilities (Young 1985; Kren 2003; Hobson et al. 2011; Faria and Silva 2013) meanwhile allowed to determine work standards that will be used as a basis for evaluation (Young 1985). Productive capability is reduced to obtain budget targets more easily achieved as one intends to produce monetary rewards (bonuses) and non-monetary rewards (Joshi and Abdulla 1996; Douglas and Wier 2000). 

Various methods are applied to reduce productive capability by subordinates, for example by increasing cost estimates, reducing income estimates (Anthony and Govindarajan 2009; Hobson et al. 2011), reducing the estimated output of production (Hobson et al. 2011), and reducing the capability performance (Young 1985; Kren and Maiga 2007). The difference between subordinates 'best estimates and budget targets that are not in line with the subordinates' capabilities is budgetary slack. 

Some reasons for managers in making budgetary slack are to be evaluated positively (Joshi and Abdulla 1996; Stede 2000), pressure from superiors to achieve budget targets (Onsi 1973), the uncertainty of budget achievement (Onsi 1973; Nouri 1994; Libby 2003), and the desire to control resources (Lukka 1988; Nouri 1994). 

Budgetary slack must be avoided because it causes various adverse effects, such as not optimal profit. After all, the cost function is not minimized (Onsi 1973), company profits are reduced due to increased costs, compensation and additional consumption of subordinates (Fisher et al. 2002), an additional allocation of resources the fault (Douglas and Wier 2000; Lau and Eggleton 2003), the nonoptimal return on investment (Douglas and Wier 2000), and resources become useless and inefficient (Yuen 2004). 

Feedback is information about the performance of subordinates that is available both for superiors and subordinates in their work environment (Chen and Jones 2004). Feedback is one of the most critical factors to improve organizational effectiveness (Lingnan and Leung 2000) because feedback conveys the compatibility between the nature and quality of subordinate performance against the goals to be achieved by the organization (Erez 1977; Karl et al. 1993; Lingnan and Leung 2000; Finkelstein and Fishback 2012). Theories that explain how individuals regulate their behavior according to the feedback they receive are Control Theory (Carver and Scheiher 1979, 1990; Mesch et al. 1994; Klunger and DeNisi 1996; Philips et al. 1996; Vancouver et al. 2001; Sitzmann and Yeo 2013) and Self-Efficacy Theory (Bandura 1977, 1999; Wood and Bandura 1989; Nicklin and William 2011). 

Control Theory and Self-Efficacy Theory require individuals to compare feedback information and objectives to be achieved in evaluating performance. Both theories affirm that there is a mismatch if the feedback does not match the intended purpose. This mismatch will impact the sustainability of discrepancy production and discrepancy reduction, which play a role in motivation (Philips et al. 1996). Control Theory emphasizes reducing nonconformities, whereas self-efficacy theory highlights the sustainability of mismatching. 

Positive feedback contains information that shows that someone has exceeded his goals (Klein 1989). An individual will further expand the gap by maximizing the distance between objectives and standards if there is positive feedback (Klein 1989). The individual may try to set goals more than the standard rather than adjust to the standard or set goals higher than the previous best performance (Carver et al. 1979; Philips et al. 1996). 

Positive feedback, such as the manager being told that last year's performance was outstanding because it succeeded in achieving the budget target, is estimated to play a role in the context of budgetary slack. Self-Efficacy Theory emphasizes the sustainability of making a gap when feedback matches the goals. This theory states that positive feedback reflects a match between the feedback and the objectives to be achieved. 

This type of feedback may encourage managers to improve their goals and performance by increasing their budget targets, thus reducing the budgetary slack possibilities. Conversely, negative feedback is characterized by negative information that contains criticism thrown by superiors to discourage subordinates who have failed to achieve their budget targets (Zheng et al. 2013). 

This type of feedback affects weakness, wrong response, and failure to achieve goals (Finkelstein and Fishbach 2012). This type reflected a mismatch between the feedback with the objectives to be achieved. Negative feedback affects budgetary slack. As an illustration, negative feedback happens when a supervisor told the manager that their last year's performance was deficient because they failed to reach the target budget. According to Control Theory, individuals will reduce or change previous reference standards (Mesch et al. 1994), change behavior, or reject feedback (Klunger and DeNisi 1996). 

As a result, the manager will change or reduce the standard reference (budget target) before, reject negative feedback, or change his behavior, leading to budgetary slacking. Budgetary slack can occur when managers reject negative feedback by reducing reference standards (budget targets).