Using budgets for performance evaluation: effects of resource allocation and horizontal information asymmetry on budget proposals, budget slack, and performance.

Accounting Review,  October, 2002  by Joseph G. Fisher

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I. INTRODUCTION

Traditional budget-based compensation plans provide economic incentives for subordinate managers to misrepresent (understate) their productivity and build slack into budgets (Horngren et al. 2000, 185; Jensen 2001). Slack creates a bias in budgets and can reduce firm profits due to costly planning errors and greater compensation or perquisite consumption for subordinate managers. To mitigate budget slack, researchers developed "truth-inducing" compensation schemes (e.g., Weitzman 1976) that explicitly reward subordinates for the truthful revelation of their private information.

Empirical research documents that truth-inducing compensation schemes do reduce subordinates' misrepresentations of productivity and budget slack (see, e.g., Young ...