Effects of Aggregation on Budgeting

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The Effects of Aggregation and Timing onBudgeting: An Experiment

Anthony D. Nikias

Texas A&M University–Kingsville

Steven T. Schwartz

Binghamton University, SUNY

Eric E. Spires

The Ohio State University

Jim R. Wollscheid

University of Arkansas at Fort Smith

Richard A. Young

The Ohio State University

ABSTRACT: We conduct an experiment to study the behavioral effect of aggregation

and timing on budgetary reports. Subordinates submit budgets to superiors regarding

two projects in a face-to-face setting. There are three treatments: 1 AGG, wherein

subordinates privately observe each project’s cost and submit one budget regarding the

aggregate cost of the two projects, 2 SEQ, wherein subordinates observe and submitindividual budgets sequentially, so are uncertain about the second-project cost when

they submit their first-project budget, and 3 DEL, wherein budgets are delayed, so that

subordinates observe both costs before providing individual budgets. In all treatments

superiors must approve the budget and subordinates can create more slack by submit-

ting a larger budget. Based on image management, guilt alleviation, and preferences

for honesty, we hypothesize that subordinates will 1 create more slack in AGG than in

the other two treatments, 2 create more slack in DEL than in SEQ, and 3 decrease

their slack creation from the first project to the second project more in SEQ than in DEL.

Our results generally support all three hypotheses. However, analysis of the results

does not support our a priori beliefs regarding the nonpecuniary motivations of subor-

dinates. We argue, a posteriori , that a likely explanation for our findings is that in-

creased

We thank John Dickhaut, Theresa Libby, Michael McKee, and workshop participants at the 2007 AAA Annual Meeting,ESA 2006 North American meeting, Binghamton University, SUNY, and Texas A&M University–Kingsville for helpfulcomments and suggestions. Financial assistance from the Texas A&M University–Kingsville, College of Business Admin-

istration Summer Accounting Research Program, is gratefully acknowledged.

BEHAVIORAL RESEARCH IN ACCOUNTING American Accounting AssociationVol. 22, No. 1 DOI: 10.2308/bria.2010.22.1.672010 pp. 67–83

Published Online: January 2010

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face-to-face interactions in SEQ and DEL cause subordinates to care more about the

welfare of the superior than in AGG. In general, the results indicate that frequent budget

interactions may provide control benefits to superiors.

Keywords: aggregation; budgeting; management control; timing.

Data Availability: The data obtained in this experiment are available from the first

author.

INTRODUCTION

Information asymmetry is at the core of most management control problems. Research in

management accounting has addressed this issue using both analytical and empirical methods.

Principal-agent analyses have investigated how to efficiently acquire and exploit accounting

information to minimize control costs e.g., Antle and Eppen 1985. Empirical studies have in-

vestigated similar questions while considering the effect of both pecuniary and nonpecuniary

motivations on behavior e.g., Evans et al. 2001. This study is of the latter type. We report on an

experiment designed to investigate the behavioral effects of aggregation and timing on budgeting

in a setting where information asymmetry induces a control problem.Accountants have long acknowledged that the degree of aggregation is an important aspect of

financial reporting both within the organization and to a firm’s absentee owners. Paton 1922

notes that “the summary balance sheet is not in itself a satisfactory unit” and he mentions several

more detailed reports that should accompany it. In a similar vein, the American Institute of

Certified Public Accountants AICPA 1975, in their Statement on Auditing Standards No. 5 on

fair presentation, notes “information … is classified and summarized in a reasonable manner, that

is neither too detailed nor too condensed.”1

In general, choosing the optimal degree of aggregation

calls for a balance between the amount of information made available and the ease of use.

With respect to budgeting, firms may choose to prepare budgets that allocate resources for an

entire quarter, a month, or a week. Similarly, budgets may be prepared for an entire division, a

department, or an individual transaction. In addition, budgets may be prepared or updated on a

timely basis as soon as any new information becomes available; alternatively, budgets may bedelayed until a large amount of new information is obtained and then combined into one budget.

In this sense, delay may be thought of as an enabler of aggregation, whereas instantaneous

reporting is by nature always disaggregated. More detailed and timelier budgeting procedures have

the potential to provide better information for planning, but involve added expenses due to the

time and effort associated with more detailed and timely budgets.

Our focus, however, is not on the planning aspects of budgeting per se, but rather on the

management control aspects of budgeting, or more specifically the potential for slack creation. We

define slack as the difference between resources provided by superiors and those needed for

operations. Subordinates may create slack by, for example, understating profitability or produc-

tivity. Subordinates may consume slack in the form of perquisites, lower effort, or even embezzle-

ment. Dunk and Nouri 1998 estimate that upward of 30 percent of operating expenses can be

attributed to slack; therefore, it is important that researchers address the effect of budget protocols,

including aggregation and timing, on the creation of budgetary slack.Various principal-agent models have been developed to study slack creation. Antle and Eppen

1985, using a one-subordinate, one-project capital budgeting setting, demonstrate that the supe-rior optimally commits to reject some profitable projects. That is, the superior trades off capital

1This viewpoint is maintained in the 1992 Statement on Auditing Standards No. 69, which superseded Statement No. 5.

68 Nikias, Schwartz, Spires, Wollscheid, and Young

Behavioral Research In Accounting Volume 22, Number 1, 2010American Accounting Association


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rationing with slack reduction. Antle et al. 1999 use a similar platform to analyze a one-subordinate, two-project capital budgeting setting. They show that the superior benefits from

bundling the projects together, in that the subordinate submits individual budgets for each project

simultaneously, and the superior compares the two budgets before deciding what to do with either

project. The benefit derives from the superior’s improved ability to trade off slack and capitalrationing.

Nikias et al. 2007 provide an extension. They demonstrate that aggregation of two potentialprojects into a single budget request also has benefits relative to separate requests, even though the

superior cannot distinguish the attributes of the individual projects and so cannot treat them

separately. Finally, Arya and Glover 2001 perform an analysis of timely versus delayed budget-

ing. They compare making the funding decision on each project in sequence as they arrive to thesubordinate with waiting until all projects have arrived. They find that under some parameteriza-tions, delay can reduce the cost of control. Altogether, these agency analyses suggest that aggre-

gation or delay of budgets may be useful.2

However, typical principal-agent analyses, while providing a rich theoretical framework, of-

ten fail to capture the full range of behavioral motivations. Experiments have shown that nonpe-

cuniary motivations such as inequity aversion Fehr and Schmidt 1999, honesty Luft 1997;Gneezy 2005, and reciprocity Berg et al. 1995 can have significant effects on behavior. Thesemotivations are relevant to the study of aggregation in budgeting because aggregation, in addition

to inducing statistical properties that provide theoretical benefits, can impact nonpecuniary moti-

vations through its effect on the perception of others’ behavior and intentions.3

An example of the real-world effect of aggregation in budgeting is found in the United States

defense budget of the 1980s. Initially, the build-up of the defense enjoyed wide popular support,

which included the procurement of multimillion-dollar tanks and aircraft. However, when inves-

tigators examined a more detailed budget and found that as part of a $32 million aircraft the

government had agreed to pay $659 for an ashtray, there was public outrage. The builder of the

aircraft offered to refund most of the money. Apparently, this was an effort by the builder to

maintain its image, as no law had been broken New York Times 1985.As a more mundane example, consider an employee who must organize several sales meet-

ings. He may be asked to prepare a budget regarding each meeting separately, in sequence. Werefer to this as sequential budgeting SEQ. Alternatively, he may be asked to aggregate the total

cost of the meetings into a single budget request, assuming that he has all the information at hand.

We refer to this as aggregate budgeting AGG. Finally, he may be asked to wait until he hasinformation on all meetings, and then make a separate budget request for each meeting. We refer

to this as delayed budgeting DEL. These are the three situations we investigate in the experi-ment, although in a somewhat more stylized, generic two-project setting.

We develop three hypotheses regarding the effects of aggregation and timing on budgeting.

First, we expect nonpecuniary motivations to lead to greater slack creation in AGG than in the

other two regimes. Aggregation allows subordinates to smooth high- and low-cost items in their

aggregate budgets, which can facilitate image management. Also, aggregation requires a single lie

or overstatement of cost, while disaggregated budgets can require two lies or overstatements to

attain the same amount of slack. This second aspect is relevant if individuals have distaste for

lying. Second, we expect slack creation to be greater in DEL than in SEQ. In DEL there is theability to better plan budget requests relative to SEQ. In addition, subordinates in DEL may view

2 The results of these analyses follow from the Central Limit Theorem, which states that distributions of means are tighterthan distributions of individual observations. A loose interpretation is the tighter distribution reduces the informationasymmetry between superior and subordinate, which is at the heart of most control problems.

3See Brown et al. 2009 on this point.

The Effects of Aggregation and Timing on Budgeting: An Experiment 69



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the situation as telling a single lie, because they make their decision on both projects simulta-

neously. Finally, within DEL and SEQ, it is possible that after an initial high-slack request sub-

ordinates will reduce slack creation in subsequent requests due to guilt, remorse, or a desire to

manage their image. Therefore, ceteris paribus, slack may decline from the first to the second

project. However, we expect a lesser decrease in slack from the first project to the second projectin DEL than in SEQ, due to subordinates’ better ability to manage their image and the general

reduced guilt in DEL.

Our results generally support our hypotheses. Slack is greater in AGG than in SEQ or DEL.

Slack is also greater in DEL than in SEQ. The difference in slack across projects is lower in DEL

than in SEQ, although this is attributable mainly to the first round of play. However, the data do

not strongly support any of our a priori rationales for the differences in slack. We conjecture, a

posteriori, that the results are primarily driven by greater concern for the superior’s welfare in

SEQ than in AGG and DEL, possibly due to subordinates adopting a more cooperative frame in

that treatment.

The remainder of this paper is organized as follows. The second section discusses background

literature and develops hypotheses, the third section outlines the experimental design, the fourth

section describes our results, and the fifth section discusses implications and conclusions.

BACKGROUND AND HYPOTHESES

Setting

The experimental setting closely resembles the model of Antle et al. 1999, wherein a

subordinate has better information than a superior regarding the profitability of two capital invest-

ment projects. The superior cannot audit project costs. The superior provides funds for investment,

and the subordinate cannot make up any shortfalls from his personal wealth. The subordinate’s

welfare is assumed to be increased by the difference between the amount funded by the superior

and the cost, which we refer to as slack. Unlike Antle et al. 1999, but similar to treatments found

in Evans et al. 2001 and Rankin et al. 2008, we assume the superior must fund all project

proposals. The purpose of this last assumption is to make honesty and other nonpecuniary moti-

vations salient to participants in the experiment.

Dunk and Nouri 1998, in their extensive review of the literature on budgetary slack, identify

information asymmetry and budget participation as two key drivers of slack creation. Further, they

cite studies claiming that slack detection by superiors can be difficult. Our setting captures these

important elements, in that 1 subordinates are better informed than superiors, 2 subordinateshave a taste for slack, 3 subordinates set the budget, and 4 ex post audits are not possible.Further, our experiment is designed to insulate our results from confounding factors such as

repeated play or market competition.

Behavioral Implications of Aggregation and Timing

In our experiment, a selfish and rational subordinate would submit a budget request so as to

create as much slack as feasible. While self-interest will undoubtedly explain much of the results,

it is not a complete descriptor of behavior. In this section, we present relevant additional theories

to explain why behavior might not conform to standard economic predictions, and how suchdeviations might vary across treatments. We then develop testable hypotheses.

Inequity Aversion

Researchers have theorized that individuals have preferences over how wealth is distributed

and have disutility for distributions they deem to be unfair Rabin 1993; Bolton 1991; Bolton andOckenfels 2000; Fehr and Schmidt 1999. The common feature of these theories is that individuals




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care not only about their own level of wealth, but also about their relative share. Individuals are

assumed to be willing to take costly actions to modify perceived-to-be-unfair distributions. Fair-

ness norms usually center on equal splits, but can also be affected by environmental factors such

as earned property rights and contextual clues Hoffman et al. 1994; Hoffman et al. 1996. In

addition, it is generally assumed that individuals are more averse to distributions of wealth if theyare unfair to themselves than if they are unfair to others.

If subordinates claim the maximum available slack, it results in highly inequitable distribu-

tions in favor of themselves. Therefore, inequity aversion argues for a deviation from purely

selfish behavior. Deviations from purely selfish behavior have been observed in many budgeting

settings, such as that in Evans et al. 2001 and Stevens 2002, and so we would expect the same

in our experiment. However, the degree of aggregation does not affect the potential distributions

of earnings, and therefore inequity aversion per se is not expected to be associated with the degree

of aggregation or timing.

Aversion to Lying

Almost all cultures view honesty as an ethically desirable trait Murphy 1993. A considerable

cognitive psychology literature has found that lies generally are considered reprehensible Lind-

skold and Walters 1983. Perhaps as a result, people often choose to be truthful, as long as it is nottoo costly. Luft 1997 theorizes that individuals trade off the pecuniary benefits of lying with thepsychic benefits of honesty, so that budgets may not be completely honest, but may also not be as

dishonest as pure selfishness would dictate. Evans et al. 2001, Hannan et al. 2006, and Rankinet al. 2008 all observe partially honest budgeting behavior. More importantly, Rankin et al.2008 demonstrate that honesty is relevant in budgeting, beyond what would be implied bysimple inequity aversion.

There is considerable evidence that individuals’ willingness to be honest is mediated by

fairness concerns. For example, when lying would result in a perceived unfair distribution of

wealth to others, participants show a greater tendency toward honesty Evans et al. 2001. Incontrast, when honesty would result in a perceived unfair distribution of wealth to themselves,

participants are generally more willing to lie Evans et al. 2001; Rankin et al. 2003. The concern

for fairness is a component of the more general concept of the consequences of lying Gneezy

2005. When deciding whether to lie, people are sensitive to how much the other party losesGneezy 2005. In our setting, self-interested budgeting would provide a very uneven distributionof wealth in favor of the superior. Therefore, we expect fairness concerns to contribute to honesty.

When budgets are aggregated, subordinates have to lie only once in order to create the desired

amount of slack. In contrast, when budgets are disaggregated subordinates may have to lie several

times to create that same amount of slack. If subordinates consider lying to be undesirable, more

slack may be created with aggregation than with disaggregation.4

With respect to delayed disag-

gregation relative to sequential disaggregation, the simultaneous cost observation occurring in a

delayed setting may cause the subordinates to act as if they are essentially making a single

decision, albeit a decision that encompasses several requests. This may alleviate some of the

disutility associated with lying relative to a sequential setting.

Image Management

Most people are concerned about the image they portray to others, and hence tend to managetheir image Hannan et al. 2006; Leary and Kowalski 1990. Because lying is viewed as undesir-

4 If the psychic costs of lying are directly proportional to size of the lie, then the hypothesized increase in lying withaggregation may not occur. If, however, the psychic costs of lying have a fixed component for each lie and a variablecomponent increasing in the size of the lie, our conjecture may hold, depending on the relative magnitudes of thecomponents.




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able but is also necessary to create slack, subordinates must balance image management with the

pecuniary incentives for dishonesty when choosing their budget. With respect to how image

management might interact with aggregation and delay, the most interesting case is when high

costs and low costs are jointly obtained. When budgets are aggregated, a subordinate may be able

to submit a moderate aggregate budget regarding the total cost to achieve a given level of slack and still not appear too greedy. However, with disaggregation the same level of slack will not be

achievable without submitting a high budget when the underlying cost is high. This is due to the

constraint that budgets may not be less than cost on a project-by-project basis. Therefore, the

subordinate would have to build in most of the slack on lower cost projects, reducing the potential

for image management. Delayed budgets offer some relief relative to sequential budgets, in that

with delay subordinates learn all project costs before they make their requests. Therefore, they

have some ability to smooth the budgets, despite the fact that their budgets must still not be less

than the cost.

Also of interest is the way in which image management affects budget requests across projects

when budgets are disaggregated. Subordinates may try to repair a potentially damaged image from

initial high budget requests with a lower budget request on later projects. After securing slack with

an earlier budget, subordinates can submit a lower request for a later project, with the intent of

improving their image. Although this effect should be present whether disaggregation is sequential

or delayed, subordinates using sequential disaggregation are uncertain about later projects and

may protect themselves with higher requests for earlier projects.5

With delay, subordinates need

not guard against unforeseen cost outcomes.

Guilt Alleviation

Tangney et al. 1996 examine individuals’ feelings of guilt, which might result from inter-personal interactions involving lying as well as other transgressions such as cheating, stealing, and

failing to help others. Guilt resulting from the effects of one’s actions and behavior is also likely

to cause feelings of remorse and empathy for others. Feelings of guilt and remorse can be caused

by moral reasoning resulting from disapproval and dishonor of one’s actions by others Kohlberg1969; Jones 1991; therefore, subordinates may make reparations for high requests by reducing

their requests on later projects. Alternatively, lying potentially breaks down the psychological

barriers to further lying, causing it to seem less morally wrong and reprehensible to the subordi-nate Bok 1978. If lying regarding the first-project cost breaks down psychological barriers todoing so for later projects, subordinates might be less concerned with the superior’s welfare when

submitting later requests.

Hypotheses

Slack across Projects in SEQ and DEL

We now present hypotheses that are specific to our experiment. Our first hypothesis, which

relates only to sequential SEQ and delayed DEL budgeting settings, concerns the difference inslack that may be created between first- and second-project funding decisions. Our background

discussion suggests that three factors might cause slack creation to decline across projects and that

this effect would be greater in SEQ settings. First, subordinates may desire to manage their image

by reducing slack across projects to mend an unfavorable impression caused by a high budgetregarding the first project. This rationale is true for both SEQ and DEL settings. Second, if

5 In contrast, in a setting where requests are made in sequence, subordinates might anticipate that high costs for laterprojects would constrain their image management efforts by forcing them to budget high amounts, in which case theymight create less slack for earlier projects. We would expect that the risk of not securing enough slack would outweighthis effect.




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subordinates submit a high budget for the first project, guilt may ensue. Subordinates in SEQ may

attempt to alleviate this guilt by submitting a relatively lower budget for the second project.6

However, because subordinates in DEL see costs of both projects simultaneously, they might view

the two budgets as a single reporting decision and thus not be affected as much by guilt or

remorse. Third, in SEQ there is uncertainty about the second project at the time subordinatessubmit their first-project budget. If subordinates in SEQ have a target in mind for how much slack

they wish to acquire, they may submit a higher budget request for the first project to guard against

a high second-project cost. This last effect would clearly not be present in DEL. One contrary

argument is lying about the first project may break down a psychological barrier to lying about the

second. Overall, our discussion supports the expectation that slack will decline across projects

within SEQ and DEL settings and that the decline will be greater in SEQ than in DEL settings.

However, due to possible confounding factors we test only the between-treatment effect.7

H1: The decrease in slack between the first and second projects will be greater in sequential

SEQ than in delayed DEL budgeting settings.

Slack across Treatments

Our second set of hypotheses regards the overall slack creation across the three treatments. In

general, our discussion leads to the expectation that slack will be greater in aggregate AGG

budgeting settings than in sequential SEQ and delayed DEL budgeting settings. Specifically,

AGG settings allow subordinates to more easily hide their slack creation for the purposes of image

management. Further, if subordinates are averse to lying, the fact that they need lie only once in

an AGG setting should increase slack creation.

We also expect greater slack in DEL than in SEQ settings, because in DEL subordinates can

plan their budgets more easily, smoothing the reports so as to acquire the desired amount of slack

while reducing the likelihood of having to submit very high budgets for any particular project.

Also, by observing costs and planning their budgets simultaneously, subordinates in DEL may feel

as if they are lying only once, thereby reducing the nonpecuniary costs of lying. Our second set of

hypotheses is as follows.

H2a: Slack creation will be greater in aggregate AGG than in sequential SEQ budgetingsettings.

H2b: Slack creation will be greater in aggregate AGG than in delayed DEL budgetingsettings.

H2c: Slack creation will be greater in delayed DEL than in sequential SEQ budgetingsettings.

EXPERIMENTAL DESIGN

A 1 3 AGG, SEQ, and DEL experimental design was used to examine the effects of aggregation and timing of budgets on subordinates’ slack creation behavior. Participants were

6In our experiment, superior/subordinate interaction is face-to-face and a given subordinate is never paired with the samesuperior for more than one round. The only opportunity for a subordinate to alleviate guilt with a given superior is toreport a lower cost for the second project in the round.

7 In four of the five rounds the costs decreased across projects. If our measure of slack systematically varied with the costoutcomes, cost outcomes could be a confounding factor for within-treatment tests. Hence, within-treatment tests areomitted. However, because costs were identical across treatments, we test differences in the mean of the decline betweentreatments.




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recruited from upper-level business courses of a medium-sized public university to participate in

one of the three treatments and were randomly assigned to the role of either superior or subordi-

nate. After receiving the instructions available from the authors, participants completed a shortquiz to ensure they understood the task and compensation procedures. At the end of the experi-

mental sessions, participants completed a post-experimental questionnaire see the Appendix.A total of 112 participants 56 pairs were recruited for six sessions. Each session lasted

between one-and-one-half and two hours. The experimental design and number of participants in

each treatment are summarized in Table 1. Participants interacted in a face-to-face setting over five

rounds, where each round involved two projects.8

A turnpike design was used in which no superior

and subordinate were paired more than once, to mitigate contamination of the results from cross-

round effects. Participants were informed that they would not be paired with the same person more

than once.

To control for differences in risk attitudes, participants were compensated according to the

procedures in Berg et al. 1986. Risk preferences of the subordinate were not a factor in the AGG

and DEL treatments, because the subordinate knew both costs prior to submitting budget requests.

However, risk preferences were an important consideration in SEQ, because the subordinates did

not learn the cost of the second project until after submitting their first-project budget. Procedures

to induce risk neutrality were used in all three treatments. A linear transformation converted a

participant’s earnings into a probability of winning the higher of two cash prizes. Each participant

played one lottery, to reduce any procedural effects that might be present between the AGG, SEQ,

and DEL treatments.9

Participants were assigned the role of either Player 1 superior or Player 2 subordinate,which they kept throughout the experiment. Player 1 was the residual claimant of an investment

project. The revenues of the project, which went to Player 1, were common knowledge and fixed

at 60. Player 2 privately observed the cost, which was an integer drawn from a uniform distribu-

tion on 11, 12,…,50. Then Player 2 submitted a budget to Player 1. The instructions made it clearto Player 2 that submitting a budget constituted making a factual assertion to Player 1 about the

cost. Therefore, any deviation from the actual cost should have been interpreted as a lie by the

participants.

8 Not only is face-to-face interaction common between superior and subordinate within many organizations, but it alsogreatly heightens the relevance of impression or image management Bohnet and Frey 1999a, 1999b.

9 Each participant’s earnings were converted to a probability of winning a lottery based on the maximum points eachparticipant could have earned. Participants received $20 if they won the lottery and $10 if they lost.

TABLE 1

Experimental Design

TreatmentCost

Observation Budget Format#

Participants

AGG simultaneous aggregate 40

SEQ sequential individual 36

DEL simultaneous individual 36

AGG Aggregate Treatment;

SEQ Sequential Treatment; and

DEL Delayed Treatment.




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Player 1 was required to fund the project at a level equal to Player 2’s budget. Player 2

received as slack the difference between funds provided and the actual cost. The only constraint on

Player 2’s budget was it could not be less than the actual cost or greater than 50. Player 1 received

60 minus the budget. Player 2 received an efficiency wage of five experimental points per round

in addition to the slack.10 Each round consisted of two projects, where the second project’s cost

was drawn independently from the first.11

The procedures specific to each treatment are described

below.

Simultaneous Cost Observation and Single Aggregate Budget (AGG)

In the AGG treatment Player 2 observed the cost of each project simultaneously. Player 2 then

submitted an aggregate budget. The aggregate budget could not be below the total cost of both

projects nor above 100. Player 2 consumed as slack the difference between the aggregate budget

and the total actual cost for both projects combined.

Sequential Cost Observation and Two Individual Budgets (SEQ)

In the SEQ treatment Player 2 observed the cost for the first project and submitted the first

budget, before observing the cost for the second project and submitting the second budget. Each

budget was constrained in that it could neither be less than the actual cost nor greater than 50.

Simultaneous Cost Observation and Two Individual Budgets (DEL)

In the DEL treatment Player 2 observed the cost for both projects simultaneously. Player 2

then submitted separate budgets corresponding to each project, with the constraint that each

budget could neither be less than the actual cost nor greater than 50.

RESULTS

Slack Creation across Projects in SEQ and DEL (H1)

We begin by examining the slack creation for the first and second projects of SEQ and DEL.Our metric of interest, similar to that used by Evans et al. 2001, is as follows.

Proportion of Slack Retained PSR =budget − actual cost

50 − actual cost

The numerator of PSR is the amount of slack the subordinate secured via the budget. The denomi-

nator is the total slack available to the subordinate.12

Note the maximum allowable budget was 50.

Therefore, this ratio represents the proportion of available slack that was actually consumed by the

10 Similar to the situation in Rankin et al. 2008, were we not to provide an efficiency wage to the subordinates, there

would have been severe tension between the subordinates’ desire to be fair to themselves and their desire to be honestand fair to the superiors. Therefore, to better observe the nonpecuniary motivations of interest we provided an efficiencywage to the subordinates.

11Similar to Hannan et al. 2006, the cost draws were made in advance so that all participants in all treatments receivedthe same costs. A few sequences of costs were discarded before arriving at the sequence used because they containedseveral extreme outcomes. Participants were only told the cost for each project was randomly and independentlydistributed. The cost draws used in rounds 1 through 5 were 31, 27, 26, 29, 43, 35, 24, 12 and 36, 13,respectively.

12PSR is undefined if the actual cost equals 50, but no such instances occurred in our experiment.




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subordinate. This measure is analogous to those used in dictator games, where researchers are

interested in the percent of available surplus consumed by the dictator. 13

PSR means, medians, and standard deviations by treatment are displayed in Table 2. Mean

median PSR for the first and second project within SEQ were 0.582 0.565 and 0.486 0.444,

respectively. For DEL, mean median PSR for the first and second project were 0.706 0.691 and0.696 0.738, respectively. To test H1, we subtracted participants’ mean first-project PSR from

their mean second-project PSR, producing one observation for each participant in SEQ and DEL.

We then performed a two-sample t-test, which showed a significant difference one-tailed p 0.034 in the direction predicted in H1.14

In the previous section we provided two potential explanations for why the decrease in slack

across projects would be greater in SEQ than in DEL: the lack of uncertainty in DEL and the

reduced guilt in DEL that comes with making a single decision. To provide insight into whether

either of the explanations may be descriptive, we provide in Table 3 PSR means for each project,

by round, for SEQ and DEL. For Rounds 1, 2, 4, and 5, the differences in slack across projects

between SEQ and DEL are in the hypothesized direction, but only significantly so in Round 1

one-tailed p 0.05. Thus, support for H1 is modest.Further, although guilt may diminish over time as subordinates gain comfort with their re-

porting choices, there is no reason to expect the effects of uncertainty to dissipate. However, only

13Although metrics similar to PSR are commonly used, they are not without defect. For example, if subordinates were toview slack in absolute rather than proportionate terms, PSR may not capture their motivations. To assess the sensitivityof our results to the use of PSR, we also tested the hypotheses using Level of Slack Retained LSR, defined as reportedcost actual cost. Results for LSR are reported in footnotes.

14 Using LSR in SEQ, mean slack was 10.4 13.1 from the first second project, an increase of 2.7. In DEL, mean slack was 12.4 19.2 from the first second project, an increase of 6.8. Consistent with H1, the mean increase in SEQ wasless than in DEL one-tailed p 0.01, using the two-sample t-test described in the text.

TABLE 2

Proportion of Slack Retained

SEQ DEL AGG

Project 1

Mean .582 .706 NA

Median .565 .691

Std. Dev. .219 .208

Project 2Mean .486 .696 NA

Median .444 .738

Std. Dev. .280 .220

All Projects

Mean .534 .701 .798

Median .506 .707 .906

Std. Dev. .239 .205 .288

SEQ Sequential Treatment;

DEL Delayed Treatment; and

AGG Aggregate Treatment.




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in the first round is there any evidence of a difference in across-project budgets between SEQ and

DEL. Therefore, it appears unlikely that uncertainty was a major factor in our results.

Instead, the pattern of results in Table 3 suggests that SEQ participants experienced disutility

from lying about the first project in Round 1 that they wished to avoid in the future. After the first

project in Round 1, where they procured about 75 percent of the available slack, subordinates in

SEQ lowered the amount of available slack they procured to approximately 50 percent and con-

tinued doing so for the remainder of the experiment. In DEL, there is some suggestion of a

reduction in lying between the first and second projects of the first round, though of a much lesserdegree than in SEQ. We used a post-experiment questionnaire to provide further evidence on

participant motivations such as this see the Appendix. Specifically, subordinates in SEQ andDEL were asked to rate the importance of their first-project budget in deciding their second-

project budget. The mean responses in SEQ and DEL were 3 and 2.8 out of 5, respectively, which

do not significantly differ from each other.

Slack Creation across Treatments (H2a, H2b, and H2c)

Hypothesis 2 examines differences in the overall PSR across the AGG, SEQ, and DEL treat-

ments. The mean median PSR, where projects are pooled, as shown in Table 2, was 0.5340.506, 0.701 0.707, and 0.798 0.906 in the SEQ, DEL, and AGG treatments, respectively.15

These differences, for both means and medians, are in the directions predicted in H2: AGG SEQ

H2a, AGG DEL H2b, and DEL SEQ H2c. The t-tests of mean differences yielded thefollowing all p-values are for one-tailed tests: t36 3.07, p 0.01 for AGG SEQ, t36 1.20, p 0.12 for AGG DEL, and t34 2.24, p 0.02 for DEL SEQ. A Wilcoxon-Mann-Whitney rank-sum test of differences in medians yielded the following all p-values are for

15 The large difference between mean and median PSR for AGG is due to one participant who had a PSR equal tozero—this participant never lied.

TABLE 3

Proportion of Slack Retained by Round

Round

1

Round

2

Round

3

Round

4

Round

5

SEQ

Project 1 .751 .528 .579 .528 .524

Project 1 .486 .569 .411 .518 .449

Project 2 Project 1 .265 .041 .168 .010 .075

DEL

Project 1 .702 .671 .762 .665 .730

Project 2 .652 .714 .582 .734 .796

Project 2 Project 1 .050 .043 .180 .069 .066

AGG

Both Projects .805 .877 .750 .756 .801

Cell entries are means.

SEQ

Sequential Treatment;DEL Delayed Treatment; and

AGG Aggregate Treatment.




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one-tailed tests: p 0.01 for AGG SEQ, p 0.03 for AGG DEL, and p 0.01 for DEL

SEQ. These results support H2a, H2b, and H2c, although the support for H2b AGG versus

DEL is only moderate.16

The lowest PSR highest degree of honesty occurred in SEQ and the highest PSR occurred in

AGG. The mean PSR in the SEQ treatment was close to 0.50, a commonly considered notion of a fair distribution of wealth, whereas the PSR in AGG was approximately 0.80, a result similar to

that found in generic dictator games. One explanation we offered for the differences across treat-

ments was subordinates could more easily appear to be honest in AGG than in DEL and SEQ. If

this were driving the results, we should find evidence that participants in AGG tried not to appear

too dishonest in their budgets. However, of the 100 budgets in the AGG treatment 20 subordinates

with five rounds of decisions each, 46 budgets were equal to the maximum of 100—superiors in

these cases knew with virtual certainty that the subordinates were lying.17

In addition, 14 of the 20

subordinates submitted a budget of 100 in at least one round. For purposes of comparison, in 16

of the 90 rounds in DEL subordinates budgeted 50 for both projects, with five of 18 subordinates

budgeting 50 for each project for at least one round. In SEQ the incidences were even rarer: five

of 90 and two of 18, respectively.18

This evidence suggests that subordinates in AGG were not

using aggregate budgeting to appear honest, contrary to our conjectures.19

We also expected that knowing both costs in advance would allow subordinates in DEL to

manage their image by smoothing their budgets, relative to subordinates in SEQ. That is, subor-

dinates in DEL could create more slack without seeming more selfish than subordinates in SEQ.

We measured smoothing as the absolute value of the difference between first- and second-project

budgets. Table 4 presents these data. Budgets in DEL were smoother on average than those in SEQ

for all rounds. The mean was significantly smaller i.e., smoother budgets for DEL, t34 2.27,

two-tailed p 0.03. Therefore, to some degree the subordinates’ desire to smooth the budget

might be responsible for the observed results.20 That is, image management may have been a

factor, but mainly in DEL.

Supplementary Analysis

The above analyses indicate that of our three rationales aversion to lying, image manage-

ment, and guilt alleviation to explain differences across treatments, only image management hassupport, but it is weak. Perhaps the lack of evidence of aversion to lying and guilt alleviationderives from subordinates not viewing misreporting as morally reprehensible. Jensen 2003, 386contends that lying about budgets and costs is expected of responsible managers and “almost no

one in this system consciously believes that he or she is lying or behaving without integrity.” If the

participants in our study believed that misreporting costs is expected behavior in a budgeting

context, they may not have had any reason to hide their misrepresentation or feel guilty. Our lack

of evidence of guilt also is consistent with the findings of Charness and Dufwenberg 2006. They

16Using LSR, t-tests of means showed AGG SEQ p .01, AGG DEL p .135, and DEL SEQ p .013.These are virtually the same as the tests of means using PSR.

17 The probability of both cost draws equaling 50 for a given round is 0.000625.18

A chi-square test showed the difference in frequencies 14/20 versus 5/18 versus 2/18 to be significant 22 = 15.1, p

0.001. Follow-up tests indicated that AGG differed significantly from the other two treatments.19 It is conceivable that the differential rate of extreme lying across treatments is due to our assignment of individuals totreatments, rather than the treatments themselves. To assess the effects of this on our hypotheses tests, we reran thet-tests and Wilcoxon tests after deleting subordinates with extreme observations i.e., mean PSR 0.95 or 0.05;there were eight of 20, three of 18, and two of 18 participants so deleted in AGG, DEL, and SEQ, respectively. Tests of the hypotheses are virtually unchanged. One-tailed p-values for the t- Wilcoxon test for H2a, H2b, and H2c were 0.0020.002, 0.195 0.023, and 0.018 0.01, respectively.

20 The nature of the simultaneous cost observation in DEL may in and of itself induce smoothing, if it causes subordinatesto view budgets in a comparative manner Hsee and Leclerc 1998.




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observe that one of the primary causes of guilt is failing to meet the expectations of others. In our

study it would be very difficult for subordinates to assess the expectations of superiors and

therefore it is unlikely guilt would ensue.

A post hoc explanation for our results is the treatments induced different frames for the

subordinates. Prior experiments in similar settings, such as dictator games, have shown that par-

ticipant behavior is very sensitive to environmental variations. In our experiment subordinatesexperienced greater face-to-face exposure to superiors in SEQ and DEL relative to AGG. In SEQ

and DEL subordinates submitted a budget regarding the first project, perhaps receiving nonverbal

responses, and then submitted their second-project budget. In AGG subordinates submitted only

one budget to superiors. This may have induced subordinates in SEQ and DEL to have greater

empathy for superiors, increasing other-regarding behavior. In other words, the SEQ and DEL

treatments may have evoked more of a “cooperate” frame than AGG. Pinkley 1990 and Pinkleyand Northcraft 1994 identify “win-orientation” versus “cooperate-orientation” as one determi-nant of behavior in bargaining situations. These orientations can be induced by the particular way

a scenario is presented, sometimes in very subtle ways. For example, Neale et al. 1987 report

that assignment of roles such as “buyer” and “seller” can induce different frames. It is possible

that the repeated face-to-face interaction with the same superior in SEQ and DEL induced a more

cooperative frame. Further, DEL may be considered a sort of intermediate case. Although subor-

dinates faced the superior twice, they had the ability to make their decisions at a single instance,before the effects of empathy would have taken hold.

The responses related to Question 2 of the post-experimental questionnaire support the notion

that subordinates may have framed the situations differently in the three treatments see theAppendix. Subordinates were asked to rate the importance of superior’s earnings to their budget-ing decisions 5 extremely; 1 not at all. The mean responses were 3.2, 2.5, and 2.6 in SEQ,

AGG, and DEL, respectively. Using t-tests, the mean response in SEQ was significantly greater

TABLE 4

Smoothness of Budgets for SEQ and DEL

SEQ DEL

Round 1 7.67 6.33

Std. Dev. 6.15 5.71

Round 2 4.28 3.67

Std. Dev. 6.17 4.33

Round 3 6.67 4.83

Std. Dev. 4.54 4.49

Round 4 9.06 4.72

Std. Dev. 6.47 4.90

Round 5 13.94 5.89

Std. Dev. 10.10 6.49

Mean 8.32 5.09

Standard Deviation by participant 4.64 3.86

Dependent variable is |first-project budget second-project budget|.Cell values are means standard deviations of the dependent variable.

Lower values are associated with smoother budgets.

SEQ Sequential Treatment; and

DEL Delayed Treatment.




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than that in AGG two-tailed p 0.05, and moderately significantly greater than in DEL two-

tailed p 0.10. The means for DEL and AGG did not differ significantly from each other, and

this may reflect the “single decision” aspect of DEL. In general, these results support the notion

that subordinates cared less about superiors’ welfare in AGG and DEL than in SEQ, which is

characteristic of a win-orientation Pinkley 1990.21

IMPLICATIONS AND CONCLUSIONS

We conducted an experiment on the effect of aggregation and timing on budgets in a setting

of information asymmetry. Information asymmetries are of first-order importance to the

information-gathering activities that necessarily attach to budgeting behavior Antle and Felling-ham 1997. Therefore, our study has the potential to significantly add to our understanding of

budgeting.

In our experiment participants observed and reported the costs of two capital investment

projects. The participants observed and reported the costs sequentially, reported the costs sepa-

rately but delayed reporting until both costs were observed, or observed the costs simultaneously

and reported them in aggregate. The first two treatments are a form of disaggregated reporting,

while the third is a form of aggregated reporting.The main findings of our experiment are as follows.

1. Slack creation was less for disaggregated budgeting than for aggregated budgeting.

2. Slack creation was less for sequential budgeting of costs than for delayed budgeting of

costs.

3. The difference in slack creation across projects was approximately the same for both

sequential and delayed budgeting systems, with the exception of the first round, in which

the decrease in slack was larger for sequential cost observation.

Formal principal-agent analyses using assumptions of selfish rationality have shown the su-

perior’s expected utility may be greater under an aggregate or a batch-process budgeting system

than under a sequential budgeting system. These analyses exploit the statistical properties of

aggregation and batch processing and the superior’s ability to make commitments to reduce slack.

In contrast, our experiment found that a disaggregated, sequential system led to less slack than the

alternatives. By design, our results can be ascribed only to behavioral motivations beyond rational

selfishness. Our work is consistent with the call by Brown et al. 2009 to focus experimentalbudgeting research on the tensions between the traditional economic assumptions and alternative

theories of behavior.

Although the experiment confirmed our expectations regarding the direction of the treatment

effects, the evidence does not support our a priori reasoning. Instead, it appears that subordinates

had a higher regard for the superior’s welfare in SEQ than in AGG, possibly due to a more

cooperative frame, and this contributed to the lower slack. Our interpretation of the results sug-

gests several practical implications of our study.

First, our experiment suggests that frequent interaction with subordinates may develop em-

pathy with the superior’s goals and needs. One could argue by extension that there may be costs

associated with budgeting through less personal media such as video conferencing and electronicmessaging, as opposed to face-to-face meetings. Second, it suggests that image management, in

21 We also examined whether a difference in reporting behavior existed among participants that scored higher on thepre-experimental quiz using a regression with mean proportion of slack as the independent variable and quiz score as thedependent variable. We found no significant relationship when either all questions or only those pertaining to thecompensation procedures were included.




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and of itself, may not be as important as previously thought, especially if the interaction is of a

one-shot nature. This differs from our earlier discussion of the defense budgets, where disaggre-

gation into relatively simple components caused many to be mystified regarding the high price of

ashtrays and hammers, which modified the behavior of some defense contractors. However, this is

not truly a one-shot setting, as contractors and legislators face their constituencies often. We mightsurmise that in the repeated settings that characterize most intra-firm budgeting interactions, both

image management and empathy are relevant. Finally, the results of our experiment suggest that

requesting frequent updates may have control benefits by denying subordinates the opportunity to

hide slack consumption.

Our experiment has several limitations. First, we considered only two projects, while in many

circumstances several projects might be available for aggregation. Second, as mentioned above,

some real-world situations may not be accurately portrayed as one-shot settings. Finally, our

post-experimental questionnaire was geared toward our a priori rationales for expected behavior.

Simple extensions of our experiment would investigate increasing the number of available projects

for aggregation, having participants interact repeatedly, and designing post-experimental question-

naires to provide more evidence on our a posteriori explanations such as increased empathy.

One may be tempted to interpret our results as emerging from a zero-sum game where only

the relative wealth of superior and subordinate is in question. However, viewed in a larger context,

the creation of slack is often wasteful and productively inefficient, in which case slack reduction

should be viewed as providing a social benefit. A recent newspaper article on one of the more

notorious perquisites, the corporate jet, quoted a consultant who had studied the purchase of

corporate jets as saying, “The corporate jet is a money-loser” Adams 2008. A more formal studyby Yermack 2006 found that not only is corporate jet use wasteful, but that it may be indicative

of a pattern of heavy perquisite consumption that reduces firm value. The implication of these

studies is that perquisite consumption is inefficient and its restriction could increase overall soci-

etal well-being, not just the superior’s wealth.

APPENDIX

SUBORDINATE QUESTIONNAIRE FOR SEQUENTIALAND DELAYED TREATMENTS

Please circle one

1. How important was the number of points you would receive to your decision of choosing

a cost report?

1 2 3 4 5

Not Not Somewhat Very Extremely

at all very

2. How important was the number of points Player 1 would receive to your decision of

choosing a cost report?

1 2 3 4 5


at all very

3. How important was the actual cost of the project to your decision of choosing a cost

report?




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1 2 3 4 5


at all very

4. How important was the cost you reported in the first period to your decision of choosinga cost report in the second period?

1 2 3 4 5


at all very

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