Research On Budgetary Slack Governance From A Contract Perspective

Budget as one of major instrument of management control had played a very important role in the practice of internal management control since 1980s of the 20th century in China. However, budgetary slack, a behavior of underestimating revenues and outputs or overestimating costs and resources by subordination, is still a problem which has not been effectively resolved. The economic consquences of budgetary slack is evident, such as an inconsistent between planning and controlling, the lack of standard for incentives designing and the breaking down of optimization of resource allocation. It is very popularization in the practice of budget control for Chinese enterprise. The crucial reason in that it is affected by conflicts of interest, measurement and incentive and management control system of organization. Planning and controlling as the major function of budget would not be harmonized as a result of budgetary slack, in turn, the effect of budget management would be lower.Theory is a forerunner for practice. By reviewing and summarizing the existing literatures, we can find that the theory research and practice had been for a long time and some fruit had been come into being, In China, some researchers and managers is paying more attention to the problem of budgetary slack. However, the theory of budgetary slack governnance has been scattered for a long time, and lacked a consistent theory framework used to research into its nature, causes and government. So the effectiveness of budgetary slack government is low.So the dissertation should see the essence beneath budgetary slack firstly. Second, the reason that why it would happen should be found. Finally, the dissertation could provide some ways to govern it. Budgetary slack is the behavior of subordination in firm. So, we can find some answers from the nature of firm. The nature of modern firm is a set of contracts which is composed of manager, shareholders, employees, creditors and customers. The contributions and entitlements of various agents are different. But a common fact is that there is an interest divergence between them. Adverse selection and moral hazard is the familiar behavior of both parties of contracts.From the perspective of contracts, we could see budgetary management as a set of contracts. In the dissertation we call these contracts is budgetary contracts which is composed of superior and subordination of firm. The content of budgetary contracts is the input, output, cost, efficient and compensation ec at. Planning contracts and controlling contracts are the most structure of budgetary contracts. There is an interest divergence between Superior and subordination too. In the process of contracting, not only the advantage of information possessed by subordination, but also the conflict between planning contracts and controlling contracts, subordination has an incentive to make opportunism behavior..Therefore, the connotation of budgetary slack is a behavior of underestimating revenues and outputs or overestimateing costs and resources by subordination which result in the information of planning contracts is lack of percise and the information of control contracts is lack of objectivity. As a result, the function of planning and control is to break down. The nature of budgetary slack is a behavior of hidden information of moral hazard by subordination who had private information. The crucial reason in that the conflict of planning contracts and controlling contracts owning to asymmetric information and interest conflict.As a result, the research perspective is the concept of contracts and the foundation of theory is contract theory. But how to apply contract theory that is comprehensive to research the problem of budgetary slack also is a difficult task. As we known, incentive mechanism which is designed to harmonize the conflict of interest between agent and principle is consistent with the core idea of contract theory. So, according to the thread of contract theory which is composed of complete contract and incomplete contract, we see explicit incentive mechanism and implicit incentive mechanism as a core of theory that make up of the foundation of theory of this dissertation.Building up a budgetary slack governance framwork follow by applying contract theory to resolve the problem of budgetary slack is not only the core of this dissertation but also a basic theory for further research. Fistly, the connotation of budgetary slack governance is made as follows:the content of budgetary slack governance was composed of connotation, nature, reasons, consequences and governance of budgetary slack governance; the aim of budgetary slack governance is to make a balance between restraint of budgetary slack and incentive; the ways of budgetary slack governance was composed of compensation contract based on risk preference, compensation contract based on relative informatin and reputation. Secondly, based on budgetary contratcs, the dissertation made a analysis for form and nature of budgetary slack. Thirdly, the dissertation made a analysis for reasons and consequences for budgetary slack. Lastly, the ways of budgetary slack governance was made.Heretofore, the research system about budgetary slack governance from a perspective of contracts was build up. The next task for this dissertation is to make an experiment study to test theory. The reason that why the method of experimental study was used as follow. First, experiment study is the most popular and effective method for budgetary slack for researcher; Second, the variable and environment such as risk preference and information asymmetry could be controlled effectively by experiment study and the outcome is credible. Third, owning to the archives data was not acquired, experiment study could remedy the limitation.The remainder of the dissertation is to make an experimental study for the ways of budgetary slack governance followeds by an restruction of model and hypothesis. First, the effects of risk preference and compensation contract on budgetary slack was test by experimental study; Second, we use experiment study to test how the effect of ratchet effect and relative performance on budget slack; Third, the effect of budget control tightness and reputation on budget slack. We can draw some inclusions as follows:First, the relationship between risk preference and budgetary slack will vary with differential compensation contract. Under the truth-induce compensation contract, the relationship will be positive correlation. Under the slack-induce compensation contract, it will be negative correlation. When subordination is risk averse, truth-induce compensation would be ineffective for restrain the behavior of budgetary slack.Second, by incorporating relative performance information into truth-induce compensation contract, we can reduce budgetary slack of risk-averse subordination, meanwhile, the relationship between budgetary slack and insurance provided by the relative performance information is positive; furthermore, the effect on incentive depended on whether the cost of insurance exceed the net income of maximized-performance, the relationship between them is negative.Third, if superior made a commitment of a participative budgeting or discretionary compensation to subordinates based on a reputation of budget reliable, it could low budget slack significantly in participative budgeting. Furthermore, making a commitment to participative budget may be cost effective substitutes for more expensive incentive contracting and a tight control in order to low budget slack. Further, making an accurate measurement of reputation and taking advantage of participative budgeting could enhance the effect of commitment to participative budgeting on budget slack.The foundation of Research and conclusion made by prior researcher play an important role in the dissertation. However, in order to enrich and improver past research and make contribution to practice, the important task for the dissertation is to innovate. So the innovation of the dissertation as follows:First, from a perspective of contracts, the connotation of budgetary contracts and functions, the connotation and nature of budgetary slack, the connotation of budgetary slack governance is made followed by analysis the conflict of planning contracts and controlling contracts which is composed of structure and function of budgetary contracts. So, the frame of reference for budgetary slack research is provided and governance framwork from a perspective of contracts was made.Second, the dissertation lays the foundation for designing compensation contracts by test the effect of risk preference on budgetary slack. The results show that the relationship between risk preference and budgetary slack will vary with differential compensation contract. Furthermore, When subordination is risk averse, truth-induce compensation would be ineffective for restrain the behavior of budgetary slack.Third, we build up an new truth-induce compensation by incorporating relative performance information into truth-induce compensation. It not only restrains the behavior of budgetary slack but also keeps incentive effectively when subordination is risk averse.Fourth, from a perspective of commitment of a participative budgeting made by superior, we enrich the mechanism of how reputation would be used to restrain the behavior of budgetary slack. In the dissertation, we build up a new measurement of reputation of budgetary credible by relative performance information. The results show that making a commitment to participative budget may be cost effective substitutes for more expensive incentive contracting and a tight control in order to low budget slack.According to the nature of firm is a set of contracts, we made the research for budgetary slack based on contracts theory. The research road is the nature of budgetary slack followed by reasons, effect and governance. The research is not only a representation of forerunner but also a direction for practice.However, owning to the limitation of ability, the research for budgetary slack from an perspective of contracts is a try. So there are some limitations in the dissertation. For example, budgetary slack may not only a problem with incentive and conflict of interest. Other variables such as organization structure, strategic decisions, corporation governance and culture may produce some effect on budgetary slack. Meanwhile, budgetary slack may be an outcome of psychology and behavior. As a result, the future research would be how to integrate contracts theory with theory of psychology and sociology to find new sights and create more complete and valid explanations of the causes and effects of budgeting practices.