Question

2. Budgeting. In reference to the paper, Beyond Budgeting or Budgeting

reconsidered…Libby and Lindsay, Four criticisms of budgeting were highlighted
(takes too much time, impedes adaptability, disconnected with strategy, unreliable
performance measurement), discuss these four (4) criticisms and what their survey
findings indicated.

Answer 1

Solution:-

Criticism 1: budgets take too much time to prepare:-

We asked respondents to indicate how many weeks the annual formalized budgeting process takes to complete in their business unit (FIRM WEEKS). Table 3 (Panel A) shows that the median response in the Canadian sample for FIRM WEEKS was 6 weeks (std. dev. = 4.7; n = 102). About 30% of firms took 4 weeks or less to prepare the budget while 31% took 9–16 weeks and about 5% took more than 16 weeks. In the US sample, median firm weeks to budget were somewhat higher at about 10 weeks (std. dev. = 6.6; n = 77).7

Survey respondents were also asked to indicate the amount of time the average manager spent on budgetrelated tasks in a year (e.g., developing the budget, revisions, reports, variance analysis).

The time spent on budgeting may be driven by the extent of detail required and the number and level of people involved in preparing the budget. We describe this construct as “touch” in budgeting and measure it by asking respondents to indicate the extent of effort and involvement managers in their business unit devote to developing budgets (TOUCH). The scale was anchored from 1 (light) to 5 (heavy)

We correlated the degree of touch in budgeting (TOUCH) with the time managers spend on budgeting (MANAGER TIME) as well as the total number of weeks it takes the business unit to prepare the budget (FIRM WEEKS). As one might expect, the correlation was positive in the Canadian sample for MANAGER TIME (r = 0.19, p < .01, n = 104) and FIRM WEEKS (r = 0.39, p < .01, n = 104).9 The results are qualitatively similar in the US sample.

Criticism 2: budgets impede adaptability

Hope and Fraser (2003a) assert that the new competitive environment is characterized by unpredictability; prices and margins are constantly under pressure, product life cycles are shorter and customer tastes are fickle. This situation leads to the importance of becoming adaptable and flexible. They argue that budgeting is antagonistic to these requirements because, once set, budgets are not typically changed resulting in plans and targets that quickly become out of date.

To explore this assertion, we asked respondents how easy it is when setting the budget to anticipate or predict changes in the external environment for the budget period. We adapted this measure from Govindarajan (1984) and Umapathy (1987). The scale ranged from 1 (easy to predict) to 6 (impossible to predict). Table 3 (Panel B) shows that the median response for this scale, called PREDICTABILITY, was 2.8 in the Canadian sample (std. dev. = 0.7; n = 110) and 3.0 in the US sample (std. dev. = 0.6; n = 78). These scores fall at the “somewhat” predictable anchor on the scale.

We explored this matter further in the US survey by asking respondents to indicate their degree of agreement with the statement “It is difficult to set accurate budgets because of the unpredictability of factors influencing the business.” Fifty-four percent of respondents at least ‘somewhat agreed’ with this statement and 24% “agreed” or “strongly agreed” with it. The correlation between responses to this statement and PREDICTABILITY was .34 (p < 0.01). Second, we asked whether “Budgets quickly become obsolete or outdated as the year goes by.” Sixty-five percent of respondents at least “somewhat agreed” with this statement and 40% “agreed” or “strongly agreed” with it. The correlation between responses to this statement and PREDICTABILITY was .23 (p < .05). These findings suggest that Hope and Fraser’s (2003) assumption that the business environment is unpredictable, resulting in budgets quickly becoming out of date, seems valid for a significant number of firms, but it would be a mistake to generalize it to the majority.

In conclusion, Hope and Fraser’s (2003b) assumption that firms’ competitive environment is characterized by unpredictability is valid for many firms in our sample, although the claim is over-generalized. Additionally, our results lend support to their assertion that the budgeting process is potentially weak in helping firms deal with adapting to change; however, firms appear to adjust budget targets in various ways to mitigate this concern and adopt processes to obtain new resources outside of the budget process when necessary.

Criticism 3: budgets are disconnected from firm strategy

Kaplan and Norton (2001) observe that the majority of firms they have worked with fail to link their budgeting systems to achieving strategic objectives. Hope and Fraser (2003b) also share the view that budgets are typically prepared in isolation from, and not aligned with strategy. To investigate this issue, we asked survey respondents whether “The budgeting process is explicitly linked to achieving strategic objectives/targets.” We designate this variable LINKAGE. Table 3 (Panel C) shows the median score for LINKAGE was 5 (somewhat agree) in the Canadian sample (std. dev. = 1.6; n = 133). Untabulated results suggest that approximately 11% of the sample disagrees that the budget process is explicitly linked to achieving strategic objectives (a rating of 1 or 2 on the LINKAGE scale) while 48% agree (a rating of 6 or 7 on the LINKAGE scale). We observed qualitatively similar results in the US sample.

Second, we asked respondents to indicate their degree of agreement with three statements drawn from Kaplan and Norton (2001) concerning the degree to which budgets are linked to strategy implementation within their business unit. These statements consisted of: (i) “Setting the budget causes us to talk about and reflect upon our strategy”; (ii) “We sometimes change our strategy/tactics based on the feedback derived from going through the budgeting process”; and (iii) “Within the budget process, managers are expected to identify tactical initiatives to close the gap between current performance and the desired level of performance.”We averaged respondents’ agreement scores on these three items to create ameasure of the degree to which budgets were linked to strategy implementation. Table 3 (Panel C) shows the median score on this measure was 5.7 (std. dev. = 1.4; n = 133) in the Canadian sample. This median score falls between the anchors “somewhat agree” and “agree” using a seven point scale. Untabulated results indicate that approximately 67% of the Canadian sample reported at least “somewhat agreeing” that concrete steps were being taken to link the budgeting process to strategy implementation.11 We observed similar results in the US sample.

In conclusion, these results indicate that that the criticism that budgets are not linked to strategy is unfounded for the majority of firms in our two samples. The budgeting process is used in many firms to promote strategically focused behavior and is recognized as being an important mechanism for doing so.

Criticism 4: the use of budgets as fixed performance contracts

Hope and Fraser’s (2003b) most strident criticism is that budgets often serve as a “fixed performance contract.” Implicitly or explicitly, the nature of this contract is that if actual performance meets or exceeds a pre-specified budget target, performance will be deemed satisfactory (or better) and this will likely result in rewards. Hope and Fraser (2003a,b) argue that a fixed target represents a poor standard for performance evaluation when factors underlying the budget may have changed during the budget period. Further, this inevitably leads to budgetary gaming by subordinates to increase the probability of receiving positive performance evaluations and associated pay increases (see also Welch, 2005)—a process Jensen (2003) refers to as “paying people to lie.” We undertook a number of analyses to investigate this criticism.

Performance evaluation. We asked respondents to rate the degree of emphasis placed on meeting budget targets in the performance evaluation process using a scale adapted from Van der Stede (2001). Table 3 (Panel D) shows that 52% of Canadian respondents and 71% of US respondents indicate that budget emphasis is high.13 For this group of respondents, we examined the prevalence of the use of fixed performance contracts. Our results indicate that only 12% of respondents in the Canadian high-budget-emphasis group and 17% of respondents in the US high-budgetemphasis group report that actual financial performance is rigidly compared against the pre-established budget target with no allowance for changes occurring in the competitive environment during the year.

These results indicate that budgetary gaming is prevalent, consistent with the writings of Bart (1988), Jensen (2001) and Hope and Fraser (2003a,b). In fact, only 5 and 1% of the respondents in the Canadian and US samples, respectively, reported no incidences across the five gaming activities examined. However, what is not so well known is whether such behaviors actually impair long-run organizational performance. To examine this issue, we correlated the degree of budget GAMING with its perceived negative effect on long-run performance of the business unit (NEGLRP). The observed correlation is r = .28 (p < .001; n = 133) in Canada and r = .56 (p < .001; n = 78) for the US respondents. These results suggest that increases in gaming are perceived to negatively impact long-run business unit performance.