Question

*Emphasize on dysfunctional consequences associated with traditional annual budget (fixed performance budget) in tying managerial rewards to budget performance*

Answer 1

The use of the budget as a fixed performance contract leads to unreliable performance evaluation and promotes budget gaming. This criticism relates to the assertion of budgets as a means that encourage gaming and
perverse behaviours. According to Hope and Fraser, organizations that use budgets usually set targets on the basis of financial numbers that, more often than not, are negotiated between superiors and subordinates before the start of the year. The numbers are fixed for the year ahead and represent the key component of the “annual
fixed performance contract”. Rewards are then linked to a fixed outcome agreed to in advance. Managers know (and supposedly therefore accept) that this element of the budget contract leads to gaming. Gaming is a commonly recurring phenomenon in relation to the budget process. However, it is not the budget process itself that is the root cause of the counterproductive actions; rather, it is the use of budget targets to determine compensation.

When managers are told they will get bonuses if they reach specific performance goals, two things inevitably happen. First, they attempt to set low targets that are easily achievable. Then, once the targets are in place, they do
whatever it takes to ensure that they hit them, even if the company suffers as a result. The latter has been evident in several studies which have found that the budget pressure facing managers leads to dysfunctional and manipulative
behaviour such as

• pulling income from the subsequent year by delaying expenditures,
• accelerating sales or by shifting funds between account

Such studies indicate that management incentives coupled to budgets and/or the felt pressure to achieve budget targets are factors that correlate with the degree of manipulative behaviour, especially in relatively uncertain environments.