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AYB321 Lecture Notes - Schlumberger, Radical Change, Ikea

2 pages78 viewsSpring 2012

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Lecture 5: Budgeting Systems (Part 2)
The goal is an ‘accurate’ budget.
If the budget is inaccurate:
o Targets are too easy (or hard)
o Firms have too much (or little) capacity
o Value is destroyed.
Behavioural Issues in Budgeting
Participative budgeting
Refers to the level of involvement lower level managers have in setting their own budget.
Two extremes:
o ‘Top-down’ budgeting
o ‘Bottom-up budgeting
Advantages of budget participation:
o Uses managers’ specific knowledge
o Encourages communication and
coordination between managers
o Creates ‘ownership’ of the final budget
o Slow
o Opens the firm up to influence costs,
especially when budget performance is
tied to the reward system.
o Budgetary slack
Budgetary Slack
Difference between the projection a person provides and a realistic estimate.
Three main reasons for budget padding by BU managers:
o Seen to be performing better if they ‘beat the budget’.
o Provides a shield against unanticipated negative impacts (reduces risk).
o Expectation of arbitrary budget cuts by the budget committee.
Tying rewards to the budget increases the perverse incentive, impacts budget integrity.
Overcoming this problem is not easy. Four possible solutions:
o De-emphasise the importance of meeting budget.
o Wider range of objective indicators (the ‘informativeness principle’).
o Design an incentive scheme that rewards not only the achievement of the budget, but also for providing
accurate budget projections.
o Get rid of budgets
Budgetary Difficulty
Budget difficulty refers to how difficult it is expected to be to achieve the budget.
Setting the budget at the right level of difficulty is challenging:
o Too easy = little incentive to improve productivity
o Too difficult = BU manager is likely to just ‘give up’.
Problem exacerbated by information asymmetry.
Targets that are challenging but achievable are often referred to as ‘stretch targets’.
Characteristics of effective target setting include:
o Targets are set participatively;
o Targets are seen to be achievable;
o Frequent performance feedback is provided;
o Employees are only held responsible for activities they control; and
o Achievement of the target is tied to the reward system.
Criticisms of Budgeting and ‘Beyond Budgeting’
These behavioural issues lead to many criticisms of traditional budgeting approaches:
o Encourages politics and game-playing (influence costs).
o Incremental thinking, thus stifling creativity and transformational change.
o Approval process is too centralised, thus ignoring dispersed specific knowledge.
o Budget ‘cuts’ focus on cost reduction at the expense of growth and value creation.
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