The Effect of Endogenous Contract Selection on Budgetary Slack: An Experimental Examination of Trust, Distrust, and Trustworthiness.

• In Event: Employee Interactions in Management Accounting

Abstract

We examine the effect of endogenous contract selection on budgetary slack using two slack-inducing contracts found in the literature: a trust contract where the superior must accept the subordinate’s budget and a discretion contract where the superior can accept or reject the budget. Because neither contract incorporates a formal control for budgetary slack, we apply insights from both agency theory and social norm theory to develop our theoretical expectations. We hypothesize and find that budgetary slack is lower for both contracts when they are endogenously selected by the superior than when they are exogenously assigned. Consistent with our theoretical expectations, exit questionnaire responses suggest that selecting a trust contract signals trust and expectations of trustworthiness whereas selecting a discretion contract signals distrust and an increased willingness to enforce trustworthiness by rejecting unreasonable budgets. In contrast to experimental studies of formal controls, signaling distrust is optimal in our budgeting setting. In particular, the greatest level of efficiency is achieved when the superior endogenously selects the discretion contract, which yields the efficiency of the optimal hurdle contract prescribed under traditional agency assumptions.

Authors

• Jeremy Douthit, University of Arizona

• Steven Schwartz, State University of New York - Binghamton

• Douglas E Stevens, Georgia State University

• Richard A Young, Ohio State University